>INDIAN HOTELS SECTOR (CITI)

■ We reiterate our cautious view — Hotel stocks have outperformed Sensex by 22% over the last 3 months; we see more downside potential than upside. Current valuations look to discount strong recovery in FY11E (close to peak EBITDA of FY08) and ignore dismal low occupancy of 53% (down 11%), 21% fall in ARRs for 1HFY10; and risks of competition and supply overhang.

■ Expensive on PE, EV/EBITDA; not cheap on P/B either —The sector is trading at 24.5x FY11 PE, 16.6x FY11 EV/EBITDA, much above the 5-yr historic median of 22x PE and 15x EV/EBITDA, and at a significant premium to Sensex. On P/B, it’s not cheap either, trading at ~1.8x. India Hotels looks a good relative asset play, but valuations are not compelling yet at 1.9x P/BV.

■ Some pick-up in Occupancy, but not enough — Occupancies at 57% in Sept’09 (vs.53% in 1H) and expectations of a further 2H pick-up (better business season) are not enough for operating leverage to play out, we believe, as the risk remains this falls short of threshold occupancy levels of ~65% on an annual basis. Furthermore, with a 21% YoY decline in ARRs, and key Mumbai properties still not operational, we see higher risks of earnings disappointment.

■ Reducing estimates, but TP raised — With a dismal 2Q, and despite building in higher occupancy for 2H, we cut EPS for FY10-11E. Our TPs rise however as we roll 1-yr-frwd PEs to 17-18x (vs. 11-14x) at a premium to Sensex (15x), recognizing op lev potential and preference for asset plays; but this is at a discount to the sector median, given near-term earnings uncertainty.

■ Likely catalyst — 1) potential capital raising/stake sale, 2) significantly higher insurance claim on settlement for loss of profit (in case of IH and EIH); and 3) sharp YoY growth off a low base in 4QFY10, though partly priced in.

To read the full report: HOTELS SECTOR