>Indian Hotels Sector: Operational Recovery Not Enough; Sector Still Expensive

■ Good occupancy recovery, but still way below peak levels — Average occupancy across 11 key cities is up a healthy 68% as of Jan’10 (vs. 65% in 3QFY10 and 58% in Jan’09)...but still far below peak levels of 79% in Jan’08. While we expect this to pick up further to 72-73% levels in FY11 with business and tourist traffic picking up; increased room supply will however limit upside.

■ Negative trajectory for ARR growth continues — Most players are concentrating on getting occupancy/traffic back with a focus on attractive pricing – ARRs decline of 21% YoY as of Jan'10 despite healthy recovery in occupancy levels underscores this. With impending room-supply, competition intensifying, we do not see ARRs going back to the peak rates in the medium-long term.

■ New room supply to cap RevPar upside — Industry grapevine expects ~15,600 new rooms to get operational across all segments in 2010 – this is ~15% of India’s total room inventory; 45% being targeted in key 5-cities of Bangalore, Pune, Mumbai, Chennai and NCR (has >6,000 rooms under construction). Though we expect occupancy levels to pick-up further, given likely supply and tariff pressures due to competition, we believe RevPar upside is limited.

■ Global hotel players more aggressive than domestic peers on room supply — Global chains are expected to add 300+ properties (est. ~55,000 rooms), investing ~$11bn in India by 2013. Marriott, Hyatt, Hilton are likely to be more aggressive than most domestic peers who have slowed expansions due to capital/leverage constraints.

■ Valuations rich — Its 3-mth relative underperformance to Sensex and volatility, explains our val concerns - reiterate our cautious outlook on the sector. Though earnings recovery is expected to continue in FY11 – we believe sector valuations (25x FY11PE, 15.6x FY11EV/EVITDA) already disc this. Indian Hotels is relativelybetter as an asset play, but believe valuations are not compelling at 2.1x P/BV.

To read the full report: HOTELS SECTOR