Hotels - Check in. Key investment rationale

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1 Sector Report Company - Hotel Industry Report January 21, 2008 FOR PRIVATE CIRCULATION Awadhesh Garg awadhesh.garg@kotak.com Hotels - Check in We believe that strong economic growth, increased business and sports activities, medical tourism and increasing foreign tourist arrival to India would be key growth drivers in the next two to three years. Our recent discussions with industry leaders indicate that pricing power for the industry would last at-least for the next two to three years. While robust economic growth is the key driver, we believe that in most key destinations pricing power will be with the industry given limited additions in pipeline till FY10. We initiate our coverage on Indian Hotels and Hotel Leela with BUY recommendation with price target of Rs.180 and Rs.84 respectively. Companies covered Indian Hotels Company Ltd Hotel Leela Venture Ltd Key investment rationale Buoyant economy and rising tourist arrivals. We believe, a buoyant economy, strong growth in foreign tourist arrival and, probably, most importantly, efforts to communicate the brand India message (through Incredible India campaign) will continue to fuel demand for hotels across star categories in a majority of leisure and commercial markets. India s hotel industry is increasingly being viewed as a worthy investment, both within the country and outside. Niche segments such as medical tourism, culture tourism, the great Indian temple circuit, yoga and ayurveda are likely to grow rapidly. We expect foreign tourist arrivals into India to grow at 12-15% CAGR over the next five years. This is likely to reach 10 mn in India-bound tourism likely to grow 7.9% CAGR during World Travel & Trade Council (WTTC) estimates that India-bound tourism will grow at 7.9% CAGR during , which would make India the third most rapidly growing tourism market in the world after Montenegro and China. Currently, India has a 0.9% share of the global travel and tourism market, which is expected to go up to 1.2% in the next five years. Medical tourism - Immense potential. Health tourism in India has emerged strongly over the last few years and is expected to grow due to its strong value proposition on cost, quality and services. We believe that, in this segment, tourists to India will comprise (1) uninsured individuals from developed countries where the cost of tertiary care is significantly higher, and (2) individuals from developing countries who come to India due to lack of adequate healthcare in their home country. The tourism factor is also seen as an influence on people s decisions to travel to India for healthcare services. Demand-Supply imbalance to continue in short-to-medium term. While the hotel industry has announced significant capacity additions in the past few years, typically long gestation periods are likely to prolong the current scarcity of rooms well into Further, rising real estate prices in metros and Tier- II cities have been pushing project costs of hotels upwards, which have raised questions on the sustainability and feasibility of the projects. We believe this may delay some of the announced hotel projects. Risks and concerns. (1) Potentially significant capacity/room addition across the key cities over the next four to five years (2) Slowdown in the economy and/or terrorism threat from neighboring country may impact tourist inflow (3) Competition from international players and shortage of trained manpower. Valuation summary (Valuation based on FY09 earning estimates) Company Price EPS P/E P/B EV/EBITDA RoE EBITDA NPM Target (Rs) (Rs) (x) (x) (x) (%) (%) (%) (Rs) Indian Hotels Co. Ltd Hotel Leelaventure Ltd Source: Registered Office: Kotak Securities Limited, Bakhtawar, 1st floor, 229 Nariman Point, Mumbai India.

2 INDUSTRY OUTLOOK Strong economic growth, increased business and sports activities and medical tourism likely to be key growth drivers Foreign tourist arrivals to India likely to grow at 12-15% CAGR over the next five years The hospitality boom in India has been led not only by the buoyancy in the Indian economy but also by the demand-supply mismatch for rooms that currently exists in major cities. We have a very favorable view on the hospitality industry and expect the hotel industry to perform well over the next three to four years. We believe that strong economic growth, increased business and sports activities, medical tourism and increasing foreign tourist arrival to India would be key growth drivers in the next two to three years. However, in the long term, several new hotels will start operating in major cities (Annexure - 1), which will more than double the room capacity and reduce the pricing power of the industry players. Our recent discussions with industry leaders indicate that pricing power for the industry would last at-least for the next two to three years. While robust economic growth is the key driver, we believe that in most key destinations pricing power will be with the industry given limited additions in pipeline till FY10. Buoyant economy & rising tourist arrivals to drive sector We believe, a buoyant economy, strong growth in foreign tourist arrival and, probably, most importantly, efforts to communicate the brand India message (through 'Incredible India' campaign) will continue to fuel demand for hotels across star categories in a majority of leisure and commercial markets. India's hotel industry is increasingly being viewed as a worthy investment, both within the country and outside. The economy has grown strongly at 9.4% during This has been led by a rise in industrial and services sector activities, which have exhibited double-digit growth. Increase in tourist arrivals and visits, medical tourism, augmentation of telecommunication services, escalated development in IT and IT enabled services (ITeS) and sharp momentum in financial services sector has kept the services sector buoyant in recent years. Buoyant manufacturing growth has kept the industrial sector buoyant. Niche segments such as medical tourism, culture tourism, the great Indian temple circuit, yoga and ayurveda are likely to grow rapidly. We expect foreign tourist arrivals into India to grow at 12-15% CAGR over the next five years. This is likely to reach 10 mn in Tourist arrival in India 12 9 Tourist (mn - LHS) Growth (% - RHS) E 2012E Source: Ministry of Tourism Sector Report - Hotel Industry Please see the disclaimer on the last page For Private Circulation 2

3 India-bound tourism likely to grow 7.9% CAGR during World Travel & Trade Council (WTTC) estimates that India-bound tourism will grow at 7.9% CAGR during , which would make India the third most rapidly growing tourism market in the world after Montenegro and China. Currently, India has a 0.9% share of the global travel and tourism market, which is expected to go up to 1.2% in the next five years. However, we believe a long-term sustainable growth of the industry depends on how successfully several issues are addressed - relating to old and poorly facilitated airports, poor roads and transport infrastructure, high levels of taxation, a bureaucratic visa processing system and timely execution of new projects. The Budget has proposed an outlay of approximately Rs.5.7 bn for the development of tourism infrastructure in , up 35% from Rs.4.23 bn proposed in Travel & Tourism Demand Growth Country % annualised Real Growth China 9.1 Montenegro 8.6 India 7.9 Croatia 7.8 Dem Pep of the Congo 7.8 Vietnam 7.5 Romania 7.4 Namibia 7.1 Hong Kong 7.0 Chad 7.0 Source: WTTC Top 10 source countries for foreign tourists (2006) UK Canada Germany Japan Malaysia Others USA France Sri Lanka Australia Nepal Source: Ministry of Tourism...CCEA approves funds for developing tourist spots In a move to increase tourism infrastructure, the Cabinet Committee on Economic Affairs (CCEA) has approved removal of ceilings on project cost for tourism infrastructure development of identified destinations and circuits. The Center's contribution will now be capped at Rs.250 mn for destination development and Rs.500 mn for circuit development, instead of Rs.50 mn and Rs.80 mn, respectively, for selectively identified circuits and destinations based on tourist traffic. The approved revision will lead to the development of world-class tourism infrastructure in at least 15 identified major tourist destinations or circuits in the country....rising household income to boost domestic travel The thriving economy will increase the spending power and fuel the growth in tourism. The number of households with annual income greater than Rs1.0mn is expected to grow at a CAGR of 15% between and , which will boost domestic inbound travel and lead to higher demand for hotel rooms across the categories....foreign tourist arrivals and forex earnings likely remain strong We believe that the continued 'Incredible India' campaign has had a strongly positive impact on tourist arrivals. Efforts are being made to communicate the 'Brand India' message by penetrating the global market and reaching the ultimate consumers through electronic, print and internet media. Foreign tourist arrivals to India have been growing at a CAGR of 14% over the last five years. We expect growth in tourist traffic to remain strong in the double digits. We believe ARR growth and room demand will remain encouraging in the next 2-3 years. Further, foreign travelers are also increasingly spending on premium segment hotels. Thus, we expect foreign exchange earning to grow faster then tourist arrivals. Sector Report - Hotel Industry Please see the disclaimer on the last page For Private Circulation 3

4 Tourist arrivals likely to reach 10mn by 2012 India achieved a significant growth in terms of foreign tourist arrivals during 2006 taking India's tourist arrivals from 3.92mn in 2005 to 4.45mn in 2006, showing an increase of 13.5%. Foreign exchange earnings from tourism also showed a phenomenal growth from US$5.73bn in 2005 to US$6.57bn in 2006, achieving a growth of 14.6%. Further, YTD Nov-07, foreign tourist arrivals increased by 12.7% to 4.4mn while foreign exchange earnings in dollar terms increased by 25.8% to US$7.23bn during the same period. Trend in foreign tourist arrivals (Nos - LHS) 2006 (Nos - LHS) 2007 (Nos-LHS) 2006 Gth (% - RHS) 2007 Gth (% - RHS) Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec Source: Ministry of Tourism Foreign Exchange Earnings (US$ Million) 2005 (US$ mn - LHS) 2006 (US$ mn - LHS) 2007 (US$ mn - LHS) 2006 (Growth % - RHS) 2007 (Growth % - RHS) Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec Source: Ministry of Tourism Tourist arrival to India is growing at 14% in the last five years Foreign tourist arrivals and Forex Earnings for the last Ten Years Year Tourist Arrivals Growth Forex Earnings Growth (mn) (%) (USD Bn) (%) (0.7) (4.2) 3.04 (4.0) (6.0) 2.92 (3.9) YTD (Nov) Source: Ministry of Tourism, Bureau of Immegration Sector Report - Hotel Industry Please see the disclaimer on the last page For Private Circulation 4

5 Medical tourism in India is currently estimated at US$300 mn Medical tourism - Immense potential Health tourism in India has emerged strongly over the last few years and is expected to grow due to its strong value proposition on cost, quality and services. We believe that, in this segment, tourists to India will comprise (1) uninsured individuals from developed countries where the cost of tertiary care is significantly higher, and (2) individuals from developing countries who come to India due to lack of adequate healthcare in their home country. The tourism factor is also seen as an influence on people's decisions to travel to India for healthcare services. Industry estimates point to US$300 mn worth of medical tourism business currently. However, it is extremely difficult to put growth numbers to this opportunity. Healthcare costs in USA, Thailand and India (US$) Treatment USA Thailand India Cardiac Surgery 300,000 14,250 6,000 Bone Marrow Transplant 250,000 62,500 26,000 Liver transplant 300,000 75,000 69,000 Orthopaedic surgery 20,000 6,900 6,000 Source: "Indian is far cheaper than Thailand", A report by India Brand Foundation in March 2004 India s contribution to world T&T demand likely to go up to 1.2% Contribution of tourism to GDP likely to rise The Indian tourism industry, despite being an important component of the Indian economy, contributed only 5.4% of the GDP and 5.5% of total employment in and currently lags behind as compared to other South East Asian countries. However, it constitutes 0.9% of the total world travel and tourist demand, which is higher than other Asian countries. We expect tourism to gain further significance over the next five years and India s contribution to world T&T demand likely go up to 1.2%. World Travel & Trade Council (WTTC) projects that inflows for South Asian countries will be the highest in the world (at 10.9%) till Contribution of T&T economy to GDP and Employment (2007) % of world T&T as % of T&T as % of T&T Demand GDP Employment World China India Malaysia Singapore Thailand Source: WTTC Travel & Tourism Economy Employment ( 000 of Jobs) Country CAGR (%) China 72,488 75, India 25,607 28, US 15,040 16, Japan 7,554 9, Indonesia 6,056 6, Brazil 5,876 7, Germany 4,261 4, Maxico 4,148 5, Thailand 4,110 4, Spain 4,046 4, Source: WTTC Sector Report - Hotel Industry Please see the disclaimer on the last page For Private Circulation 5

6 Demand-Supply imbalance to continue for next 2-3 years While the hotel industry has announced significant capacity additions in the past few years, typically long gestation periods are likely to prolong the current scarcity of rooms well into Further, rising real estate prices in metros and Tier-II cities have been pushing project costs of hotels upwards, which have raised questions on the sustainability and feasibility of the projects. We believe this may delay some of the announced hotel projects. For a long period, hotel companies faced huge shortages of rooms in major cities leading to sharp jump in ARRs and RevPARs. Hence, domestic and international chains are aggressively building capacity in high growth markets such as Hyderabad, Bangalore, Chennai and Pune. We believe this will put downward pressure on occupancy ratio and ARRs. However, increase in revenue from additional rooms (assuming sustained demand) will partially offset the loss due to lower ARRs. Supply and Demand : April-Sept 2007 vs. April-Sept 2006 (Rs) Room supply per day Rooms occupied per day Occupancy (%) H1FY08 H1FY07 Chg (%) H1FY08 H1FY07 Chg (%) H1FY08 H1FY07 Chg (%) Bangalore (1.8) (12.3) Chennai (2.8) Goa Hyderabad (14.7) Kolkata Mumbai (0.3) New Delhi (1.0) Supply and Demand : April-Sept 2007 vs. April-Sept 2006 (Rs) Average Daily Rate (ARR) RevPAR H1FY08 H1FY07 Chg (%) H1FY08 H1FY07 Chg (%) Bangalore (1.1) (12.3) Chennai Goa Hyderabad (6.6) (21.2) Kolkata Mumbai New Delhi Source: HVS International Leisure destinations to witness sustained higher occupancy With demand growth matching supply additions growth, leisure destinations are expected to sustain occupancy between 62-66% over the next five years. A year round average of 62% and above for a leisure destination is perceived to be good because of the prevalence of an off-season when occupancy rates hit a low curve. The rise in occupancy rates as compared to the average rates of 60% prevalent two years back in leisure destinations can also be attributed to the narrowing of offseason in destination such as Jaipur and Goa due to the increasing share of the MICE segment (Meetings, Incentives, Conventions and Exhibitions) in these regions. Sector Report - Hotel Industry Please see the disclaimer on the last page For Private Circulation 6

7 Major hotels have shifted to single currency system to hedge from rupee appreciation Rupee appreciation impact likely in the short-term We expect the appreciation in rupee to have a moderate impact on the earnings of the hotel companies, which could dampen the sentiment in the short-term. However, we expect the rupee appreciation to impact earnings only in the first two quarters of FY08, as the companies revise their room rates each year in September before the start of the peak season. For FY08, companies have already revised their tariff upward between 10-15%. Further, major hotels across the country have shifted to single currency system (rupee denominated) to hedge themselves from rupee appreciation against foreign currencies. We believe there is more value for money earned in rupees resulting in a decision to price hotel services in rupees. However, foreign customers are given the option to settle their bills in an international currency. Going forward, in the shortterm, the existing demand-supply gap in the industry will ensure pricing power remains with hotel companies and thereby help them to post strong performance over the next two to three years. Sector Report - Hotel Industry Please see the disclaimer on the last page For Private Circulation 7

8 RISKS AND CONCERNS Significant capacity/room supply expected after 2009 The hotel industry is expected to witness significant capacity/room addition across key cities over the next four to five years. HVS international, a hospitality industry consultant, has estimated that around 102,000 rooms would be entering the Indian hotel industry over the next five years, out of which active development of supply is 58%. This means that based on the probability factor, 58% of proposed supply is active and under construction or is likely to open before This is expected to not only bring occupancy levels down but there may be an oversupply in certain markets resulting correction in room rates (ARRs). Typically, the occupancy level is the key determining factor of average room rates. This has been the case in the past and is a global trend. So, if occupancy goes up, the rates rise as well. Conversely, if occupancies decline the players will have to reduce the rates. We believe that in two to three years Bangalore, Chennai, Hyderabad and Pune may face the risk of lower occupancy while Goa, Mumbai and New Delhi are likely to remain robust markets due to modest capacity addition. Supply projection in premiun (5-star) segment (FY07-12E) (Room Nos) FY07 FY08E FY09E FY10E FY11E FY12E Agra 1,504 1,504 1,629 1,829 2,029 2,179 Ahmedabad ,136 Bangalore 2,282 2,282 2,707 5,370 6,595 6,595 Chennai 1,541 1,595 2,076 2,822 4,313 4,423 Delhi (NCR) 7,051 7,299 8,307 10,231 12,601 13,326 Goa 2,565 2,565 2,671 3,211 3,561 3,561 Hyderabad 1,302 1,669 2,159 3,258 4,619 5,169 Jaipur 1,351 1,466 1,681 1,981 2,081 2,281 Kolkata 1,249 1,249 1,249 1,474 2,582 3,307 Mumbai (North) 4,616 4,732 5,351 6,635 7,596 7,721 Mumbai (South) 2,097 2,238 2,355 2,605 2,855 2,855 Pune ,365 1,865 2,065 Kerala State 1,130 1,345 1,930 2,290 2,620 2,920 Total Room Availability Source: CrisInfac Competition from international players Attracted by India s fast growing hospitality industry, international hotel chains are increasing their presence in the country. For instance, Hilton, Marriott, Starwood, Shangri-La, Carlson, Inter Continental, Accor, Hyatt and Choice have all charted out extensive expansion plans in India. Some of these hotel chains such as Hilton and Marriott have formed alliances with large Indian real estate developers such as DLF and Unitech, respectively. These developers would develop and own the hotel properties, while the hotel chains would manage and market these properties. We see this as a concern rather risk, as this will lead to increase in supply in the long run thus putting pressure on ARRs and occupancies. Also, their expertise and experience may attract customers from smaller chain. However, increasing real estate prices, higher interest costs, and regulatory hurdles could increase the lead-time and the project cost. Sector Report - Hotel Industry Please see the disclaimer on the last page For Private Circulation 8

9 Shortage of trained manpower We see the issue of trained manpower shortage within the hospitality sector as a concern. The hotel industry is witnessing high attrition rate in its manpower as the sector is losing employees to other industries such as airlines and retails. Addition of room inventory over the next four to five years would also require trained manpower while hotel management institutes are unable to provide sufficient graduates. If we assume employee-to-room ratio of an average 2.0x for luxury hotels, the manpower requirement for hotel industry would be around 56,000 over the next five years. This may lead to rise in employee costs in the medium to long term. Manpower Requirement (FY07-12E)* Room Manpower (Nos) Addition required ,195 2, ,256 2, ,426 8, ,564 21, ,496 20, ,310 6,620 Total 31,247 55,874 * Assumed employee-to-room ratio 2.0x; Source: CrisInfac, Sector Report - Hotel Industry Please see the disclaimer on the last page For Private Circulation 9

10 ANNEXURE - I City wise Occupancy, ARRs and RevPAR (April-Sep 2007) City occupacny (%) H1FY07 H1FY S. Mumbai N. Mumbai Delhi Bangalore Chennai Hyderabad Kolkata Goa Source: IHCL investor presentation City ARRs (Rs) H1FY07 H1FY S. Mumbai N. Mumbai Delhi Bangalore Chennai Hyderabad Kolkata Goa Source: IHCL investor presentation City RevPARs (Rs) H1FY07 H1FY S. Mumbai N. Mumbai Delhi Bangalore Chennai Hyderabad Kolkata Goa Source: IHCL investor presentation Sector Report - Hotel Industry Please see the disclaimer on the last page For Private Circulation 10

11 ANNEXURE - II Table 1 - Company-wise financial performance (FY07) Financial performance (Rs mn) No. of Net OPM Net profit NPM RoCE Gearing Rooms Sales (%) (Rs mn) (%) (%) (x) Asian Hotels 1,150 2, Bharat Hotels 1,519 3, , EIH Associated Hotels Ltd 896 1, EIH Ltd 3,193 9, , Hotel Leelaventure 1,086 4, , Indian Hotels Co Ltd 9,901 25, , Oriental Hotels Ltd 664 1, Royal Orchid Hotels 764 1, Taj GVK Hotels & Resorts Ltd 679 2, Source: CrisInfac; Kotak Securities Private Client Research Sector Report - Hotel Industry Please see the disclaimer on the last page For Private Circulation 11

12 Table 2 - Performance of branded hotels across cities Occupancy rate (%) Agra Bangalore Chennai NCR Goa Jaipur Kolkata North Mumbai South Mumbai Hyderabad Pune n.a. n.a. n.a Average room rate (Rs) Agra 1,918 2,051 2,060 2,284 2,451 2,991 3,758 4,781 Bangalore 4,203 4,625 4,566 4,740 6,227 9,149 11,857 14,154 Chennai 4,350 4,218 3,867 3,546 3,564 4,118 5,119 7,139 NCR 5,164 5,111 4,788 4,367 4,441 5,404 7,448 10,716 Goa 3,265 3,396 3,285 3,243 3,741 4,085 5,011 6,311 Jaipur 3,613 4,301 3,649 3,864 4,595 5,294 6,957 8,046 Kolkata 3,792 3,814 3,438 3,360 3,264 3,498 4,340 5,719 North Mumbai 5,509 5,185 4,781 3,858 4,180 4,730 6,149 8,659 South Mumbai 5,795 6,067 5,594 5,091 5,142 5,806 7,280 9,992 Hyderabad 2,601 3,368 3,301 3,044 3,641 4,649 6,562 8,842 Pune n.a. n.a. n.a. 2,690 2,901 3,579 5,152 7,754 RevPAR (Rs) Agra ,076 1,645 2,108 2,717 Bangalore 2,810 3,374 2,921 3,400 5,114 7,095 9,165 10,538 Chennai 2,601 2,557 2,113 1,877 2,220 2,965 4,006 5,475 NCR 3,163 3,112 2,555 2,622 3,128 4,200 5,884 8,404 Goa 1,723 1,839 1,564 1,885 2,092 2,676 3,307 4,544 Jaipur 1,999 2,768 1,837 1,760 2,593 3,271 4,307 5,660 Kolkata 2,033 2,249 2,043 1,844 1,900 2,363 3,208 4,260 North Mumbai 3,954 3,795 2,343 2,548 2,903 3,638 4,870 6,973 South Mumbai 3,628 4,118 2,981 2,865 3,202 3,989 4,937 6,965 Hyderabad 1,955 2,613 2,627 2,159 2,762 3,688 5,575 6,809 Pune n.a. n.a. n.a. 1,978 2,240 3,132 4,329 6,314 Source: CrisInfac; n.a.: Not available Notes 1) Revenue per available room was calculated as occupancy rate multiplied by the average room rate. 2) As revpar includes both the performance variables, ARR and occupancy rate, it is a better indicator to assess the operating performance of a hotel. Sector Report - Hotel Industry Please see the disclaimer on the last page For Private Circulation 12

13 Table 3 - New branded Hotels addition over the next 3-4 years Name of the propsed hotel MUMBAI No. of Rooms Year Expected Four Seasons, Lower Parel Renaissance Expansion, Powai Trident, Oberoi, BKC Sofitel, BKC Searock (after renovation), Bandra Total 1375 BANGALORE JW Marriott Shangrilla ITC Sheraton Ritz Carlton Hilton Trident Airport Hotel Total 1550 NEW DELHI (NCR) EMMAR/MGF 300 Hotel Leela (Gurgaon) Hotel Leela Unnamed hotel in North Delhi 250 DLF and Convention center other plot auctioned by Govt. 500 Total 2264 GOA Hyatt Hilton with Convention Center Unnamed Resort Total 775 Name of the propsed hotel CHENNAI No. of Rooms Year Expected Marriott Hilton Hyatt Hotel Leela Balaji Total 1455 HYDERABAD JW Marriott 250 Hyatt 250 Hilton 275 Nagarjuna Group Hotels 300 GMR Hotel 250 Hotel Leela ITC Sheraton 250 Total 1825 PUNE Marriott 250 Hyatt 275 Hilton 250 Taj (Indian Hotels) 250 Hotel Leela other Un-branded hotels 500 Total 1725 Source: Industry Source: Industry Sector Report - Hotel Industry Please see the disclaimer on the last page For Private Circulation 13

14 Table 4 - Category-wise hotes, room availability and occupancy Number of hotels D and 5-Star Star Star Star Star H CA Total 1,420 1,541 1,570 1,722 1,892 1,190 S Number of rooms D and 5-Star 23,598 25,086 26,527 27,301 28,867 23,106 4-Star 7,588 7,958 8,551 8,655 8,831 5,483 3-Star 19,271 20,542 22,783 26,071 28,783 19,985 2-Star 15,078 16,153 15,999 17,629 18,449 5,673 1-Star 6,169 6,296 6,343 6,606 6,765 1,629 H 1,758 2,530 2,124 2,124 2,173 1,970 CA 3,731 3,616 3,334 3,334 3,902 9,767 Total 77,193 82,181 85,661 91,720 97,770 67,613 S Occupancy rate (%) D and 5-Star Star Star Star Star H CA Total D: 5-Star deluxe; CA: Classification awaited; H: Heritage; Source: Department of Tourism (DoT) Sector Report - Hotel Industry Please see the disclaimer on the last page For Private Circulation 14

15 Table 5: Industry average of key constituents of income and expenditure (%) Hotel income to total income Forex earnings to total income Forex spendings to total income Hotel income Rooms F&B (excluding liquor) Wine and liquor Communications Others Expenditure Wages and salaries F&B Fuel, power and light Advertising and publicity Rent Sub total Others Source: CrisInfac 2 Total expenditure excludes interest and depreciation charges 3 In , Industry average has been calculated as average of Asian Hotels, Bharat Hotels, EIH, Hotel Leela venture and Indian Hotels Note In & , industry average has been calculated as the average of Asian Hotels, Bharat Hotels, EIH, Hotel Leela Venture, Indian Hotels, and ITC Hotels. Table 6: Key constituents of income and expenditure in (%) Industry Asian Bharat EIH Hotel Indian average 1 Hotels Hotels Leelaventure Hotels Hotel income to total income Forex earnings to total income Forex spendings to total income Hotel income Rooms F&B (excluding liquor) Wine and liquor Communications Others Expenditure Wages and salaries F&B Fuel, power and light Advertising and publicity Rent Sub total Others Source: CrisInfac 1 Industry a verage has been calculated as the average of Asian Hotels, Bharat Hotels, EIH, Hotel Leelaventure, and Indian Hotels 1 Total expenditure excludes interest and depreciation charges Sector Report - Hotel Industry Please see the disclaimer on the last page For Private Circulation 15

16 Companies Sector Report - Hotel Industry Please see the disclaimer on the last page For Private Circulation 16

17 Awadhesh Garg INDIAN HOTELS COMPANY LTD (IHCL) Price : Rs.138 Recommendation : BUY Target Price : Rs.180 FY09E PE : 19x Stock details BSE code : NSE symbol : INDHOTEL Market cap (Rs bn) : 82.1 Free float (%) : 71% 52-wk Hi/Lo (Rs) : 178/115 2 Wk Avg Volume : 484,180 Shares o/s (mn) : Summary table Rs mn FY07 FY08E FY09E Revenues 25,063 31,188 36,802 Growth (%) EBITDA 7,218 9,044 10,672 EBITDA margin (%) Net profit 3,717 4,504 5,701 Net Margin (%) EPS diluted (Rs) Growth (%) 43.8 (1.4) 16.8 DPS (Rs) RoE (%) RoCE (%) EV/Sales (x) EV/EBITDA (x) P/E (x) P/BV (x) FY07/08 Q3 Q4 Q1 Q2 Revenue (Rs mn) 4,098 5,052 3,465 3,414 EPS (Rs) Source: Company & Kotak Securities - Private Client Research Shareholding pattern (Q2FY08) Corporate 4% Public 21% Institutions 22% Foreign 24% One-year performance (Rel to Sensex) Sensex Promoters 29% We believe IHCL's wider geographic presence, potential turnaround of overseas properties and execution of assets-light strategy would be the key growth drivers for the company. The company is de-risking its business model by increasing its focus on budget hotels and management contracts and by increasing its presence in international locations. Further, expansion of service offering to spas, service apartments and F&B outlets are likely to aid growth. We believe that overseas properties (mainly US and Australia) will stabilize and generate positive cash flows in the next two years. This is expected to insulate the company from any potential decline in profitability once new supply comes on stream in the Indian market. In the short-term, domestic operations are likely to register strong growth led by demand-supply mismatch in a few key markets. We expect revenue and PAT to grow at a CAGR of 21 & 24% over FY07-09E, resulting into an EPS of Rs.7.3 in FY09. We initiate our coverage on IHCL with a BUY recommendation, with a target price of Rs.180 over a one-year time horizon. Key Investment Arguments Focus on asset-light strategy for future growth. IHCL is leveraging its brand and service quality record for securing franchises and management contracts with a view to expand presence without much investment. At present, the company operates about 15% of total room inventory (10118 rooms) through management contracts. IHCL plans to add 6248 rooms (1628 rooms in FY08, 1764 rooms in FY09 and 2856 rooms in FY10) in the next three years of which 39% (2439 rooms) will be through management contracts. We believe the company will be able to leverage its international presence to win more management contracts, which should enable it to become asset-light. Aggressive scale-up plans for budget hotels. IHCL sees strong growth opportunities in the 'budget hotel' segment, and has aggressive plans to set up 30 such hotels in Tier-II and Tier-III cities across the country under the 'Ginger' brand over the next three years. These hotels would target the economy and mid-market segment in business and religious destinations, which we see as a significant growth opportunity in India, given the lack of a large organized 'budget' hotel chain. The theme of budget hotels is to build standard 100-rooms hotels with no frills and self-service concept but better service quality and luxury feel priced around Rs.1000 per room/night. We view 'Ginger' as a positive move for the company and expect this business to break-even by FY09. Turnaround of overseas properties to boost overall profitability. IHCL's subsidiary companies registered revenues of Rs.9.6 bn in FY07, constituting 38.4% of consolidated revenues. However, the profitability of these companies was less than 4%, mainly due to properties in the UK and US, which incurred losses. Pierre, which contributed 32% of subsidiary revenues, recorded losses in FY07 while its UK property St James Court (23% of subsidiary revenue) posted lower profit. We believe any improvement in the financial performance of these international properties could boost overall profitability. Source: Capitaline IHCL Economic growth and tourist inflow. Strong economic growth and increased sports and business activities due to liberalized foreign investment policies have contributed to huge demand for hotel rooms in India, in both business and leisure segments. Further, foreign tourist arrival in India is registering double digit growth for last four years. Foreign tourist arrival in India was 4.45 mn in 2006, registering a growth of 13.5%. We expect tourist inflow to cross 5 mn in 2007 registering a growth of 12.3%. Sector Report - Hotel Industry Please see the disclaimer on the last page For Private Circulation 17

18 We expect 21% and 24% revenue and earning CAGR over FY07-09E. We remain confident about the strong industry trends in the 2-3 years, given increasing tourist inflow and continuing demand-supply mismatch in hotel rooms. For IHCL, we expect 21.2% and 24.1% compounded growth in revenues and earnings over the next two years. For FY08, we expect revenue growth of 24.4% to Rs.31.2 bn and net profit growth of 21.6% to Rs.4.5 bn. In FY09, we expect revenue growth of 18% to Rs.36.8 bn and net profit growth of 26.6% to Rs.5.7 bn. We recommend a BUY on IHCL with a price target of Rs.180 Valuations & recommendation We believe industry trends will remain strong in the 2-3 years with growth in revenue per available room (RevPAR) being driven by growth in ARRs. Further, potential new supply by other industry players is likely to come on stream well beyond Hence, the demand-supply mismatch in some markets may continue at least for the next two years. We expect net profit of Rs.4.5 bn in FY08 and Rs.5.7 bn in FY09, which implies fully diluted earning per share of Rs.6.2 and Rs.7.3, respectively. The earning per share is likely to be lower due to the planned rights offering, which we have taken in our estimates. At the current market price of Rs.138, the stock is trading at 22.2x FY08 and 19x FY09 earning estimates. We initiate coverage with BUY recommendation with target price of Rs.180 over a one-year time horizon based on two-stage DCF methodology. Key risks and concerns Significant supply of rooms ahead of expectations are likely to adversely impact our ARR growth and occupancy assumptions Any delay in execution of its new hotels in Chennai, Pune, and Hyderabad, which would push back growth estimates and dampen sentiment on the stock Any delay in the roll-out of 'Ginger' hotels and planned room increases Lengthening pay-back period beyond our estimates as the company is overpaying for hotel acquisitions in international markets given management's push to expand its brand franchise in global markets Any slowdown in economic activity, which could lead to lower hotel room demand Sector Report - Hotel Industry Please see the disclaimer on the last page For Private Circulation 18

19 COMPANY PROFILE Geographic sales - FY07 Foreign 25% Source: Company Domestic 75% Indian Hotels Company Ltd (IHCL) is a part of India's premier business house, the Tata Group of Companies. IHCL commenced its operations in December 1903, when Jamshetji Nusserwanji Tata opened India's first super luxury hotel, the Taj Mahal Palace & Tower, Mumbai. Currently, IHCL operates under two well-known brands - TAJ in the deluxe/luxury segment GINGER in the budget segment IHCL is the largest hospitality service provider in India with a presence in the luxury, business and leisure hotel segments. IHCL through its owned hotels, management contracts and subsidiaries/associates operates in around 40 cities in India and in 11 countries globally. It owns the 'Taj' brand and operates 81 hotels, with over rooms in almost all major business locations and tourist destinations across India with 11 international hotels in Maldives, Mauritius, Malaysia, Australia, UK, USA, Bhutan, Sri Lanka, Africa, and Middle East. IHCL s operations comprise of owning assets, their management and the branding/franchising and marketing activities of these hotels. The Taj Group operates hotels under three categories: Hotels owned directly by IHCL and its subsidiaries; Hotels owned by Associate companies; and Hotels on management contract from third party owners. Corporate Holding Structure IHCL Luxury Hotels 7 Hotels, 200 rooms Business Hotels 4 Hotels, 298 rooms Leisure Hotels 8 Hotels, 567 rooms Subsidiaries 4 Hotels 652 Rooms Associate/Joint Ventures 28 Hotels 3207 Rooms Management Contracts 12 Hotels 1293 Rooms Source: Company The group has grown by both ownership of hotels and partnering with like-minded organizations and individuals in the ownership of hotels, so as to encourage the development of hotels and simultaneously provide them with the benefit of professional management and a well recognized brand. The company is now aggressively looking to enter the budget hotel segment through its new brand 'Ginger', and making a foray into the adventure business with wildlife lodges. IHCL currently has nine Ginger hotels, which are up and running and about eight properties are under construction. The company has identified around 20 sites for setting up Ginger hotels in key cities across the country. We expect IHCL to have around 30 Ginger properties in the next three years - eight properties in FY08 and six properties each in FY09 and FY10, respectively. The company is also looking to expand in international locations through strategic alliances, acquisitions and/or management contracts. Sector Report - Hotel Industry Please see the disclaimer on the last page For Private Circulation 19

20 INVESTMENT ARGUMENTS Turnaround of international property and execution of assets - light strategy would be key growth driver We believe IHCL's wider geographic presence, potential turnaround of overseas properties and execution of assets-light strategy would be the key growth drivers for the company. The company is de-risking its business model by increasing its focus on budget hotels and management contracts and greater presence in international locations. Further, expansion of service offering to spas, service apartments and F&B outlets are likely to aid growth. We believe that overseas properties (mainly US and Australia) will stabilize and generate positive cash flows in the next two years. This is expected to insulate the company from any potential decline in profitability once new supply come on stream in the Indian market. In the short-term, domestic operations are likely to register strong growth led by demand-supply mismatch in a few key markets. Economic growth and tourist inflow to benefit IHCL Strong economic growth and increased sports and business activities due to liberalized foreign investment policies have contributed to huge demand for hotel rooms in India, in both business and leisure segments. Further, foreign tourist arrival in India is registering double digit growth for last four years. Foreign tourist arrival in India was 4.45 mn in 2006, registering a growth of 13.5%. We expect tourist inflow to cross 5 mn in 2007 registering a growth of 12.3%. Foreign tourist arrivals and forex earnings Year Tourist Arrivals Growth Forex Earnings Growth (mn) (%) (USD Bn) (%) YTD (Nov) Source: Ministry of Tourism, Bureau of Immegration Revenue by business - FY07 Air Catering 10% Source: Company Others 1% Hoteliering 89% Low risk business model to insulate IHCL from segmental business risk IHCL is de-risking its business operations by extending its line of business to other areas like management contracts and budget hotels. It has low concentration risk in terms of geographical spread. It operates 81 hotels in almost all major business locations and tourist destinations across India and abroad. Further, its presence in various spheres of the hospitality sector, namely, F&B business, air catering and travel assistance services insulates it from segmental business risk. The company is gearing up its operation in the F&B business with a target of generating annual revenue of Rs.50 bn within five years. Focus on asset-light strategy for future growth IHCL is leveraging its brand and service quality record for securing franchises and management contracts with a view to expanding presence without much investment. At present, the company operates about 15% of total room inventory (10118 rooms) through management contracts. The company plans to add 6248 rooms (1628 rooms in FY08, 1764 rooms in FY09 and 2856 rooms in FY10) in the next three years of which 39% (2439 rooms) will be through management contracts. We believe the company will be able to leverage its international presence to win more management contracts, which should enable it to become asset-light. Sector Report - Hotel Industry Please see the disclaimer on the last page For Private Circulation 20

21 Category-wise room additions in FY08-10E Hotel FY08 FY09 FY10 Own - Five Star Domestic International Management Contract ,512 - Domestic 5-star Domestic 3-star Service apartments International Budget Hotels (Ginger) Total 1,628 1,764 2,856 Source - Company IHCL to have around 30 Ginger properties in the next three years US properties to stabilize and generate positive cash flows in the next two years Aggressive scale-up plans for budget hotels IHCL sees strong growth opportunities in the 'budget hotel' segment, and has aggressive plans to set up 30 such hotels in Tier-II and Tier-III cities across the country under the 'Ginger' brand over the next three years. These hotels would target the economy and mid-market segment in business and religious destinations, which we see as a significant growth opportunity in India, given the lack of a large organized 'budget' hotel chain. The strategy of budget hotel is to build standard 100-rooms hotel with no frills and self-service concept but better service quality and luxury feel priced around Rs.1000 per room/night. We view 'Ginger' as a positive move for the company and expect this business to break-even by FY09. IHCL currently has nine Ginger hotels, which are up and running and about eight properties are under construction. The company has identified around 20 sites for setting up Ginger hotels in key cities across the country. We expect IHCL to have around 30 Ginger properties in the next three years - eight properties in FY08 and six properties each in FY09 and FY10, respectively. The economy hotels segment has generated significant interest with a large number of international players such as Accor, Holiday Inn and Dawnay Day Hotels announcing their plans to enter the segment. IHCL has identified this opportunity ahead of other chains and is in a strong position as the first operator to actually set up hotels in budget segment. Focus on increasing international presence IHCL is seeking to bridge gaps in its business model by increasing its presence in international markets through acquisitions/joint ventures and/or management contracts. The strategic rationale for this strategy is to: Establish its presence in key gateway cities of the US, Europe, Australia, South Africa, Dubai and China; Promote the 'Taj' brand and position itself as a luxury brand in the global hospitality markets; and De-risk country specific risk by geographic diversification. As part of its international expansion strategy, the company has acquired properties in the US and Australia and made strategic investments in one global hospitality company in the last two years. We believe these acquisitions/investments will provide it with a headstart in newer markets. However, it has also dampened investor sentiment, given the expensive valuations and lower profitability for international properties. On the positive side, the management has confirmed that average room rates (ARRs) and occupancy rates (ORs) at the properties in the US and Australia has been quite strong during FY07. Further, St. James Court (London) has registered a sales growth of 18% with 24% EBITDA margin and 5% net margin in FY07. We expect the US properties (currently making losses) to stabilize and generate positive cash flows in the next two years. Sector Report - Hotel Industry Please see the disclaimer on the last page For Private Circulation 21

22 International acquisitions Properties / Location Rooms/ OR ARR Acq. Cost Remark Hotels (%) (US$/day) (US$ mn) The Pierre, New York Management contract for 40 years Annual lease rental paid by IHCL US$5mn Ritz-Carlton, Boston 273 > Acquired from Millennium Partners, New York Renamed to Taj Boston up on closure of the purchase Hotel Campton Place, San Francisco A four-star 110-room luxury boutique hotel The Blue, Sydney Orient-Express Hotels, Global 39 hotels Acquired 11.5% stake with an intension to form strategic alliance. Owns 49 properties Total cost 504 Source: Company presentation Turnaround of overseas properties to boost overall profitability IHCL's subsidiary companies registered revenues of Rs.9.6 bn in FY07, constituting 38.4% of consolidated revenue. However, the profitability of these companies was less than 4%, mainly due to properties in the UK and US. Pierre, which contributed 32% of subsidiary revenues, recorded a loss in FY07 while its UK property St James Court (23% of subsidiary revenue) posted lower profit. IHCL is renovating its property in New York which will increase the room rates to US$ /day from the current US$560/day. We believe any improvement in the financial performance of these international properties could boost overall profitability. Fianacial performance of key subsidiaries (FY07) (Rs mn) Country Stake (%) Revenue Net Profit NPM (%) Taj Investment and Finance Co. India KTC Ltd India Innovative Foods Ltd India United Hotels Ltd India Roots Corporation Ltd (Ginger) India Taj SATS Air Catering Ltd India Apex HMS P. Ltd Singapore Taj International Hotels (HK) Ltd Hong Kong St. James Court Hotels Ltd UK Taj International Hotels Ltd UK IHMS Inc., (Pierre + Taj Boston) USA IHMS Australia Pte Ltd Australia Total Source: Company Annual Report IHCL to spend US$100 mn on Pierre renovation in 2008 IHCL plans to start refurbishment work at The Pierre starting January During the renovation period of one year, the rooms will not be available for letting out. However, the banqueting business will continue. The company has increased total refurbishment cost to US$100 mn from US$35 mn decided at the time of O&M agreement while the lease period has been extended from 30 years to 40 years. The company explains that cost benefit analysis favors the decision and the benefit from refurbishing the rooms will be substantial, as after the renovation, room rates could move up to US$ per day from the current US$560 per day. We believe the refurbishment activity will increase the loss in FY09 for Pierre, as all rooms will be off the market for almost one year. However, IHCL could renegotiate the wage structure at the Pierre for the period when the rooms are off the market, which would reduce the losses. The company expects all international properties to generate positive cash flows in the next two to three years. Sector Report - Hotel Industry Please see the disclaimer on the last page For Private Circulation 22

23 INVESTMENT IN ORIENT-EXPRESS HOTELS (OEH) Strategic investment in Orient-Express Hotels In September 2007, IHCL invested US$233 mn for the acquisition of a 11% stake in Orient-Express Hotels Ltd with the intention of forming a strategic alliance. It has further increased the stake to 11.5% taking total investment to US$247 mn. OEH operates in the deluxe luxury market through its 39 hotels, two restaurants, six trains, and two river cruises, and offers exposure to US markets including Italy and Latin America. Financial summary of Orient-Express Hotels (US$ mn) CY06 CY05 % Change Revenue EBIDTA Net Profit EPS (Rs) EBIDTA Margin (%) bps Source: Company Rationale for investment The strategic rationale for IHCL acquiring 11.5% stake in OEH was to establish an alliance with a company that had properties that would complement those owned by IHCL. OEH has an exclusive focus on the deluxe luxury market and does not have any presence in the Indian market. As a result, the alliance with OEH could give each company an entry point into the markets the other is catering. OEH's refusal to form alliance with IHCL is a negative surprise OEH has refused to form any alliance with IHCL, which is a negative surprise. The company has rejected IHCL s fresh overtures for an alliance with the company. It said that any association of its brands and properties with the predominantly domestic Indian hotel chain would result in an erosion of the brand and business value of its global portfolio of luxury hotels. We believe if the collaboration does not go through then IHCL will have two options (1) to increase the stake upto 15% and trigger the open offer; (2) dispose off the investment, which has risen about 10% in value. In that case, there could be oneoff profits. However, this huge investment in OEH could dampen return ratios in the short-term. The company has clarified that it has no intention to make hostile take over bid since it is against the Tata groups overall strategy. The company will take appropriate action in the due course. Sector Report - Hotel Industry Please see the disclaimer on the last page For Private Circulation 23

24 EXPANSION AND FUND RAISING PLANS IHCL plans to add 54 new propertis over the next 3-4 years taking total room count to around 16,366 Planning Rs.12 bn capex over the next three years IHCL is planning about Rs.12 bn capital expenditure over the next three years. It plans to add 54 new properties, taking their total to 137 from the current 83 across the globe. The room count will increase from the current to around in the next three years (including 40% in management contracts and 30% in the budget segment). We believe the asset-light strategy is doing well and IHCL will be able to leverage its international presence to gain additional management contracts in the future. Further, in its efforts to expand in overseas markets, the company is considering a foray into Vietnam, Indonesia and Fiji. IHCL is also likely to have a presence in Thailand, South Africa, Doha and Western Europe in the near future. Expansion Plans - New Builds Hotel Rooms Year IHCL Taj ITPL, Bangalore 199 Jan-08 Taj Lake End, Udaipur 80 Apr-08 Taj Lands End, Mumbai (Expansion) 142 Apr-08 Taj Falaknuma Palace, Hyderabad 60 July-08 Taj Santa Cruz, Mumbai 175 Nov-08 Taj Surya, Coimbatore 150 Dec-08 Taj Residency, Yeshwantpur, Bangalore 350 Apr-09 Non - IHCL Taj Mount Road, Chennai (Taj GVK Ltd.) 215 Sept-07 Ginger (Roots Corporation) 2000 Ongoing Wilderness Lodges, (TWLL) 42 Ongoing International Taj Palace, Cape Town (TISA) 152 July-08 Taj Exotica Resort & Spa, Phuket (Taj Asia Ltd) 79 Apr-09 Taj, Johannesburg 165 Apr-09 Total 3,809 Source - Company Expansion Plans - Management Contracts Hotel Rooms Year Domestic Gateway, Vijayawada 108 July-07 Taj Residency, Trivandrum 134 Dec-07 Taj Residency, Nagpur 300 Apr-08 Gateway Resort, Bekal (Kerala) 75 Jan-09 Gateway, Chennai 159 Jan-09 Portman Residences 700 Apr-09 Taj Residency, Panjim 154 Apr-09 Gateway, Raipur 125 Sept-09 Gateway, Jalandhar 100 Sept-09 International Rebak Marina Resort, Langkawi, Malaysia 106 July-07 Taj Tashi, Thimpu, Bhutan 66 Dec-07 Taj Exotica Palms Jumeirah, Dubai 262 Dec-09 Taj Exotica, Doha 150 Jan-10 Total 2,439 Source - Company Sector Report - Hotel Industry Please see the disclaimer on the last page For Private Circulation 24

25 Right issue to fund expansion and repay debt IHCL plans to raise Rs.14.5 bn by way of right issues of equity shares and nonconvertible debentures. It plans to raise Rs.8.4 bn through a 1:5 rights issue of equity shares at Rs.70 per share and Rs.6 bn through issue of 6% non-convertible debentures in the ratio of one debenture for every 10 equity shares. Each debenture will carry a warrant convertible within 12 months within a price band of Rs per share. The exercise of warrants will raise an additional Rs.8.4 bn. The rights issue will partly be used to fund domestic capex, pre-payment of high cost debt and for investment in domestic and international subsidiaries. Fund utilization Gen. Corp purposes 15% Debt Repayment 28% New hotels / expansion 30% Refurbishment 27% Source: IHCL Draft Letter of Offer Sept-07 Utilisation of funds raised through rights issue (Rs mn) Amount Funding of the capital expenditure Setting up New Properties: - Taj Surya, Coimbatore Taj Residency, Bangalore 1,600 Expansion Projects at the Existing Properties: - Taj Lands End, Mumbai 763 Investments in the Subsidiaries - Domestic Subsidiary: Roots Corporation 1,200 - International Subsidiary: Pierre renovation 2,200 Repayment of Debt 4,000 Funding of the replacement/ renovation Capex 1,700 General Corporate Purposes 2,237 Total 14,470 Source: IHCL Draft Letter of Offer Sept-07 IHCL will add over 6000 rooms by FY04 FY05 FY06 FY07 FY08E FY09E FY10E Source: Company, Sector Report - Hotel Industry Please see the disclaimer on the last page For Private Circulation 25

26 FINANCIAL PERFORMANCE AND OUTLOOK Revenue grew by 36% driven by healty room rates and occupancy Strong financial performance in FY07 and H1FY08... IHCL's financial performance in FY07 and H1FY08 has been driven by healthy room rate hikes, which led to the robust RevPAR growth. In FY07, consolidated revenues grew 36.4% to Rs.25.1 bn from Rs.18.4 bn in FY06 and net profit after tax and minority interest grew 49% to Rs.3.7 bn. The company has registered 33% growth in RevPAR, which was driven by 28.5% growth in ARRs and 300 bps increase in occupancy. On a standalone basis, the company has posted 46% growth in room revenue to Rs.8.94 bn and 32% growth in F&B revenues to Rs.4.72bn. RevPAR growth led by highr ARR & Occupancy Occupancy (%) ARR (Rs) RevPAR (Rs) FY07 FY06 FY07 FY06 FY07 FY06 Chg (%) Q ,160 5,576 4,819 3, Q ,401 5,639 4,861 3, Q ,674 8,150 8,048 6, Q ,082 8,888 9,194 7, Full Year ,234 7,186 6,723 5, H1FY08 H1FY07 H1FY08 H1FY07 H1FY08 H1FY07 Change Half Year ,581 7,289 5,818 4, Source: Company... Revenues grew by 18% YoY in H1FY08 In H1FY08, standalone revenues grew 17.7% to Rs.6.88 bn from Rs.5.84 bn in the same period of last year. The growth was largely due to a 17.7% increase in ARRs and 100 bps increase in occupancies. RevPAR for the first six months grew 19%. EBITDA margin improved 270 bps to 30.3% from 27.6% in H1FY07. Net profit after tax grew 26.6% to Rs.1.08 bn from Rs.853 mn. Interest cost was higher due to debt raised for the acquisition of Campton Place. The company has shifted to a rupeebased tariff effective September 1, 2007 along with the room rate hikes. Revenue breakup (H1FY08) F&B 35% Others 12% Source: Company Room sales 53% For H2FY08, we are expecting relatively strong growth mainly due to the following reasons: For the last six to eight months part of the Mumbai property has been under renovation, resulting in lower inventory in an important markets. This property is now fully operational. Revenues were impacted in H1FY08 by 8-9% due to rupee appreciation. Rates have been revised to rupee denominated effective September 1, 2007 Revision in rooms rate by around 10-25% effective from October 2007 The October-March period remains seasonally strong due to high business activities and strong tourist inflow Financial Performance (Standalone) - H1FY08 (Rs mn) H1FY08 H1FY07 YoY (%) Q2FY08 Sales & Operating Income 6,879 5, ,414 Expenditure 4,794 4,230 2,425 EBIDTA 2,085 1, Depreciation Interest Other Income PBT 1,613 1, Tax Reported PAT 1, EPS (Rs) EBIDTA Margin (%) PAT Margin (%) Source: Company Sector Report - Hotel Industry Please see the disclaimer on the last page For Private Circulation 26

27 IHCL's revenue growth stronger than peers The company has registered relatively stronger revenue and EBITDA growth compared to its peers (EIH and Hotel Leela). The better performance was mainly due to higher ARR growth across all its properties. We believe the wider geographical spread of its properties and its diversification into various segments of the industry helped it to benefit from strong industry trends, albeit some of the overseas properties such as The Pierre, New York and The Blue, Sydney have reported losses. Relative Financial performance (FY07) (Rs mn) IHCL EIH Leela Revenue 25,063 10,042 4,156 Growth (%) EBITDA 7,218 3,232 1,930 Growth (%) Margin (%) Net Profit 3,703 2,005 1,260 Growth (%) Margin (%) Source: Companies International properties lost around Rs.450 mn in FY07 In FY07, standalone net profits grew 75% to Rs.3.22 bn from Rs.1.84 bn. However, consolidated net profits increased 49% to Rs.3.70 bn from Rs.2.49 bn. The lower growth in consolidated profit was largely due to the Rs.459 mn loss in the US operations and Rs.88 mn loss in The Blue, Sydney. The company expects The Blue to break-even in FY08. However, St James Court, London, has generated a profit of Rs.102 mn in FY07. Expect 21% and 24% revenue and earning CAGR respectively over FY07-09E We remain confident about the strong industry trends in the short-term, given increasing customers inflow and continuing demand-supply mismatch in hotel rooms. For IHCL, we expect 21.2% and 24.1% compounded growth in revenues and earnings over the next two years. For FY08, we expect revenue growth of 24.4% to Rs.31.2 bn and net profit growth of 21.6% to Rs.4.5 bn. In FY09, we expect revenue growth of 18% to Rs.36.8 bn and net profit growth of 26.6% to Rs.5.7bn. We believe that overseas properties (mainly US and Australia) should stabilize and generate positive cash flows in the next two years. If this happen, then they should become earnings-accretive and also insulate the company from any potential decline in profitability once new supply come on stream in the Indian market. Revenue by Business (FY07) Consolidated Financial Performance (FY04-09E) Air Catering 10% Others 1% Revenue (Rs bn - LHS) PAT (Rs bn - LHS) EBITDA (% - RHS) Source: Company Hoteliering 89% 10 0 FY04 FY05 FY06 FY07 FY08E FY09E 10 0 Source: Company, Sector Report - Hotel Industry Please see the disclaimer on the last page For Private Circulation 27

28 VALUATIONS AND RECOMMENDATION We believe industry trends will remain strong in the 2-3 years with growth in revenue per available room (RevPAR) being driven by growth in ARRs. Further, potential new supply by other industry players is likely to come on stream well beyond Hence, the demand-supply mismatch in some markets may continue at least for the next two years. We recommend a BUY on IHCL with a price target of Rs.180 We expect net profit of Rs.4.5 bn in FY08 and Rs.5.7 bn in FY09, which implies fully diluted earning per share of Rs.6.2 and Rs.7.3, respectively. The earning per share is likely to be lower due to the planned rights offering, which we have taken in our estimates. At the current market price of Rs.138, the stock is trading at 22.2x FY08 and 19x FY09 earning estimates. We initiate coverage with BUY recommendation with target price of Rs.180 over a one-year time horizon based on two-stage DCF methodology. Fund Raising Plans: Assumed dilution (Rs mn) FY08E FY09E Right Issue in the ratio of - Share Capital Share Premium 8320 sub-total % NCD (FV 100/-) with warrants in the ratio of 1: Exercise of warrants with NCD - Share Capital 60 - Share Premium 8380 sub-total 8441 Total Source: DCF valuation DCF valuation per share (Rs mn) Total FCFF 148,120 Less: Net Debt (adj for cash) 18,160 Shareholders' Value 129,960 Less:Preference Share Capital - Value per share 180 Source: Kotak Securities - Private Client Research Free Cash Flow to Firm (FCFF) FY06 FY07 FY08E FY09E FY10E FY11E FY12E PAT 2,251 3,374 4,039 5,162 5,691 6,355 7,203 Add: Depreciation 1,274 1,607 1,808 1,911 1,965 2,017 2,004 Add: Interest (1-tax rate) ,065 1,065 Less: Capex 2,260 12,986 4,000 3,000 3,000 2, Less: Change in NWC (758) (186) (122) (134) (147) FCFF 1,417 (6,532) (6,756) 5,098 5,767 7,571 9,919 Discounted Value (6,532) (6,756) 4,614 4,723 5,610 6,652 Source : Assumptions (%) Growth (FY13E-17E) 10.0 Terminal Growth 4.0 WACC 10.5 Equity (M Cap) - ( Rs mn) 99,840 Debt (Rs mn) 20,281 After tax cost of debt 5.6 Risk free rate 7.0 Risk premium 6.0 Adjusted Beta (x) 0.8 Cost of equity 11.5 Source: Kotak Securities - Private Client Research Sensitivity Analysis WACC (%) Terminal growth (%) % % % % % Source: We have valued IHCL based on the DCF methodology (WACC 10.5%; Beta 0.80 and Terminal growth 4%) for one-year time horizon At our target price of Rs.180, the stock will be valued at 12.3x FY09 EV/EBIDTA and 24.7x FY09 earning estimates Our target price provides 30% upside over the period of one year. We recommend BUY. Sector Report - Hotel Industry Please see the disclaimer on the last page For Private Circulation 28

29 PE band 250 Price 20x 25x 30x 35x FY04 FY04 FY04 FY04 FY05 FY05 FY05 FY05 FY06 FY06 FY06 FY06 FY07 FY07 FY07 FY07 FY08 FY08 FY08 FY08 Source: Capitaline, Key risks and concerns Significant supply of rooms ahead of expectations are likely to adversely impact our ARR growth and occupancy assumptions Any delay in execution of its new hotels in Chennai, Pune, and Hyderabad, which would push back growth estimates and dampen sentiment on the stock Any delay in the roll-out of 'Ginger' hotels and planned room increases Lengthening pay-back period beyond our estimates as the company is overpaying for hotel acquisitions in international markets given management's push to expand its brand franchise in global markets Any slowdown in economic activity, which could lead to lower hotel room demand Peer Valuation (Valuation based on FY09 earning estimates) Company Price (Rs) EPS (Rs) P/E (x) P/B (x) EV/EBITDA (x) RoE (%) EBITDA (%) NPM (%) Indian Hotels Co. Ltd EIH Ltd Hotel Leelaventure Ltd Source: Sector Report - Hotel Industry Please see the disclaimer on the last page For Private Circulation 29

30 Financials: Indian Hotels Company Ltd. (IHCL) Profit and loss statement (Rs mn) Year end March FY07 FY08E FY09E FY10E Revenues 25,063 31,188 36,802 40,482 % Change Y-o-Y Total Expenditure 17,844 22,143 26,129 28,742 EBITDA 7,218 9,044 10,672 11,740 % Change Y-o-Y Other Income Depreciation 1,607 1,808 1,911 1,965 EBIT 6,561 7,537 9,062 10,074 Interest 1,222 1,322 1,120 1,320 Profit before tax 5,339 6,214 7,942 8,755 Tax 1,965 2,175 2,780 3,064 as % of PBT Net Income 3,717 4,504 5,701 6,367 % Change Y-o-Y Shares outstanding (Mn) EPS - Fully diluted (Rs) CEPS (Rs) BVPS (Rs) DPS (Rs) Balance sheet (Rs mn) Year end March FY07 FY08E FY09E FY10E Shareholder's Equity Reserves 20,363 31,939 44,682 49,711 Total Networth 20,966 32,663 45,466 50,495 Minority Interest 2,758 3,001 3,310 3,652 Secured Loans 17,016 17,545 17,545 17,545 Unsecured Loans 3,689 2,736 2,736 2,736 Total Loans 20,704 20,281 20,281 20,281 Net deferred tax liability 1,466 2,087 2,882 3,757 Total Liability 45,895 58,032 71,939 78,185 Goodwill 3,141 3,141 3,141 3,141 Net Fixed Assets 35,526 37,718 38,807 39,842 Investments 5,143 14,463 14,463 14,463 Inventory Debtors 2,048 2,599 3,067 3,373 Cash & Bank Balance 1,772 2,121 15,125 20,458 Deposits 1,492 1,492 1,492 1,492 Loans & Advances 4,216 4,611 5,172 5,540 Current Liabilities 4,590 4,947 5,837 6,421 Provisions 1,937 2,495 2,944 3,239 Net Current Assets 1,958 2,582 15,400 20,612 Misc. Exp. Not w/off Total Assets 45,895 58,032 71,939 78,185 Cash flow statement (Rs mn) Year end March FY07 FY08E FY09E FY10E PAT 3,360 4,039 5,162 5,691 Depreciation 2,462 2,429 2,705 2,841 Change in NWC (186) (122) Operating Cash Flow 5,655 6,193 8,053 8,653 Investments (677) 9, Capex 12,986 4,000 3,000 3,000 Investment Cash Flow (13,662) 5,320 (3,000) (3,000) Loans 5,361 (423) - - Dividend 1,129 1,248 1,338 1,338 Issue of capital 362 8,441 8,441 - Financial Cash Flow 4,594 6,769 7,102 (1,338) Change in Cash (2,127) ,004 5,333 Opening Cash 3,899 1,771 2,121 15,125 Closing Cash 1,771 2,121 15,125 20,458 Source: Company, Ratio analysis Year end March FY07 FY08E FY09E FY10E Debt-Equity Ratio Current Ratio Inventory Turnover Debtors Turnover Fixed Assets Turnover Interest coverage (x) EBIDTA Margin (%) PAT Margin (%) RoE (%) RoCE (%) EV/Sales (x) EV/ EBITDA (x) Price to earnings (x) Price to book value (x) Price to cash earnings (x) Sector Report - Hotel Industry Please see the disclaimer on the last page For Private Circulation 30

31 APPENDIX Table 1: Financial performance of key subsidiaries As on March 31, 2007 Country Holding Revenues Growth Net Profit Growth (Rs. Mn.) (%) FY07 FY06 (%) FY07 FY06 (%) Taj Investment and Finance Co. India KTC Ltd India Innovative Foods Ltd India United Hotels Ltd India Roots Corporation Ltd (Ginger) India Taj SATS Air Catering Ltd India Apex HMS P. Ltd Singapore Taj International Hotels (HK) Ltd Hong Kong St. James Court Hotels Ltd UK Taj International Hotels Ltd UK IHMS Inc., (Pierre + Taj Boston) USA IHMS Australia Pte Ltd Australia Total Source: Company Annual Report Sector Report - Hotel Industry Please see the disclaimer on the last page For Private Circulation 31

32 Awadhesh Garg Stock details BSE code : NSE symbol : HOTELEELA Market cap (Rs bn) : 22.2 Free float (%) : 51% 52-wk Hi/Lo (Rs) : 77/38 2 Wk Avg Volume : 1,839,810 Shares o/s (mn) : Summary table Rs mn FY07 FY08E FY09E Revenues 4,156 5,490 6,239 Growth (%) EBITDA 1,930 2,525 2,948 EBITDA margin (%) Net profit 1,266 1,406 1,533 Net Margin (%) EPS diluted (Rs) Growth (%) (4.1) DPS (Rs) RoE (%) RoCE (%) EV/Sales (x) EV/EBITDA (x) P/E (x) P/BV (x) FY07/08 Q3 Q4 Q1 Q2 Net sales (Rs mn) EPS (Rs) Source: Company & Kotak Securities - Private Client Research Shareholding pattern (Q2FY08) Corporate 8.6% Institutions 9.6% Public 18.9% Foreign 13.5% One-year performance (Rel to Sensex) Source: Capitaline Sensex Promoters 49.4% Hotel Leela HOTEL LEELA VENTURE LTD Price : Rs.61 Recommendation : BUY Target Price : Rs.84 FY09E PE : 16.7x Hotel Leela is planning to enter into five new locations and will more than double its room inventory by mid-2011 with an investment of over US$500. The company is also entering into hotel management contracts and building an IT park and Casino as a part of assets light and business de-risking strategy. Leela s Mumbai property, which constitutes 32% of revenues, is expected to be a key growth driver over the next two years. We expect 22.5% and 10% revenue and earnings CARG, respectively over the next two years. We estimate a fully diluted EPS of Rs.3.8 and Rs.3.6 in FY08 and FY09, respectively. We initiate our coverage on Hotel Leela with a BUY recommendation, with a target price Rs.84 over a one-year time horizon. Key investment arguments Diversifying business as part of de-risking strategy. Hotel Leela is derisking its business operations by extending its line of business to other areas like management contracts, casino and an IT Park. We believe this business diversification would mitigate the company's operational risks to a little extent. Casino and IT Park are expected to contribute about 20% of net profits in FY09. Casino income, rooms refurbishment & expansion to drive growth in FY08. With Mumbai refurbishments (90 rooms) and room expansion (105 rooms) at Bangalore available starting Q4FY07, we believe additional rooms and sustained high ARRs, particularly in Mumbai and Goa will drive growth in FY08. Goa had witnessed a dip in revenue in H1FY08 due to the withdrawal of 30 rooms for refurbishment. We expect these rooms to come on stream by December 2007 and add to revenues. The Kovalam had added 56 club rooms in July 2006, which will also be reflected for the full year FY08. Further, Casino in Goa that is likely to come up in Q3FY08, will contribute around Rs.50 mn to the net profit. Huge capex plan to spur growth from Hotel Leela is on a huge expansion spree and has slated a US$500 mn capex plan over the next three to four years, mainly for developing four new properties, and renovating and upgrading existing properties. So far, the company has already spent US$254 mn (including land acquisition in New Delhi) and plans to spend around US$300 mn over the next three to four years. We believe benefit of this capex to fructify by Distant room addition may limit revenue growth in short-term. Hotel Leela plans to add six new luxury hotels (including one management contract) at Udaipur, Chennai, Hyderabad, Pune, New Delhi and Gurgaon. It plans to add over 1500 rooms to its current inventory of 1086 rooms by FY Except the addition of 29 rooms in Goa in FY09, we do not expect any significant room addition in the next two years, which limits revenue and earnings growth potential, during this period. We expect 22.5% revenue CAGR over FY07-09E. We expect 22.5% and 10% compounded growth in revenues and earnings over the next two years. For FY08, we expect revenue growth of 32.1% to Rs.5.49 bn and net profit growth of 11.1% to Rs.1.4 bn. We believe the Mumbai and Goa properties will be key growth drivers in FY08 led by strong ARRs and occupancy. We also expect Rs.50 mn income from Casino at Goa. However, in FY09, we expect lower revenue and earning growth. Revenues are likely to grow by 10% to Rs.6.24 bn and net profit is expected to growth by 9% to Rs.1.53 bn. We believe that new room additions at Goa and rental income from the IT Park will drive growth in FY09. Sector Report - Hotel Industry Please see the disclaimer on the last page For Private Circulation 32