Lemon Tree IPO: Strong prospects but high valuation for the hotel chain

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Lemon Tree, the country’s largest hotel chain in the mid-priced segment, has 4,697 rooms in 45 hotels across 28 cities. Roughly half its revenue comes from the upper midscale (Lemon Tree Premier), 23-28 per cent from the midscale (Lemon Tree Hotels) and the rest from the economy (Red Fox) segment.

During FY13-17, annual revenue grew 18 per cent and operating profit rose 33 per cent. The company made a profit for the first nine months of FY18, after losses over the past several years. Analysts expect the revenue to see robust growth, given the strong expansion plan and 11 per cent annual growth in the mid-segment room demand, to outstrip supply till 2022.

Geographically diversified presence of the properties, including metros, tier-1 and tier-2 cities, and the leisure destinations of Goa, Kerala, Bandhavgarh and Madhya Pradesh, should aid growth.

The positive trend of higher occupancies, 65 per cent in FY17 from sub-60 per cent in prior years, is expected to improve to 76 per cent by FY21, on the back of higher demand and tourism investments by the government. While the prospects of the mid-priced segment look good, analysts are sceptical about the Initial Public Offering (IPO), given the steep premium.

At the upper end of the price band, on the basis of enterprise value (EV) to operating profit (OP), the IPO is valued at 44 times the company's FY17 figure and 38.6 times the annualised operating profit for FY18. This is higher than larger established players such as Indian Hotels, available at 33 times its estimated FY18 EV/OP. Other players (Royal Orchid, EIH) are available at 25 times or lower on this measure. 

What brokerages say

BROKERAGE: IIFL
VIEW: Though we like the positioning of leisure industry stocks from a cyclical perspective, the steep valuations are nowhere near our comfort zone.
Recommendation: Avoid 

BROKERAGE: Angel Broking 
VIEW: Further improvement in margins has to largely come via price hikes, which looks difficult, especially in the lower range hotels, amid intense competition 
Recommendation: Neutral  

BROKERAGE: Ambit Capital 
VIEW: Lemon Tree’s IPO valuations are at 10-20% premium to peers. This is despite peers having 
higher scope of margin improvement due to lower occupancy and operating efficiency. 
Recommendation: — 

BROKERAGE: ICICI Securities  
VIEW: Not recommending to investors due to high capex oriented nature of expansion, low RoCE, higher competition in the mid-scale segment and premium valuations 
Recommendation: Avoid