In the competitive landscape of the Indian hospitality sector, Lemon Tree Hotels stands out as a notable player. The company's stock has experienced a remarkable rise, from Rs. 14 during the COVID-19 downturn to approximately Rs. 140 today.
However, despite the impressive 10x returns, the company gets a valuation considerably lower than its peers. This has primarily been on account of its presence in the ‘economy’ category, and due to subpar financial metrics, versus its listed peers.
So, what looks like an already run-up stock, might just show some more promising returns, if it delivers on bridging the gap with peers. Lemon Tree seems to have already embarked on a strategy to overcome challenges - as investors, are there more returns to be squeezed out?
Lemon Tree - Low Valuations Despite High Profits
Lemon Tree Hotels is the third-largest hotel chain in India, and operates across premium, upper-midscale, midscale, and economy segments. It has a diverse portfolio, with brands like Aurika, Lemon Tree Premier, Red Fox Hotels, Keys Prima, and Keys Select.
However, despite being the third largest, and boasting the highest profitability, it trades at a discount to its listed peers.
Metric | Lemon Tree | Chalet | EIH | Indian Hotels |
Average Room Rate (ARR in Rs.) | 5,900 | 10,700 | 18,700 | 9,900 |
Owned:Managed Ratio | 60:40 | 7:93 | 75:25 | 50:50 |
EBITDA Margins (FY24) | 49% | 44% | 42% | 35% |
Debt to Equity | 1.9x | 1.0x | 0x | 0.3x |
ROCE | 11% | 10% | 24% | 15% |
1-year Forward EV/EBITDA | 18x | 23x | 23x | 32x |
It’s Not Just about Profits
We reckon Lemon Tree’s valuation discount to peers is on two counts:
1. Higher Presence in the Economy Segment
Lemon Tree's lower ARR is largely due to its strong presence in the economy and upper-midscale segments. While competitors like EIH and Chalet Hotels target the premium and luxury markets with significantly higher ARRs, Lemon Tree operates in more affordable accommodations.
The economy segment exhibits a relatively lower ARR and, as a result, lower revenue per room compared to competitors. Lemon Tree’s ARR hovers around Rs. 6,000, while the same metric for the industry is around Rs. 9,000.
2. Subdued Financials
The owned hotel portfolio of Lemon Tree (60%) catering to a larger economy segment seems to be a drag on financials. A higher owned share simply means higher capital requirements, and higher amounts of capital being engaged, which is reflected in:
Lower return ratios - ROCE of 11%, compared to over 15% for competitors, and
Significantly higher debt-to-equity ratio - at 1.9x, than that of its peers, who stand at around 0.3x
How Is It Addressing the Issues?
The company is planning to address these issues in two ways:
1. Moving up the value chain through its premium brand, Aurika
Aurika, Lemon Tree's premium brand, launched its first hotel in Udaipur in FY20, followed by the massive Aurika Mumbai in October last year. The Aurika brand has an ARR close to Rs. 11,000 and an occupancy rate of 42% in FY24 (mainly due to Aurika Mumbai stabilising).
Projections show occupancies reaching 70–75% by FY25, with ARRs climbing to Rs. 14,000, contributing 20% to Lemon Tree’s revenue and EBITDA margins of 56–59%.
Aurika's growth in the premium segment is crucial for Lemon Tree for several reasons:
Boosting ARR and revenue - higher ARR to elevate top-line growth
Enhancing profitability - better EBITDA margins from premium services, and
Diversifying the portfolio - reducing reliance on the economy or midscale segments
2. Taking the split between owned and managed to 30:70 from 60:40 currently
The company is focussing on opening mostly asset-light properties, where it only retains the management fees without owning the properties, leveraging its brand. This shift towards an asset-light model has several advantages:
No Capital Investment in Physical Assets - Reduces financial risk and increases operational flexibility
100% of management income goes to the bottom line - which enhances profitability and improves margins
Over the next four years, the company plans to double its room capacity (from ~10,000 to 20,000+), and the and the majority of this will be through an asset-light model only.
This will take the company’s portfolio of owned vs. managed properties to 30:70 by 2028, from the current levels of 60:40.
Can the Valuation Discount Go Away?
The improvement in Lemon Tree Hotels can translate into better financial metrics, resulting in potential re-rating.
While the move from economy to premium aids better ARR, higher revenue, and even better return ratios, the transition to an asset-light model is expected to enhance the company’s return ratios and bring down leverage.
Lemon Tree, using the above strategy aims to improve its ROCE from the current 16% to 20%, and achieve debt-free status by FY28.
Such a change in fortune might well catch the eye of investors, potentially leading to a re-rating of the stock, making this more than just another Lemon Tree!
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