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Lemon Tree Hotels: Squeezing Success ๐Ÿ‹

Updated: Apr 10

4,35,000 - thatโ€™s the number of passengers in India that travelled by plane on just one day in December 2022, making it the maximum amount of domestic air traffic since pre-COVID levels (4,20,000)! Tourism is definitely back in business after a major setback caused by the pandemic, and with the desire to fly to various places comes to need to stay somewhere.


Enters Lemon Tree Hotels - a name that has become increasingly popular among the affordable range of hotels for travellers, and we think they have something else that is affordable and can make you money - its stock!


The stock was listed at around Rs. 61 in April 2018 and has made its investors only 28% over a period of 5 full years. You could have made more money with a fixed deposit. But wait, this company has gone through a complete shutdown of operations during the pandemic, when the stock lost 3/4th of its value, and has come up 4x from there.


Now that things have stabilised, and more people are travelling again than before the pandemic, this stock can be re-looked at - there seems to be more to squeeze out from this lemon!


Hotels are a Hit ๐ŸŽฏ

Hospitality was hit badly during the pandemic. Occupancy rates (percentage of occupied rooms at a given time) dropped from 66% to 35% in FY21. But that storm has passed, and owing to several factors such as discretionary travel, retribution tourism, pick-up in business and industrial activity, and cultural events, the demand for hotels in India is surging.


These factors have cumulatively contributed to the revival of the hospitality industry in India, indicating a positive outlook in the foreseeable future, with the occupancy rates already back up to 55% in FY22. In fact, industry-wide expectations suggest that demand may outpace supply over the next few years - with demand set to grow by a 10% CAGR over FY23-27, compared to a supply growth of 4-5% CAGR over the same period (Source: HVS Anarock).


As we know, whenever demand exceeds supply, prices rise - and the industry might see an uptick in the average rates of rooms, occupancy rates and therefore the revenue per available room (total revenue from rooms/number of available rooms) - all of this is good news!


๐Ÿฅ‡ While this might look like an industry-wide positive, we believe that there is one player that will stand out of the crowd - Lemon Tree Hotels!


Lemon Tree: Sour No More ๐Ÿ‹

With over 85 hotels and more than 8,400 rooms under its brand, Lemon Tree Hotels has shown remarkable resilience in the face of a pandemic. Being the largest mid-priced chain and the 3rd-largest overall hotel chain in India, it has managed to garner a 17% market share in the hotel business in India.


Its value-for-money approach has worked well for it since its opening in 2004, and it seems to be poised to capitalise on market revival better than its competitors can!


1. More Rooms = More Money

Logically, if a hotel business needs to get more revenue, it just has to add more rooms so that it can host more customers - and Lemon Tree is doing just that!


For context into how logical it is, Lemon Treeโ€™s revenues grew at a CAGR of 18% over FY18-20 mainly driven by an 18% increase in the room inventory over the same period!


Therefore to replicate and accelerate the growth, Lemon Tree Hotels plans to add another 2,800 rooms by March 2025, taking its total count to more than 11,000.


The addition of these rooms will result in an increase in the company's capacity to serve more customers, thereby leading to those higher revenues!



2. Changing Product Mix

The second key driver after capacity is pricing. For Lemon Tree, the Average Rate per Room (ARR) for 9MFY23 has been Rs. 5,150. We expect this number to rise significantly supported by both the rise in demand and the upscale-focused expansion.


For example, Aurika Hotels (an upscale hotel in the Lemon Tree brand) is seeing significant expansion compared to other chains under Lemon Tree, as seen above, which will grow from 2% of the current number of rooms to 8% by 2025!


These upscale hotels clock in ARRs in excess of Rs. 10,000, and with 30% of total expansion being in this segment, we will see the average rates of rooms increasing as a whole, fuelling the possibility of higher revenue growth.


3. Higher Occupancy

Lemon Tree clocked in an impressive occupancy of 77% during 3QFY23, significantly higher than the All-India Average of 60%!


With the increased demand and the supply being added to accommodate it, these occupancy rates might just increase or stay at these highs, both being positives for the company.


4. Improving Margins

While a higher number of rooms, better rates and higher occupancy contribute to higher revenue growth, they also make a big difference in the profitability of hotels.


With all three improving, Lemon Tree's EBITDA margins have skyrocketed from 16% in FY19 to 50% in 9MFY23.


Additionally, to aid margin improvement, Lemon Tree has also taken some massive cost-efficiency methods:

  • Efficiency measures during COVID-19, including cross-training staff across departments and reducing employee count by 10-15%

  • The "Skills on Wheels" program, where employees are trained in different skills and departments, leads to better flexibility. This has reduced the staff cost from 24% of revenue in FY22 to 16% in 9MFY23!

  • "Lemon Tree Kitchen" program, which focuses on optimising menu offerings and reducing food costs, leading to a reduction of 15-20% in the same. Food costs reduced from 7% of revenue in 3QFY22 to 5.6% in 3QFY23, a quarter-on-quarter development!

5. Asset-Light Growth

Despite the high margins, hotels often face the issue of lower return ratios. After all, they have to support all that expansion using funds - equity, debt and/or internal cash accruals.


If you were wondering how Lemon Tree affords this massive expansion, don't worry! It isnโ€™t buying all these rooms and properties anyway.


74% of the expansion will be through the asset-light management contract/franchise route - meaning it will manage hotels on behalf of the actual owners of the hotel, making this a load off its balance sheet.


Additionally, the company's mix of managed rooms has improved, with the mix of these managed-but-not-owned rooms increasing from 32% in H1FY20 to 39% of the total rooms in 1HFY23.


This is a positive development for the company as it indicates a shift towards a more asset-light growth model, which will enhance the company's profitability in the long run.


Valuation๐Ÿ’ฒ

Strong results can be expected from Lemon Tree based on more rooms, higher occupancy, increased ARR, a changing product mix, and continued cost leadership. It has the potential to deliver a revenue CAGR of 27% and PAT CAGR of 36% from FY23 to FY25E.


We have valued the company at 15x EV/EBITDA to FY25E (currently trades at 12x EV/EBITDA to the FY25E) setting a target price of Rs. 110 giving it a 40% upside potential over current levels. The higher target multiple can be attributed to:

  1. EBITDA growth accelerating - from an EBITDA CAGR of 7% over FY13-22, Lemon Tree is set to deliver a 24% EBITDA CAGR over FY23-25E.

  2. Better placed versus competitors - peers like IHCL and Chalet trade at an EV/EBITDA of 13x on FY25E estimates. We think Lemon Tree will trade at a premium to peers given its (i) asset-light model, (ii) growth in the upscale to midscale segment, and (iii) higher occupancy compared to peers.

Clearly, we can make some stock market lemonade out of this stock, or you could just order it through room service at your nearest Lemon Tree Hotel!



Disclaimer: Investment in the securities market is subject to market risk. Read all the related documents carefully before investing. The securities quoted are for illustration purpose only and are not recommendatory.

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