Was looking at the latest results of the hotel industry. The headlines are screaming about the triple digit growths and the tight demand supply situation. The rise in tourist inflows / good business climate are being cited as the reason for the optimism.

I am not too excited by the results or by the economics of the hotel industry. It is typical commodity industry. Some companies have good brand names, but do they have a strong franchise. What i mean by that is, can these companies charge a premium price? . Taj and others can charge a premium compared to the other hotels, but when there is excess supply, the typical occupancy rates and ARR (average room rents) suffer. During such period the margins drop and due to the high fixed costs , even the best of the companies can barely remain in black.

So over a complete business cycle most of the companies in this sector can barely cover their cost of capital. The asset turnover ratios are very low and so to earn a return over their cost of capital, most of these hotels need to maintain a Net profit margin in excess of 10 % ( a tall task when times are bad).

On the contrary this industry looks almost like the steel, cement and the other commodity industry, where only a low cost producer like gujarat ambuja or Tata steel can be profitable over the long term. Can’t think of any such hotel company …

Compare this with the FMCG/Pharma/IT and most of these companies even during a downturn, earn over their cost of capital.

As a side note, ITC seems to be investing their cash flows from ciggarette business to hotels, Paper and FMCG which are businesses with poor economics. Granted , that the company is getting growth, but is it profitable ( doesnt seem to be as of now)?

2 Comments

  1. sandy says:

    why do companies like itc love unprofitable growth…..the company shows a 110% roic in the cigarette business then why doesnt it returns the money to its shareholders instead of investing it in business with low returns?

    wat drives the business managers to follow such kind of unprofitable growth plan.

  2. Rohit Chauhan says:

    managers get paid by the size of the company. also it is gratifying to the ego to run a large company with average returns than a small company with high returns.
    so managers tend to throw money to increase their domain than return money to shareholders

    regards
    rohit

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