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City Lodge Hotels: a share to hold

Doing all the right things for long-term growth

City Lodge Hotels offers the best of both worlds: a healthy dividend (a dividend yield of 3.3%) coupled with growth expected to come from the construction of new hotels in and outside SA.

The share has traded at a premium to its peers and the market for the past five years. This is supported by City Lodge’s consistence in performance. However, we believe a lot of value will be realised in the medium to long term, particularly if the economy picks up. In the interim, its growing interest rate bill, as City Lodge accumulates more debt to finance its huge capex requirements, will constrain the bottom line. Therefore in the short to medium term the share looks fully valued.

The company has stuck to its payout ratio of 60% – despite its heavy capital expenditure requirements. So in order to meet capex it leverages off its credit facilities, combined with its own cash resources, to purse an organic growth strategy. This has set a platform for handsome rewards in the medium to long term. The balance between debt and equity drives its valuation up as the cost of debt is lower, which translates to a lower weighted average cost of capital. The net debt:equity ratio stands at 23% from 18% previously.

The World Travel and Tourism Council has forecast that SA tourism will grow at an annual rate of 4.3% compared with 4.9% for the rest of Africa in the next decade. However, with the enactment of SA’s draconian visa laws this growth might be difficult to come by. This is a concern for City Lodge as it derives 90% of revenue in SA. However, it is growing its exposure in countries such as Kenya, where the policy framework is supportive of tourism. Africa’s contribution to group revenue has increased remarkably to 10% from just 3% in FY14. The Ebola epidemic does create uncertainty and recent reports suggest that it is proving difficult to eradicate.

Group revenue grew 22.6% to R1.3 billion for the year to end-June. Notable contributions also came from new SA hotels that became fully operational in February, and from the acquisition of Hospitality Property Fund’s 50% stake in the Courtyard joint venture with effect from May 1 – which was consolidated for the last two months. Operating profit climbed 27% to R453.2 million. But interest expenses escalated 168% as a result of additional debt to fund the ongoing construction, with interest-bearing debt rising 35% to R250 million. As a result the net debt-to-equity ratio rose to 23% from 18%. This took a chunk out of headline earnings which grew only 12% to 722.8c/share. A final dividend of 230c/share was declared, bringing the total dividend for the year to 460c/share, an increase of 17.7%.

According to Forwardkeys, a travel data intelligence company, the local tourism industry recorded an 11% year-on-year decline in international arrivals from June to August. World Travel and Tourism Council CEO David Scowsill says he has no doubt that is due to the new visa regulations. Although the Reserve Bank and tourism ministry have spoken openly against the new visa laws, other sections of the government maintain the cause is the vestiges of the Ebola epidemic that has hit western parts of Africa.

City Lodge is a pure hotel play. We like the way the group has managed to grow room occupancies in this tough trading environment, characterised by poor economic activity, ahead of its peers. It is worth noting that these peers generate significant income from gaming, an area City Lodge can always tap into – though it has not indicated that it has any plans to do so. But with its growing geographical spread the group could complement its hotel income and leverage off its existing real estate by introducing gaming. So there is potential for additional growth at a relatively low cost.

The company has authorised capital commitments of R1 billion and anticipates spending R499 million in FY16. It has cash resources of R85 million. In the year under review it generated R232 million (FY14: R183 million) in cash from operations. We can roughly deduce that 50% of this might be funded by borrowing – it has a borrowing capacity of R890 million. However, management says the current developments are set to increase capacity by 15%.

We like the value and growth blend proposition of the group. However we think the share price is fully valued, though the valuation should improve as economic prospects get better.

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Bull factors

  • Local expansion enables group to capture market share from higher-end competitors as poor economy forces consumers to trade down
  • Significant market share with well-established brands
  • African expansion will enhance earnings diversification and position the company to participate in Africa’s growth

Bear factors

  • Increasing financial gearing could undermine both earnings growth and cash flows
  • High degree of revenue concentration in domestic market, though this is being addressed through African expansion
  • SA’s new draconian visa policy
  • Depressed commodity prices and threat of Ebola

 

2015A

2016E

2017E

2018E

Revenue(R’m)

1 303.1

1 479.0

1 626.9

1 789.6

Normalised EBITDA (R’m)

539.5

623.7

683.5

740.3

Normalised PBT (R’m)

394.7

457.8

501.3

541.4

Normalised attributable income (R’m)

318.3

327.8

358.9

387.6

Normalised headline earnings per share ( cents)

722.8

756.0

827.8

894.1

PER(times)

19.4

18.5

16.9

15.7

 

Nature of business: City Lodge Hotels operates hotels targeted at both business and leisure travel. It operates 54 hotels under five brands: Fairview, The Courtyard, City Lodge, Town Lodge and Road Lodge, with more than 6 700 rooms

Disclosures: The analyst has no financial exposure to the instrument discussed. The opinion represents his true view.
Analyst: Phibion Makuwerere; Editor: Colin Anthony

 
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