Why Covid-hit hospitality sector could attract strategic investors, increase deal flow

As the hotel industry is inherently capital intensive in nature with a long gestation period, historically, industry-wide debt levels for the hospitality industry has been high.

Why Covid-hit hospitality sector could attract strategic investors, increase deal flow
(Representational image – Westin Goa)

By Vishal V Singh, Siddharth Pal

The Indian hospitality industry was at the cusp of an up-cycle which started from FY16 through FY19. In FY19, the Indian hospitality sector was at an inflection point and was poised for strong growth led by healthy demand-supply outlook for the next couple of years with increasing disposable income and foreign tourist arrivals (FTAs). However, Covid-19 pandemic abruptly halted the Indian hotel industry upcycle. A marginal dip was witnessed in FY20, owing to the early impact of Covid-19 in Feb 2020 and Mar 2020. Hit hard by the repercussions of the Covid-19 pandemic, the Indian hospitality sector witnessed one of its lowest performances ever in FY21.

As the hotel industry is inherently capital intensive in nature with a long gestation period, historically, industry-wide debt levels for the hospitality industry has been high. With the onset of Covid-19, FY21 witnessed contracted revenues, massive operating losses resulting in increase in debt levels (companies opted for loan moratoriums and borrowed incrementally for liquidity and working capital). The economic fallout on account of the Covid-19 pandemic led to significant financial stress for hotel owners potentially impacting the long-term viability of many hospitality firms.

To tide over this period of financial stress, the RBI on August 06, 2020, allowed corporates to avail of loan restructuring for a period of two years, limited to debt distressed solely due to the Covid-19. However, most of the hotel companies couldn’t meet sector-specific benchmark/threshold ratios as set under RBI Resolution Framework and this framework could not provide much-needed succor to hotel players.

On June 07, 2021, RBI announced Emergency Credit Line Guarantee Scheme 3.0 (ECLGS) which provided 100% guarantee to member lending institutions offering fresh credit facility to its borrowers in the hospitality (hotels, restaurants, marriage halls, canteens etc.), travel & tourism, leisure & sporting and civil aviation sector. This liquidity should provide much-needed immediate support to cash-strapped hospitality businesses. However, the industry needs to brace for a much longer period of muted demand resulting from the pandemic with many sector experts pointing that sector to return to Pre-Covid levels by FY23/ 24.

It all wasn’t doom in the hotel industry. Some of the hotel players showed that they are nimble and adjusted their strategies to survive during the pandemic. In FY21, some of the listed players, witnessed changes in cost structures as hotels rationalized staff cost per room, focused more on increased automation and outsourced some of the non-core cost items. Some of these cost rationalization measures undertaken during the pandemic are expected to have a lasting positive impact on the operating profit margin of the hotels in the future. FY21 also witnessed increased share of F&B and ancillary services as hotels scaled up services such as food delivery (through online platforms) or leasing of kitchens for cloud kitchen requirement and offered extended stay options or staycation or workcation packages to guests. 

As per market feedback, FY21 has witnessed strong performance of leisure hotels with diversion of outbound leisure travel inside India. This has renewed interest of hotel companies on increasing footprint at leisure destinations to tap into the growing domestic demand. FY21 also saw a shift in customer behaviour and preferences- most customers now prefer branded hotels for their planned stay (rather than independent non-affiliated properties). Muted market conditions could lead to delayed openings in next few years and some property closures causing a shift in the supply dynamics or negative supply growth in the near term. 

These positive changes in the cost-revenue structure and impact of supply-demand patterns has provided a major boost to strategic players and investors who have a strong long-term vision of the hotel industry and are looking to expand their footprint in India.

Considering the financial stress in the hospitality sector which has been exacerbated with Covid-19, lenders and hotel owners could look for exit or ways to reduce debt. Lenders may initiate a spate of insolvency proceedings against hotel companies. There could also be opportunities for one-time settlement of loans in the hotel assets, trades on the hotel loan portfolio, proprietary transactions and strategic opportunities with banks and financial institutions. FY21 did not witness high profile hotel transaction activity, however, with extended weakness seen in the sector, gap between the bid ask and the offer prices is expected to narrow significantly and M&A activity in the hospitality industry could accelerate in FY22-23. There might also be opportunities to acquire suitable portfolio of hotel assets in key markets to grow footprint. With customer preference towards branded hotels, there could be a huge opportunity for Indian operators to enter into management contracts and focus on an asset-light model. Strategic players and investors with strong liquidity could benefit from a lower cost of acquisition and probably more favourable terms.

(Vishal V Singh is a Partner at Deloitte India and Siddharth Pal is an Associate Director at Deloitte India. Views expressed by the authors are their own.)

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