Aitken Spence Hotels’ refocused expansion

Aitken Spence Hotels built some iconic Sri Lankan resorts in the 1990’s before shifting attention to expanding overseas. Since the long conflict ended here, Spence’s hotel unit has refocused on growing its Sri Lankan business. Its challenge is to maintain shareholder returns as it grows its inventory by 50%

Pasikudah bay’s white sandy beach and shallow turquoise water are travel brochure worthy. Its legendary beauty attracted enterprising hotel investors keen to secure a foothold there when Sri Lanka’s long conflict ended. The bay’s beauty, they argued, would make the grueling seven-hour drive from the international airport to the Eastern coast worth it.

More than a dozen hotels, a few mid-market and many upmarket, completed construction in the past four years. Everyone who invested has been disappointed by the unwillingness of tourists to make the trip.

Lined up along the Pasikudah beach, two rows facing each other, is a development that could easily be mistaken for low-cost housing built for 2004 Tsunami victims whose homes were destroyed. But these Tsunami-housing resembling structures are listed Aitken Spence Hotel PLC’s part-owned and managed Amethyst Resort Pasikudah.

This acquisition is a wide departure for a company that owns unique five star resorts like Heritance Kandalama and Ahungalla, designed by renowned Sri Lankan architect Geoffrey Bawa.

It is difficult to imagine what Amethyst Resort, a 40-room hotel, adds to the group, other than stretching its reach to the east coast. Pasikudah is about 35 kilometres north of Batticaloa town. Its singular attraction is the long stretch of coastline, with shallow, clear water.

Gr-9But tourism is lacklustre due to inadequate infrastructure, especially the lack of a highway from the airport. Aitken Spence Hotels acquired a strategic 23% stake and management rights at Amethyst Resort and, with Stassen Exports and Distilleries Group, holds 51%. Billionaire businessman Harry Jayawardena controls the three firms. Amethyst was acquired from former parliamentarian Sajin Vaas Gunawardena, who still holds 38% of its equity.

This isn’t Spence Hotels’ only recent expansion. Ongoing projects in Sri Lanka and the Maldives will add 1,094 rooms to its current 2,051 rooms in Sri Lanka, India, Oman and the Maldives. Of these, almost 70% will be added in Sri Lanka. It’s a major jump for a hotel group that previously added its Sri Lankan properties very gradually.

Aitken Spence Hotels is a subsidiary of Aitken Spence PLC, which owns 71% of its stock. The holding company Aitken Spence PLC started business as a partnership in Galle between two Scotsmen in 1868. Initially, it was an export company, but later became insurance firm Lloyd’s of London’s agent in Colombo Port and then expanded into shipping, travel and plantations. The company was listed in 1983. Today, Harry Jayawardena controls it.

Entering the hotel trade with two Bawa-designed resorts, Hotel Neptune in Beruwala (now Heritance Ayurveda Maha Gedara) in 1973 and Hotel Triton (now Heritance Ahungalla) in 1981, Spence’s hotels unit took an early lead among local groups when it opened the iconic Kandalama and Tea Factory Hotels in 1994 and 1995.

But for the next twenty years, it mainly added hotel properties outside Sri Lanka. It had ventured into the Maldives in 1993 – the first Sri Lankan firm to do so – and added four more resorts there. It also secured management rights in a number of hotels in India and Oman. By 2014/15, the Sri Lankan sector earned less than 30% of the hotel unit’s revenue.

Meanwhile, other companies caught up in Sri Lanka. John Keells Hotels, a subsidiary of Sri Lanka’s most diversified group, JKH, added to its Cinnamon and Chaaya brands. The unlisted, family-owned Jetwing Hotels sharply increased its properties, including unique resorts like The Lighthouse Hotel and Vil Uyana. Amaya Resorts & Spas also grew. By 2014/2015 – excluding Spence Hotels’ current expansion–Keells Hotels had far more rooms in Sri Lanka, with 996 versus Spence Hotels’ 743.

Stockbrokers Bartleet Religare and CT CLSA both select Spence Hotels as the current stock pick among hotel groups

Spence Hotels owns or operates five Maldivian resorts and eight Sri Lankan resorts today, including five resorts each under its rebranding as “Heritance” in Sri Lanka and “Adaaran” in the Maldives, as well as Hotel Hilltop, The Sands, Amethyst Resort, Bandarawela Hotel and Earl’s Regency. It also manages six hotels in Oman. Its most recent venture is the “Turyaa” brand, designed to attract young, tech-savvy travelers.

Keells Hotels includes three Maldivian properties and two Sri Lankan city hotels – through JKH’s holding in Asian Hotels and Properties – and eight resorts. This leaves the group even at 13 properties, with about 1,350 rooms each. With over twenty properties, Jetwing Hotels has surpassed these groups’ numbers, but some are only managed properties.

Spence Hotels is currently performing better than Keells Hotels. The former’s revenue grew at 13% over the 2012-15 financial years, though its top line increased only marginally in the last financial year to Rs13.3 billion while profit after tax dropped 2% to Rs3.4 billion. Its gross profit margin was at 81%. In contrast, Keells Hotels earned Rs11.4 billion revenue and Rs2 billion profit after tax.

Gr-10Stockbrokers Bartleet Religare and CT CLSA both select Spence Hotels as the current stock pick among hotel groups. In an October note to investors, Bartleet Religare had a buy recommendation on the stock. CT CLSA, which doesn’t publish recommendations, is optimistic about Spence Hotels’ long-term performance.

“Because it’s the only one with a real growth story,” explains Ryan Jansz, who covers Spence Hotels at CT CLSA. “Everyone else is also doing something because everyone wants a piece of the pie, but they’re not aggressive at all compared to Spence.”

In addition to the new Pasikudah property, Spence Hotels has recently acquired and refurbished a 143-room five star hotel that it markets as Turyaa Chennai, its first Indian property, as well as its first owned city hotel.

Tourist arrivals have grown year on year in every month in 2015 and topped 1.5 million by end-October versus 1.4 million total last year

The hotels group has also partnered Spanish resort developer and operator RIU, which has more than 100 resorts in tourism hotspots from the Caribbean to the Mediterranean, for a 500-room five star resort costing $100 million in Ahungalla. This will be operated on a charter flight-centered model – for the first time since Sri Lanka’s prewar charter flight tourism. RIU’s owner, the TUI Group, operates a fleet of charter aircraft, which will fly mostly European tourists to the hotel. The RIU-branded, RIUoperated hotel will open by the end of 2016.

Spence Hotels has also added a 90-room wing to The Sands, a hotel it owns in Kalutara, which will double its room count. The hotel group has also demolished Browns Beach Hotel to build a 143-room five star resort, Heritance Negombo, where it holds 37% equity and handles management. Spence Hotels has also leased two new islands in the Maldives to boost the group’s room count there by 360.

The hotel group’s long-term debt almost doubled to Rs5.4 billion in 2014/15. “Our gearing remains low,” says Tilak Gunawardena, Spence Hotels’ Chief Financial Officer. “Of course, we have earmarked some property specific funding requirements and equity infusions required for our planned strategic expansion.” He points out that the firm’s cash flows and reserves have been adequate to sustain ongoing routine capital investment. “Our reserves are used for expansion. We have a 60:40 structure, 60% equity is close to Rs4 billion, and we’ve borrowed close to Rs2 billion.”

“Net debt to equity isn’t very high,” points out Jansz. “Net cash from operations for 13/14 and 14/15 was Rs4.4 billion and Rs4.7 billion, so internal cash flow is sufficient to service debt.”

The hotel group has also borrowed on attractive terms. The average interest on US-dollar-denominated debt is LIBOR plus 2%, which effectively is a rate below 3%.

Gr-12Spence Hotels seems to be preparing the most among Sri Lankan hotel owners to cater to expected tourist growth. Tourist arrivals have grown year on year in every month in 2015 and topped 1.5 million by end-October versus 1.4 million total last year. The government target is for 4.5 million tourist arrivals by 2020.

But recent growth has been driven more by budget travellers, as shown by the boom in ungraded, low-budget establishments. This will challenge Spence Hotels’ new properties – other than the 500-room charter flight-centered one, which will benefit from RIU branding and its already-established network. “Budget travellers don’t visit hotels like these,” says Jansz. “Especially in the south, the company faces a lot of competition from ungraded establishments.”

He adds, though, that hotels like Heritance Ahungalla have still managed to do well with 70% to 80% occupancy rates because they have a lot of repeat customers. “People are almost on a first name basis with the staff there,” he says.

Gunawardena says that the company maintains relatively healthy occupancy, despite the pressure on the average rates at beach properties, highlighting the strength of their unique portfolio. “We’re very selective in choosing our projects.” In addition to the Bawa-designed hotels, the company’s Heritance Ayurveda Maha Gedara is a dedicated Ayurveda resort, while the Heritance hotel in Nuwara Eliya district is a tea factory converted into a hotel, where everything from activities to the menu are inspired by the century and half old Sri Lankan tea industry.

The inventory increase, especially along the beach, is impacting the group’s yield. Occupancy may be good, but competition is squeezing rates. On room rates and occupancy, John Keells Hotels beats Aitken Spence Hotels.

Maldives occupancy hovered around 90% for both groups, but John Keells beat Aitken Spence in Sri Lanka with 85% versus just 70%. John Keells also had higher average room rates in both countries, with $400 in the Maldives versus Aitken Spence’s $336 and $132 in Sri Lanka versus $122.

Gr-11The government may well take steps to attract higher spending tourists, as indicated by the Prime Minister’s comments in his recent Economic Policy Statement. “We expect a shift in tourism trends, with higher-spending tourists constituting 2.5 million of the 4.5 million expected by 2020,” says Jansz. In that scenario, Spence Hotels will reap the rewards of its current forward-thinking expansion. As such, it may be the best investment prospect in the medium-term. Its return on equity fell almost a fifth in
the 2015 financial year, but at 13.8%, is higher than Keells Hotels’ 9.7%. “The share has been range-bound during the past four years,” says Jansz. “We tell investors that, if they’re looking at short-term gains, they’re better off with stand-alone hotels like Club Hotel Dolphin or perhaps Hotel Sigiriya. But in the medium term, Spence Hotels is the way to go. Looking at a medium-term horizon, putting large chunks of money into a stand-alone hotel doesn’t make much sense. So, overall, Spence Hotels is our pick because the expansions will start bringing in revenue only after two to three years.”

The tourism sector currently seems to be overvalued, analysts warn. Most of the good news was priced in immediately after the war, along with the rest of the market. The sector’s earnings multiples have continued to climb and are at 23 times now, well above the market. “We think the sector is overpriced,” says Jansz. “That said, recently Spence Hotels’ share price has corrected. On fairly large institutional selling,
it came down and is hovering around Rs67 or Rs68. On those prices, on our estimates, we’re looking at high-single-digit forward multiples. It’s relatively cheap, compared to the other hotels, given that this group is the one with the strongest growth story.”

Spence Hotels’ price to earnings was at 10 times in 2014/15 versus Keells Hotels’ 11.3 times.

The tourism sector currently seems to be overvalued, analysts warn. Most of the good news was priced in immediately after the war, along with the rest of the market

Spence Hotels is struggling to open the hotels in its pipeline on schedule. Licensing issues have delayed Turyaa Chennai’s opening from its planned July 2015. The company expects to open by year-end. Heritance Negombo – the former Browns Beach, which was demolished and replaced by a 143-room property costing Rs5 billion – was also due to be open for business sooner. The new deadline is April 2016.

The hotel group is also exploring more opportunities in Sri Lanka, with a focus on developing its existing land bank. Attractive property it owns includes those in the Galle Fort and Beruwala, and parent company owned land in Trincomalee.

As for Amethyst Resort, the purchase doesn’t indicate that Spence Hotels is looking at catering to a different kind of traveller. “Most of our properties are in the four to five-star range,” says Gunawardena. “Our present portfolio doesn’t include the really low end of the market. Having said that, we want to see a mix that aligns with our overall strategy. The strength of our portfolio is our unique properties, so we’d like to maintain that.”

Spence Hotels’ initial plans to upgrade Amethyst, bringing it in line with the rest of its hotels, have been shelved. Analysts believe that the company will invest in the property once the area gains popularity with tourists. “It’s a lovely place,” says Gunawardena. “It’s currently not getting what it deserves as a destination. But it’ll be better in the medium-to-long term once there’s improved infrastructure and connectivity, with the government´s fresh emphasis on north-east development.”