The tourism industry in Brazil is on a high growth trajectory with rising disposable income among locals boosting tourism coupled with a steady increase in foreign tourists in an attractive holiday destination. The point is underscored by the fact that domestic arrivals in the Brazilian tourism industry have increased to 84.9 million people in 2012 from 49.6 million in 2010. During the same period, the international arrivals have increased to 9.2 million from 5.8 million. A major consolidation and upside in the Brazilian tourism industry is impending with the country being host to the FIFA World Cup 2014 and the Olympic Games 2016. With these growth triggers, the Brazilian tourism industry is certainly on a roll and can experience one of its best phases over the next few years.
Given the secular growth trends, this investment note discusses how the third largest hotel company in Brazil, Brazil Hospitality Group (BZHGY.PK) is set to benefit from the impendin g growth.
Strong Brand Association
The Brazil Hospitality Group has an exclusive contract with Golden Tulip Hospitality Group in South America which allows it to use the Royal Tulip (5-star), Golden Tulip (4-star) and Tulip Inn (3-star) brands. The Golden Tulip Hospitality Group is part of an international hotel company with more than 1,000 hotels in 40 countries. In July 2009, Golden Tulip was acquired by Starwood Capital, becoming part of the world’s 10th largest hotel chain. This contract gives Brazil Hospitality Group significant visibility and helps raise the hotel standards in-line with international standards. In the budget brand, the company has acquired Soft Inn, which offers an attractive cost-benefit relation for corporate tourism. Through these brands, Brazil Hospitality Group is well positioned in the hospitality market in the country.
Big Growth Plans…
Brazil Hospitality Group currently has 20 hotels u nder development throughout Brazil and the completion of these projects will add nearly 4,400 rooms by 2015. This will take the number of rooms offered by the Group to 13,077 from the current 8,691. Besides the organic growth, the company also plans to invest $136 million in acquisitions to increase the rate of expansion from 1,500 rooms annually to 1,800 rooms. I must mention here that the company has successfully invested $180 million since 2010 in eight acquisitions. If the company is successful in increasing the room expansion rate to 1,800 rooms annually, the revenue growth will surpass the 2010-12 CAGR of 36%, which came at a relatively lower annual room addition. It is worth mentioning here that the company already has 1,837 rooms under negotiation for acquisition according to the June 2013 corporate presentation. Therefore, it is very likely that the Brazil Hospitality Group will achieve its targeted room expansion for the next three years. The FIFA World Cup 2014 an d the Olympic Games 2016 will also ensure that the occupancy rate remains healthy. Of the total rooms as of 1Q13, the company has 43% of the rooms in the host cities of the FIFA World Cup 2014. Therefore, the company is well positioned to capitalize on the increased tourist inflow coming from a major event.
Are Adequately Funded
In May 2013, IFC, a member of the World Bank Group, became an anchor investor in Brazil Hospitality Group with a $25 million equity investment. During the same period, the company also closed a successful public offering of $200 million. The successful public offering ensures that the company is adequately funded to meet its acquisition and capital expenditure plans. Besides this, the company also has cash and cash equivalents of $13.6 million as of 1Q13.
In terms of financial flexibility, the company has a debt to capitalization of 27.9% and a debt to EBITDA of 4.0 considering a relatively moderate EBITDA growth of 20% in FY13 to $73 million Brazilian Real. Therefore, on the debt funding side, the company has sufficient financial flexibility and can leverage further for funding its expansion plans.
Key Operating Metrics Trending Higher…
Some of the key operating metrics of the company continue to improve indicating greater operational efficiency and the growth in pricing metrics. The company’s average daily rate has increased to 280.6 Brazilian Real in 1Q13 from 194.5 Brazilian Real in 2010. During the same period, the company’s revenue per available room has increased to 180.5 Brazilian Real from 125 Brazilian Real. This growth has translated into a robust improvement in EBITDA margin to 27.3% in FY12 from 8.7% in FY10.
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And Will Continue To Improve
Going forwa rd, as the company expands and as the hotel rates remain firm due to anticipated demand for rooms coming from mega global events, the EBITDA margin will sustain at higher levels. At the same time, the occupancy rate, which has averaged 64.9% in the last three years, should witness a significant bump-up in 2014 and 2016. I am certainly not suggesting that the company’s growth will be muted other than 2014 and 2016. Brazil’s hospitality market still has ample room for growth with the number of hotel rooms per 1,000 urban inhabitants at 2.5. This is miniscule when compared to 20 for the United States and 10 for the United Kingdom. Even China, which is an emerging market, has 4 hotel rooms per 1,000 urban inhabitants. Therefore, besides the growth coming from major global events, the underpenetrated local market also provides scope for growth in the long-term.
Monetization of Land Bank
The book value of the company’s land bank as of 1Q13 was approxim ately $71 million and the company’s investment value of the same land bank stands at $136 million. This is against a current market capitalization of $330 million. As the land bank does not provide for any cash inflow, its impact on the company’s valuation is negligible. However, the Brazilian Hospitality Group plans to monetize the properties either through development or sales, which will serve as an additional source of capital for acquisitions. As and when this happens, the incremental impact will be witnessed in the share price. Besides the land bank value stated above, the company has already completed deals for five of its properties. Two properties have been sold at book value, one property at a 96% premium over the book value and the valuation is yet to be announced for two other properties. With 13 remaining properties, the monetization spree can result in meaningful stock upside.
The Brazil Hospitality Group is well position ed to capitalize on the coming growth in the hospitality sector. Being the third largest hotel player in Brazil and being associated with global brand names like Golden Tulip, the company has an edge in the highly fragmented Brazilian market. Further, the aggressive growth and acquisition plans are well funded and the past records suggest that the company has successfully executed its strategic plans. Considering these factors and the growth drivers, Brazil Hospitality is certainly worth considering with a medium to long-term investment horizon. At a current price of $7.91, the stock trades at a price to book value of 0.9. As the company monetizes its land bank, the valuations will improve. Robust growth in revenue and EBITDA will also support valuations. Considering a conservative EBITDA growth of 20% for FY13, the company is trading at 14 times EV/EBITDA. With 12 new hotels to be operational in 2014, resulting in an addition of 2,200 rooms, a major bump-up in EBITDA would imply attractive current valuations. Further, the 2014 World Cup will also provide a boost to occupancy rates and key margins. Investors can therefore consider the stock at current levels with a first target time horizon of end-2014. The investment thesis can then be revisited for exploring further stock upside potential.
Finally, I would like to mention here that trading in the OTC market is not very robust. I certainly do believe that the stock will gain more visibility and trading volumes will improve in the future. However, foreign investors can buy stocks directly on the BM&FBOVESPA and the stock trades under the name of BHG and a trading ticker of BHGR3. The trading volumes are high in the Brazilian exchanges.