Having listed on the Alternative Investment Market (Aim) in June 2014, raising £24m of capital to invest in development and operation of owned hotels, progress to date has been painfully slow. So much so that in the summer the board was overhauled and beefed up significantly.
The appointment of Guy Parsons as chief executive four months ago was quite a coup. As former chief executive of leading budget hotel chain Travelodge, he grew that business to over 500 hotels in the UK, Ireland and Spain. The company has also appointed a vastly experienced new finance director, Marc Vieilledent. He joins the company having spent 16 years at Accor where he was responsible for strategy, real estate and acquisitions. Non-executive director Jonathan Lane, the former chief executive and current non-executive chairman of Shaftesbury (SHB), a FTSE 250 real-estate investment trust, takes the role of chairman. Other appointments include a new head of marketing, a dedicated franchise director, and an operations director who has over 18 years experience in the industry.
These are major management changes and I strongly feel the new broom shows the company means business. Mr Parsons is backing himself with his own money, too, having purchased 70,000 shares in the company post last week's full-year results. It's a lead worth following because there were a number of green flags in those results to suggest the expansion of the estate, and value creation for shareholders, is now set to accelerate.
Currently, easyHotel owns three hotels outright in the UK and has 18 franchised operations across Europe. The owned hotels comprise 390 rooms and are located in Croydon, Glasgow and on the fringe of the financial centre in London. The 18 franchise hotels have a total of 1,490 rooms and are located in 12 European locations: Bulgaria (Sofia), Czech Republic (Prague), Germany (Berlin, Frankfurt), Hungary (Budapest), The Netherlands (Amsterdam, Rotterdam, The Hague), Switzerland (Basel, Zurich), UAE (Dubai), and the UK (Edinburgh).
Both parts of the business are already profitable: the owned hotels generated pre-tax profits of £1.76m in the 12 months to end-September 2015 and the franchised operations posted a profit of £880,000. Both figures are before accounting for central overheads of £1.48m. But the key to driving a major re-rating of easyHotel's share price will be a ramp up the new hotel openings to scale up the operation.
Scaling up the owned-hotel business
This is exactly what the new board are doing, having identified the potential for 12,000 owned easyHotel rooms, two-thirds of which are in over 30 cities in the UK, the remainder being in key gateway European cities.
Market research is supportive of an accelerated expansion programme, too. According to researchers at Melvin Gold Consulting, the branded budget hotels market in the UK is expected to grow from 137,000 rooms to 180,000 rooms by the end of 2020, rising to 215,000 by the end of 2030. This represents a 3 per cent average annual increase over the next 15 years, with a similar long-term trend expected to materialise within the rest of Europe. Furthermore, established budget hotel chains are gradually increasing their room rates leaving a gap in the market for a truly budget offering. This explains why the share of branded budget hotels in the UK hotel market is set to rise from 19 per cent to 25 per cent by 2030. That's not as ambitious as it first appears because branded budget hotels are underrepresented in the UK compared with other mature markets. For instance, this segment controls 31 per cent and 24 per cent, respectively, of the hotel market in the US and France.
And with average revenue per available room (RevPar) of £30 a night on its owned estate, easyHotel offers a compelling value proposition to guests. Price aside, the company's key differentiating strengths in its hotel offering are location (hotels are located where people actually want to stay); accessibility (they are easy to get to and do business with); and customer experience predicated on offering well-designed rooms, and hotels manned by well-trained staff. Research highlights that almost three-quarters of bookings are made based on location and then price in terms of the priority of guests.
Bearing this in mind, the company will open new hotels in Manchester and Liverpool early in 2017, having acquired the sites this year, which will add a total of 193 rooms to the owned estate. Including site acquisition, the total costs of these two hotels is £9m. But analysts now believe that the company could ramp up the wholly-owned estate by 300 rooms a year, by focusing on buildings or sites with potential for 100 room hotels, representing a threefold increase on previous guidance. easyHotel's board can certainly afford to do so as the company had cash of £22.64m on its balance sheet at the end of September 2015. Bank borrowings were unchanged year-on-year at £7.2m, charged at a reasonable interest rate of Bank of England base rate plus 1.94 per cent, so net funds of £15.4m currently account for nearly half net asset value of £32.4m, and about 30 per cent of its current market capitalisation of £51.7m.
Rolling out the franchise
There is also scope to ramp up the franchise operation and not just the earmarked 4,000 rooms in the UK and Ireland as the new board have identified potential for 15,000 easyHotel rooms in Europe and the Middle East. In fact, the company has just entered into a partnership agreement with MAN Investments LLC, a UAE-owned commercial and investment group, to develop easyHotels in the Middle East with a focus on new developments in the UAE and Oman. The new easyHotels are expected to comprise new purpose-built assets and conversions of existing hotel or office buildings.
Initially, the development programme will target an opening of 600 rooms by 2017 with easyHotel entering into a franchise agreement for each hotel. MAN Investments has already secured land or properties which will accommodate the 2017 openings and its first hotel will be a 300-room easyHotel built in the Bur Dubai area of Dubai, widely recognised as being the trading hub of Dubai and the UAE. Following these initial openings, MAN Investments will target at least another 1,000 rooms by the end of 2020. Prospects look promising given the positive backdrop of ongoing growth in the UAE and Oman and, in particular, the government's support for building budget hotels ahead of Dubai hosting the World Expo, Expo 2020. The Dubai Ministry of Tourism is targeting growth of more than 30 per cent in inbound tourism by 2021, which if achieved will see 20 million tourists visiting the region annually.
In Europe, a new 107-room easyHotel franchise will open in Brussels in January 2017. The hotel is ideally located within five minutes walk of the central Grand Place and will be the first easyHotel in Belgium. The company's recently appointed franchise director is tasked with overseeing and exploiting the value in the brand to develop this side of the business and will be working closely with existing and new franchisees in this regard. These hotels will be predominantly 50 to 100 rooms each and in locations where easyHotel has no intention to develop an owned hotel.
Accelerated expansion not in the price
Given that easyHotel's market value of £51.7m is only £19m higher than its last reported net asset value, and the company has net funds of over £15m on its balance sheet, then the likely value creation from a successful franchise and owned hotel roll-out programme is not fully reflected in the price.
In fact, property assets are held in the balance sheet at £21m, being the book value of the Glasgow, Croydon and Old Street hotel in London. However, having added 70 new rooms to the Old Street hotel in April 2014, analysts at Liberum Capital believe the valuable property is worth between £20m to £25m. It's in easyHotel's accounts at £14m and was last valued at £18.65m in June 2014. That valuation is reassuring to know if Islington Council's decision on easyHotel's retrospective planning consent for the Old Street expansion, expected in 2016, proves unfavourable.
There is hidden value in the Croydon site, too. That's because two years ago easyHotel was granted a lease of the Croydon property for a term of 999 years and at a nominal initial rent of £25 per annum upon payment of a premium of £1.6m. The company then spent £1.9m on developing the 103-room hotel that is located next to East Croydon railway station. The 125-room hotel in Glasgow site is in the books for £2.75m.
So, I believe these three owned hotels could easily have a market value of £31m, or £10m more than their book value in the accounts. This means that after factoring in cash on the balance sheet the franchise operation is being attributed a valuation of only £5m in the company's current market valuation despite the fact that the operation has just posted a full-year pre-tax profit of £880,000.
Moreover, based on the conservative assumption that easyHotel doesn't open any more rooms beyond Liverpool and Manchester between now and the end of September 2017, and 300 rooms each year thereafter, analysts at Investec still believe that its cash profits will treble to £4.3m by the 2019 financial year to deliver EPS of 3p. On this basis, they value the equity at 100p a share. However, in a bull case scenario whereby the company rolls out 600 rooms a year from 2017 onwards, cash profits would surge to £11m by the 2019 financial year to deliver EPS of almost 9p, or nine times higher than the EPS just reported for the 2015 financial year. On this basis, they value the equity at 189p.
Risks, but potentially huge rewards
Of course, the board have to execute the roll-out successfully, but I believe that given their experience the odds of a favourable outcome are good. It's also worth flagging that the hotel industry is cyclical, but even this plays into easyHotel's hands as guests are more likely to be price-sensitive in any downturn. And with such low hotel rates, the value proposition is hard to beat on price no matter what the economic backdrop.
Liquidity is worth considering because easyGroup Holdings, a company ultimately controlled by the Stelios Trust, a Cayman Islands trust established for the benefit of Sir Stelios Haji-Ioannou, is the principal shareholder in easyHotel and holds 55.7 per cent of the share capital. In addition, Polar Capital has a 12.9 per cent stake and Schroders Investment Management a further 5 per cent. This means that 73.6 per cent of the 62.3m shares in issue are held by these three parties which accentuates price moves. That said, given that I expect a steady stream of positive news on new site acquisitions and franchise agreements, both of which will be highly supportive of the investment case, the risk looks to the upside.
So with the benefit of a new management structure and accelerated business model, I feel a value of the company's equity nearer £63m, or 100p a share is appropriate. There's a small dividend, too. It's worth noting that the share price has risen post last week's full-year results, so although I would still recommend buying around the current price of 83p given there is still potentially 20 per cent upside, I would be disciplined. On a six-month basis, I rate easyHotel shares a buy.
Please note that for a limited period of time, my book Stock Picking for Profit is being offered for sale at a promotional price of £11.99 plus postage, subject to availability, full details enclosed below.
MORE FROM SIMON THOMPSON...
I have published articles on the following companies since the start of last week:
■ UK housebuilding sector: Buy and hold until end March 2016 ('Time to start building once more', 7 December 2015)
■ GLI Finance: Recovery buy at 35p ('Refinancing for GLI Finance', 9 December 2015)
■ Ensor: Hold at 90p and await news of disposals; Renewable Energy Generation: Await capital payout of 60p a share in January 2016 ('M&A updates', 9 December 2015)
■ Non-Standard Finance: Buy at 89p and take up open offer; Arbuthnot Banking: Buy at 1,530p, break-up value 2,200p ('Speciality finance plays', 9 December 2015)
■ Bilby: Buy at 132p, new target range of 150p to 160p (‘Bilby set for new highs’, 10 December 2015)
■ 600 Group: Hold at 13p, medium-term fair value target of 24p (‘European markets hit 600 Group’, 10 December 2015)
■ Vislink: Hold at 28p (‘Vislink’s sales fall short’, 10 December 2015)
■ For a limited period and strictly subject to stock availability, Simon Thompson's book Stock Picking for Profit can be purchased online at www.ypdbooks.com at a special promotional price of £11.99, plus £2.95 postage and packaging, or by telephoning YPDBooks on 01904 431 213 to place an order. It is being sold through no other source. Simon has published an article outlining the content: 'Secrets to successful stockpicking'
