It’s a major vote of confidence in the ability of the board led by chief executive Guy Parsons, the former chief executive of leading budget hotel chain Travelodge, to scale up the company’s hotel development programme and deliver hefty returns for shareholders. The investment target is a 15 per cent return on capital employed on an unleveraged basis.
It’s making good progress since the Aim flotation in 2014, having secured five owned hotel developments and increased the number of owned and franchised hotels operating under the brand. easyHotel currently has a hotel portfolio of 1,795 rooms consisting of two wholly owned freehold hotels, one long leasehold hotel and 17 franchised hotels, boasting a presence in 13 cities across eight countries.
In the owned hotel market, the board has identified the potential for 12,000 easyHotel rooms, two thirds of which are in over 30 cities and Greater London in the UK, and the remainder in key gateway European cities. In the short term the owned hotel development expansion will focus predominantly on the UK market which has experienced 3.7 per cent growth in revenue per available room (RevPAR) during July and August, driven predominantly by 'staycations'. Weaker sterling exchange rates and the risk of terrorism has reduced demand for some overseas holiday destinations, while also increasing inbound tourism, a trend that’s expected to continue.
Ramping up the development programme
Since the flotation, the company has acquired five owned hotel development projects, representing 576 committed owned rooms. It is investing £17.4m to develop four hotels in the UK, of which it had invested £4.59m by the end of the first half, in order to double its hotel stock to 760 rooms by July next year. These hotels are located in Liverpool, Birmingham, Manchester and Ipswich.
Currently, easyHotel has an estate of 390 rooms across three wholly owned hotels located in Croydon, Glasgow and in Old Street, on the fringe of the financial centre in London. Funding for the new hotels will primarily come from drawing down some of the £15.5m of cash on its balance sheet at the end of August this year, and from additional bank lending. easyHotel has a bank loan of £7.2m outstanding and due for repayment in January. The company is in negotiations with its lenders to secure a larger five-year term facility of £12m on an attractive margin of 2.5 per cent above LIBOR.
The company’s fifth opening, a 204-room owned hotel in Barcelona, the 12th most visited city in the world, is by far the largest of the five new owned hotels and is costing €15m (£13m) to develop. The scheduled opening is slated for early 2018. The site is located on Gran Via, the main avenue of L'Hospitalet de Llobregat, with easy access to Barcelona City Centre and Barcelona Airport. It has good transport links, with a train and Metro station adjacent to the proposed hotel, and is within walking distance of the Gran Via shopping centre. To fund this project the company is in negotiations with a Spanish bank to secure a 15-year euro denominated term loan to finance 55 per cent of the cost at a margin of 2.25 per cent above euribor, with the balance of the investment being funded from cash on its balance sheet.
Exploiting a golden opportunity
Given the return on capital being targeted, and the size of the target market, there is a clear opportunity to ramp up the opening programme even faster which is why the company has just raised £38m with institutional investors. The proceeds from the placing exactly match the acquisition and development costs on easyHotel’s owned hotel acquisition pipeline of five hotels which compromise a total of 686 rooms. These sites are typically between 100 to 170 bedrooms and are a mixture of office conversions and new build development sites. Each of the sites is located in the centre of a British Isles city, with each site agreed in principle.
If all these sites are acquired, the board expects them to open through 2017 to 2018 and produce high cash profit return on investment in line with its minimum target. However, there is no guarantee that these five hotels will be acquired, so as part of its ongoing process easyHotel’s management has also identified a further nine potential acquisition sites representing 1,175 rooms which are at various stages of evaluation and negotiation. Importantly, the board expect the addition of these new hotels to be “materially earnings enhancing in the medium term.”
Analysts have yet to update their forecasts, but I would expect substantial upgrades in light of the fact that the company’s owned hotel room stock is set to rise from 390 rooms to at least 1,650 rooms in the next couple of years. The three owned hotels generated a pre-tax profit of £810,000 from their 390 rooms and before central overhead in the six months to end March 2016 which gives you some indication of the profit potential of the hotel expansion programme.
Indeed, analysts at Liberum Capital had previously expected easyHotel’s cash profits to more than double from £1.5m in the current financial year to £3.5m in the 12 months to September 2018 based on revenues rising from £6m to £11.5m. However, the owned room stock in the 2018 financial year is set to be 70 per cent higher than Liberum had previously factored into their models. And it’s not just the expansion of the owned hotel room stock that will lead to major upgrades, so too will a ramp up of the company’s franchised hotels.
Franchise model
In the franchised hotel market, the company has identified the opportunity to open a further 15,000 franchised easyHotel rooms in the UK and Europe, and in locations where they do not currently intend to establish an owned hotel in the foreseeable future. The board considers the roll-out of its franchised estate to be extremely valuable to the business as it contributes high incremental margin, support the brand marketing budget, and increases the easyHotel brand presence without the need for capital investment by the company.
In total 1,135 rooms are currently being developed by its franchise partners, representing a significant increase on the current 1,405 current franchise room stock at the 17 franchise easyHotels located mainly across Europe. For instance, a 107-room hotel is due to open well ahead of schedule later this month in Brussels; the second franchise hotel in the Benelux region will open in November following conversion of a building on Arena Boulevard in Amsterdam into a 131-room easyHotel; and its Benelux franchisee is also developing another easyHotel in the Amsterdam region, a 96-room easyHotel in the heart of Zaandam, next door to the railway station and only 11 minutes from Amsterdam Central Station and Schiphol Amsterdam Airport. This hotel should open early next year.
The company has franchise agreements in place with operators for 100-room new hotels in both Lisbon, Portugal and in Bernkastel-Kues, one of Germany's most popular tourist destinations, and a state-recognized health resort set amongst historical vineyards. The town is located 20 minutes from Frankfurt Hahn Airport. Both are scheduled to open by the end of 2017. Other agreements in place include one 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 development programme is targeting the opening of 600 rooms by 2017 with easyHotel entering into a franchise agreement for each hotel. MAN Investments has secured land or properties which will accommodate the 2017 openings and its first hotel is a 300-room easyHotel built in the Bur Dubai area of Dubai, widely recognised as being the trading hub of Dubai and the UAE. Prospects look promising given the Dubai Ministry of Tourism is targeting growth of more than 30 per cent in inbound tourism by 2021 in order to attract 20m tourists to the region annually.
Moreover, I understand that easyHotel’s management team are in various stages of negotiation with potential franchisees for four new hotels across the UK and Middle East and which have planned openings next year. The hotels vary in size from 65 rooms and are a mix of new build sites as well as conversions of existing buildings and hotels. These will add a further 940 rooms to the current franchise stock of 1,405 rooms which taken together with the raft of current developments mentioned above will swell the room stock to over 3,500 rooms by the end of next year.
Valuation
easyHotel’s shares hit my 100p target price last week, having last recommended buying them at 80p in mid-August (‘Scaling up for a budget opportunity’, 16 Aug 2016).
Post the placing the company now has a market value of £95m, and is heavily asset backed. It has net funds of £46m, the three hotels in Glasgow, Croydon and Old Street hotels are in the books for only £21m, or significantly below estimated open market values nearer £30m, and the company has a further £5m invested in property under development.
Or put it another way, I reckon the company’s pro-forma book value is closer to £80m if you mark property to market value, so the equity is only being rated on a modest 1.2 times book value on this basis. That valuation doesn’t attribute any value creation from the owned development pipeline, nor the increase in profits set to be generated from both the accelerated franchise and owned hotel expansion programmes.
Prior to the share placing Liberum Capital had a target price of 120p, and Investec Securities’ target was slightly higher at 130p based on a discounted cash flow valuation. Frankly, having just raised a slug of equity at nearly double the last reported net asset value, I feel those target prices are achievable given the company will invest its cash pile into a designated pipeline of developments and on which a targeted return on capital of 15 per cent is being aimed for on an unleveraged basis.
To put this into perspective, if the company is operating 1,650 owned hotels by 2018, and also has around 3,500 franchise hotels, then I reckon it will be making cash profits of at least £6m on revenues of £18m based on a conservative cash profit margin of 33 per cent. And as these hotels mature, then that margin will only rise. In the circumstances, expect some significant analyst upgrades to follow once they have modelled in the new cashflows and profits from the accelerated development programme. Trading on a bid-offer spread of 93p to 95p, I continue to rate easyHotel’s shares a buy and have a new target price of 125p.
