Is it time to invest in quality, listed hotel groups at ground level?
THE TRAVEL and leisure industry in South Africa was perhaps the industry that suffered the most as a result of the lockdowns and travel restrictions worldwide to curb the spread of the coronavirus.
Longer-term investors in the sector saw their investments decimated as the FTSE/JSE Africa Travel & Leisure Index underperformed the market by nearly 50 percent since the end of February this year.
The reset of the hospitality industry has begun, though, and the successful development of coronavirus vaccines is likely to pull the industry out of its current malaise and set it on a new growth path.
The hospitality sector was already in a down trend before the coronavirus hit our shores. The ailing South African economy saw declines in occupancy numbers during 2019 and in the first two months of this year. The strict lockdown protocols resulted in the average stay nights sold by hotels falling by more than 95 percent in the second quarter compared to the average of 1.19 million stay nights sold in January and February this year.
As lockdowns were gradually eased, stay nights sold improved to 379 000 by the end of September, but was still down by nearly 70 percent compared to the average of January and February.
The strict lockdown protocols had a massive impact on the liquidity levels of hotel groups, resulting in serious cash flow problems and working capital constraints as revenue dried up.
Basically all hotel groups and independent hotels had to engage with their funders to secure short-term liquidity and seek rental relief from landlords.
Risks in the hospitality sector will remain high as fierce competition is likely as the oversupply of rooms is likely to lead to heavy discounting, specifically by hotel chains and independent hotels in financial distress to avoid liquidation. The lockdowns also exposed the lopsided capital structures of some hotel groups, which amplified the impact on their financials.
City Lodge, for instance, found itself in a squeeze. After falling from a high of R66 per share in the first week of February, the share price was trading at R30 the day before the announcement of a proposed rights issue on June 22, trading at R30.60. The proposed offer of R1.2 million was inter alia intended to enable City Lodge to discharge its liability of R774m for the guarantee of the BEE funding in 2008 which was unlikely to have any equity value at the debt maturity date at the end of January next year.
The prevailing market circumstances before the eventual rights issue forced the share price down to R14.68 on the last day to register in August – virtually spot-on as the reported net asset value per share. The rights offer of 13 shares at R2.12 per share for each existing ordinary share held was fully subscribed.
The other proceeds of the rights offer will be used to reduce corporate debt, to provide for sufficient working capital to fund its current cash flow shortfall during the pandemic and lockdown. The company also indicated in the 2020 Integrated Report that they may look to acquire other hotels or properties in distress.
City Lodge’s war chest may also receive a major boost if negotiations to sell its hotels in Kenya and Tanzania are successful. According to my calculations, the net asset value per share immediately post the rights issue was approximately 290 cents per share and compares to Friday’s close of 350c.
Yes, City Lodge is lean and mean, but I hope they do not make the same mistake as in 2008 by guaranteeing a BEE funding at high price-to-net asset value multiples.
Sun International also concluded a rights offer in August at a subscription price of R9.44 to provide the business with an estimated additional 12 months liquidity. A holder of one Sun International share on the last day to register in July and who followed his rights effectively got the total package at R10.50 per share or a discount of 8 percent to the post rights issue net asset value of R11.06 per share. The rights offer was 95 percent subscribed.
In addition, Sun International is proceeding with the sale of non-core assets such as the recently concluded disposal by Sun Latam SPA of its remaining 50 percent equity interest in Sun Dreams. My calculations indicate that Sun International is currently trading at a price-to-net asset value multiple of 1.8 times.
One thing is certain: Asset managers and shareholders are prepared to recapitalise a company, but they lay down the rules. Pay no more than what the company is worth, in other words, the net asset value (NAV) of the company and no multiples of the NAV.
Depending on market circumstances, the waiting period before we will see multiples of NAV being paid may take years and will depend on future earnings growth – something that, at least at this stage, is impossible to forecast or anticipate.
The Google Mobility Indexes point to increased activity in South Africa’s hotel industry and, if one assumes that the coronavirus vaccines are effective and readily available, things will look on the up by the middle of next year.
All I know is that, for the first time in many moons, I am able to invest in quality listed hotel groups at ground level.
Ryk de Klerk is an analyst at large. Contact [email protected] The views expressed above are his own. He has a direct interest in City Lodge and Sun International. You should consult your broker and/or investment adviser for advice. Past performance is no guarantee of future results.