The Erawan Group

The Erawan Group Plc (ERW)

Deeper core loss than expected
ERW reported an all-time high net profit of Bt731m for 2Q13 (Bt3m for 2Q12), up 393% QoQ. However, it posted a core operational loss of Bt74m (against a core loss of Bt15m for 2Q12 and a net profit of Bt148m in 1Q13). The core loss was deeper than our expectation (Bt50m), due to heavy tax expenses of Bt35m (our estimate was Bt7m). The 2Q13 core loss was also deeper than the consensus projection of Bt47m.
Results highlights
The record bottom-line was due to Bt864m in gains from the spinning off of two Ibis hotels (Patong and Pattaya) to the ERWPF property fund. Note that ERW realized a Bt59m asset impairment for the Naka Phuket Hotel in 2Q13. The core operational loss for 2Q13 was because hotel GM was squeezed 5.3% YoY. The SG&A/sales ratio rose 0.9% on expenses related to establishing ERWPF (and a rental guarantee for the fund) and higher tax expenses (no tax credit in 2Q13). The margin contraction outweighed the effect of 4% YoY growth in Hotel revenue to Bt991m. Hotel RevPar rose by 20% YoY for luxury resorts, by 21% for mid-scale and by 33% for Ibis, but dropped 10% for Bangkok five-star properties.
The QoQ operational deterioration was led by low season and renovations at the Grand Hyatt Erawan Bangkok (half the rooms were closed in 2Q13 against a full operation in 1Q13). The net gearing ratio plunged from 2.1x at end-March to 1.5x at end-June (the best since 2008).  
Outlook
We anticipate a slimmer YoY and QoQ core loss for 3Q13 (the net loss was Bt54m in 3Q12). The revenue target for the quarter implies growth of 15% YoY and 4% QoQ. ERW will resume core earnings in 4Q13 (a QoQ turnaround and YoY growth from a Bt53m core profit for 4Q12).
What’s changed? 
Our model stands unchanged (1H13 net profit = 86% of our forecast). 
Recommendation
Our BUY rating stands with an unchanged YE13 target price of Bt6.80, a 15% discount to DCF value. ERW trades at 30% below its replacement value of Bt6.3/share. The next asset sale to ERWPF is expected to be approved by YE13 and executed in 1H14 (likely to be Ibis-branded properties in Bangkok or Koh Samui).
There is scope for long-term earnings upside from the new budget hotel brand, HOP INN. Conservatively assuming that 10 HOP INN hotels launch in 2H14, we calculate that they would add 1% to our FY14 revenue forecast and 2% to our FY15 projection. We preliminarily assume that HOP INN will add 4% to our FY15 EBITDA forecast and 5% to our profit estimate.