The Erawan Group

The Erawan Group Plc (ERW)

Investment thesis: We have upgraded our ERW rating to BUY from TRADING BUY with a higher YE13 target price of Bt3.80 (up from Bt3.20), which factors in an 8% rise to our FY13 earnings forecast. Our discount to DCF value has narrowed from 35% to 25% in anticipation of a bottom-line turnaround in FY12 and 61% profit growth in FY13 (WACC is unchanged at 14.0% and a 1% terminal growth rate). ERW’s YE13 PBV of 1.6x is below its FY06-11 mean of 1.9x and lags far behind the sector average of 2.5x. Its FY13 PEG is only 0.6x (fully diluted), a 29% discount to MINT’s and CENTEL’s.

Earnings turnaround ahead: ERW will post a shallow loss for 3Q12 (against a Bt68m loss in 3Q11). But that will be followed by a profit for 4Q12 (a Bt101m loss in 4Q11) and hefty 1Q13 earnings during high season, boosted by better numbers for the Naka Phuket hotel. 

Shallower loss for Naka: Following re-branding in 4Q11 (from Six Senses to Luxury Collection), the Naka Phuket’s occupancy rate has ramped up. As such, the EBITDA loss was only Bt10m in 1H12 versus an FY11 EBITDA loss of Bt90m. EBIT will break even in 2013 and the bottom-line will be black in FY14.

No new hotels in FY13: No new hotels will open next year. The two newest hotels (Ibis Siam and Mercure Siam, which are to launch on Dec 12, 2012) are unlikely to squeeze FY13 earnings—the investment costs were low (only Bt1.6m/room for Ibis Siam and Bt2.6m/room for Mercure). We expect high occupancy rates for the two collocated properties, due to their good location and inexpensive room rates.

Portfolio expansion in low-risk segments: ERW targets enlarging its hotel portfolio from the current 14 hotels (3,512 rooms in total) to 20 hotels in 2015 (5,000 rooms). The firm has an FY12-15 revenue CAGR objective of 15% to Bt6.5bn in FY15. It guides for EBITDA in excess of Bt2.4bn in FY15 (we model for 1.2bn in FY12). New hotels will mostly be in the economy and tourist segments in order to mitigate downside risk. ERW will announce the locations of two new Ibis hotels (in central Bangkok) by YE12.

Deleveraging trend: Management guides that the net gearing ratio will be 2.1x at YE12, but there aren’t any plans for a capital increase. The ratio is expected to decline to 1.7x at YE13, its lowest level since 2007, and fall further to 1.6x at YE15.

Outlook
Shallow loss in 3Q12 is behind us: In the second week of Nov, ERW will report its 3Q12 results. We estimate a shallow core loss of around Bt10m (against Bt68m in 3Q11, when The Naka Phuket was closed for re-branding). RevPar growth should post a rise of 1% YoY (but decline 3% QoQ on seasonality)—an occupancy rate of 70% versus 69% in 3Q11 and 73% in 2Q12. The mean room rate was flat YoY, we assume.

Bottom-line turnaround ahead: We are confident that ERW will report earnings for 4Q12 (it has posted fourth-quarter losses since 2008). RevPar in 4Q12 is expected to hit its FY08-11 average level—up by 33% YoY and 25% QoQ. The average occupancy rate in 4Q12 will increase to 79% (from 65% in 4Q11, the lowest level of that year, due to flooding in Bangkok). The mean room rate is anticipated to rise by 10% YoY and 11% QoQ. Furthermore, 1Q13 profit will increase YoY and QoQ on first-quarter high season.

 Shallower loss at Naka Phuket: After re-opening in 4Q11 (rebranded from “Six Senses” to “Luxury Collection”, a Starwood brand), the hotel’s numbers have ramped up strongly, led by occupancy (Figure 3). We expect an occupancy rate of 40% for 3Q12 and 65% in 4Q12 (17% in 3Q11 and 38% in 4Q11). Naka Phuket’s RevPar growth was 30% YoY in 4Q11, 29% in 1Q12 and 37% in 2Q12 (versus a YoY contraction for every quarter, 1Q-3Q11). There are two key reasons for the recovery. Firstly, Starwood has a strong global brand (1,041 properties in 100 countries). Secondly, the hotel concept has changed from a niche concept (a spa destination serving only organic vegetables and fish that prohibited the use cell phones) to high-end visitors. In 1H12, Naka Phuket operated at an EBITDA loss of Bt10m versus a Bt90m EBITDA loss for FY11. Naka’s EBITDA should break even in FY13 and the bottom-line be black in FY14.