Home Inns & Hotels Management (HMIN) is the premier economy hotel chain in China, targeting business travelers and domestic tourists. Despite the macroeconomic concerns surrounding Chinese growth, the poor performance of Chinese stocks over the past 12 months has expanded the risk premia on Chinese equities to a very attractive level. We also believe that a ‘China 2.0’ opportunity exists in companies which will benefit from the growth of the domestic Chinese consumer and middle class, tourism being one of the primary beneficiaries.
The bear case against HMIN hinges on a slowing macroeconomic environment in China and the perception of a plateau in HMIN’s growth. Chinese GDP growth has slowed, largely due to a tightening in monetary policy as a result of the government’s concerns over heightened inflation and a potential real-estate bubble. Nevertheless, Chinese macroeconomic data does not bear out a hard landing scenario. In fact, while GDP growth slowed from a 9.5% yoy pace in Q2 to a 9.1% yoy pace in Q3, this blip-on-the-radar hiccup has already spurred monetary easing from the government, which lowered its reserve requirement at the end of November. Though there are legitimate concerns about the sustainability of Chinese export growth and real estate prices, the recent slowdown has largely been the result of tighter monetary policy actions. The larger structural concerns about China’s economy are unlikely to have an impact for the next few years. Further, any negative impact will be mitigated as the Chinese government steps in to preserve growth.
Over the past year, macro concerns have reduced HMIN’s P/E ratio from around 65x to the current 50x level. Though that may seem excessive upon first glance, applying HMIN’s average quarterly growth rate for the past 2 years implies that a zero-percent return in the stock would yield a trailing P/E of 20x by 2014. This multiple assumes a very conservative long-term RMB-dollar exchange rate (6.37) and the average growth assumption includes earnings volatility associated with the Shanghai World Expo. Nevertheless, twenty times LTM earnings is a number we just can’t imagine seeing given the dynamics of China’s developing economy.
Over the long-term, the ratio of 'Hotels to Population' should fall from the current 87,000 in China towards the current 2,500 in the US. The idea that a minor slowdown in Chinese growth expectations should trigger such a significant revaluation of HMIN’s growth prospects is unlikely to be the result of efficient pricing mechanisms. It seems that China’s structural bears (legit concerns about real estate lending, inefficient allocation of credit, and lax financial reporting standards) have taken advantage of the short-term concerns about tightened macro-policy to trigger strong selling pressure far in advance of when their legitimate concerns may have an effect.
Demand for the economy hotel lodging which HMIN provides has not fallen off. In fact, the slight underperformance in HMIN’s earnings is largely due to a hangover from last year’s Shanghai World Expo. Since HMIN has its strongest presence in the Shanghai market, the year-over-year comparisons have not been especially favorable during the last few quarters. Nevertheless, with the normalized numbers from this year, HMIN should have more favorable earnings comparisons going into Q4 and 2012. Occupancy rates remain elevated, Revenue Per Available Room (RevPAR), and Operating Margins remain elevated above long-term averages or all-time highs.
Revenues suffered a setback post-SWE, but remain at all-time highs with growth stabilizing above the average of the past few years. All of this has been driven by continued expansion in the number of hotels HMIN operates. There are strong reasons to believe that until occupancy rates and RevPAR fall noticeably, selling HMIN is not a fundamentally sound decision.
The most recent price declines present a very compelling value opportunity. A few additional facts about HMIN deserve mention. First, the fact that Chinese inflation has been elevated may help explain the robust RevPAR numbers from recent quarters. While this ‘inflation effect’ may seem artificial, the fact that the RMB-dollar peg is not being moved means that investors in the ADR should receive significant benefits from Chinese inflation. Until the peg is revalued to account for RMB inflation, higher RevPAR should be viewed as a good thing for ADR investors.
Additionally, the successful acquisition and integration of Motel 168, a former competitor in the economy space, will boost HMIN’s growth as the financial results will be consolidated beginning in Q4. Finally, HMIN management remains very bullish on hotel openings and revenue growth. During the Q3 earnings call CEO David Sun issued a forecast of 26% yoy revenue growth for the fourth quarter, a message that was positively received by the market. This message is corroborated by management’s long-term growth expectations of around 15%.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.