In a recent article, I advised Seeking Alpha readers who want to get in on China's growth -- but are tentative -- that they'll be safe with a stock audited by PWC Zhong Tian. After studying the group, I find that Home Inns & Hotels Management (HMIN) is experiencing spectacular growth and is undervalued.
As noted by Kevin Mulhern, the hotels-to-population ratio in China is 87,000 compared to 2,500 in the US. While I'm not entirely sure how accurate that statistic is or how it can be used to measure China hotel usage growth rates, the wide disparity in the hotel industry between the two countries demonstrates how hotel expansion in China is a rapidly growing business. As the Chinese middle class grows, so does their traveling for business and/or pleasure.
Home Inns & Hotels Management dominates the Chinese hotel space with the most guest rooms by far -- 176,824 as of Dec. 31, 2011 -- of any other Chinese hotel company. The company's revenue grew 31% from 2010 to 2011, and management projects it to grow another whopping 48% in 2012. As shown in its 2011 reported financial highlights, adjusted diluted earnings per ADS for 2011 was RMB6.92, or $1.10, which puts the company's trailing twelve months P/E ratio at $26.50 / $1.10 = 24. As evident in my discounted cash flow model, the company is worth quite a bit more than this with its explosive growth.
As of December 31, 2011, Home Inns & Hotels Management operated across 212 cities in China with a total of 1,426 hotels, 698 of which were leased and operated hotels and 728 which were franchised and managed hotels. 2011 was a huge growth year for the company. Not only did it open 306 new hotels under the Home Inns brand, but it also acquired the Motel 168 brand on Oct. 1, 2011, which added another 307 hotels.
Home Inns & Hotels Management had very little income growth in 2011, and as a result the stock fell much lower than its 52-week high of $44 (trading currently around $26.50). Wall Street needs to cut the company some slack. It almost doubled its hotel count in one year. Is it any wonder that net income didn't increase? The company is busy digesting all its new hotels. 2012 and 2013 will be the years that Home Inns & Hotels Management will really shine and give the shareholders great income growth. The company didn't include net income in its 2012 guidance, only revenue. One must analyze the numbers to predict future income.
To see how much more revenue the hotels opened in 2011 will provide in 2012, we first need to figure out how much revenue hotels that will open in 2012 will provide, and subtract that amount. Home Inns & Hotels Management expects to open 330 to 360 new hotels in 2012, including approximately 105 to 125 leased and operated hotels, and 225 to 235 franchised and managed hotels across the three brands.
Spreading these new hotel openings evenly over the course of the year, we could say about 100 leased and operated hotels and 210 franchised hotels will open equally across the first 11 months. I'm using 11 instead of 12 months because I'm assuming it will take about a month to reach average occupancy. That would come out to nine new leased hotels opened every month and 19 new franchised hotels opened every month. This equates to 9 x 66 = 594 months of average occupancy for new leased hotels, and 19 x 66 = 1,254 months of average occupancy for new franchised hotels ( I used 66 because 1+2+3 . . . +11 = 66).
Measuring the number of months the older hotels (ones that were opened in 2011) will be open in 2012: 698 x 12 = 8,376 months for leased hotels, and 728 x 12 = 8,736 months for franchised hotels. This means revenue for new hotels will add 594 / 8376 = 7.1% for leased hotels and 1254 / 8736 = 14.35% for franchised hotels. Since most of the company's earnings are from leased hotels, the majority of the 48% in revenue growth for 2012 will be from existing hotels. This is good news for the company. Getting increased use out of existing hotels will cut down on fixed costs as a percentage of revenue, which will increase income. Naturally, the hotel industry is an economies of scale business.
As the company works on increasing the occupancy of all its hotels, income will rise as fixed costs become a smaller percentage of total costs. Ramp-up and pre-opening expenses will also shrink as a percentage of total expenses. With a maturing Chinese economy, Home Inns & Hotels Management is not only a safe investment, but also one that could give considerably above-average returns.
My trade recommendation: Buy.
Disclosure: I am long HMIN.