The Short Case on Home Inns & Hotels Management

My weekly stock pick comes from a play on China. I love the China growth story just as much as anyone, but when the trader in me sees fear and greed going on in the markets I take notice. I see greed on the following stock near term as I will explain below. I do consider this pick a buy longer term, but near term, I’m looking for it to sell off before major buying support comes in for longer term investors.

Short Sell: Home Inns & Hotels (HMIN)

HMIN Trade Setup:

Sell-Stop Entry at $25.43 with Fairly Tight Stop-Loss at $26.50

Or

Sell Limit Entry at $27.26 with Stop-Loss at $29.50

Another possible scenario could see prices of $29.23 to $30.20 before the possible correction I’m anticipating unfolds. Major support now sits at $23.59 to $22.80. A break of this level would indicate a sell signal. If the price holds at $23.59 or higher, this could mean higher prices are on the way.

Take Profit Areas: $23.41 to $22.40, $17.83 - $16.67

I would be looking to buy if and when HMIN price goes below $20.00.March 4th HMIN gapped down to a close of $24.51 with the share price hitting a low on March 19th of $17.79. The gap has been filled now with May 16th closing price at $26.15.

This Could Mean Two Things

The price could keep heading up to my other possible scenario or a low risk high reward trade to short sell is now setting up based on my analysis above. A correction below the recent low of $17.79 would be a nice long entry position after cleaning out any further weak hands on this stock.

Home Inns & Hotels Management Inc. is a China-based economy hotel chain. The Company develops and operates economy hotels across China under its Home Inn brand. The Company either leases real estate properties, on which it develops and operates hotels or it franchises its brand to hotel owners or manages these hotel properties. The Company refers to the former type of hotels as leased-and-operated hotels and to the latter type of hotels as franchised-and-managed hotels. As of December 31, 2007, the Company’s Home Inns Hotel chain consisted of 195 leased-and-operated hotels in operation with an additional 78 leased-and-operated hotels under development and 71 franchised-and-managed hotels in operation with an additional 37 franchised-and-managed hotels under development, covering 82 cities in China.

A main bullish topic about Home Inns & Hotels is that it will be a beneficiary of the Beijing Olympics. Conventional wisdom would agree. In reality currently, it may not have much effect as Home Inns & Hotels is already filling up its room’s, with an average of almost 90% occupancy. The month during Olympics rooms could see 100% occupancy, and that's not very far from where current occupancy is right now. So tell me where more earnings are coming from near term to support a Price Earnings Ratio on this stock at 195.

I also think HMIN stock price will continue heading south because of currency losses as the dollar has tanked even more since the 4th quarter 2007. Also more and more Chinese hotel operators are spending substantial amounts of money into expansion and not into shareholders equity and the company bottom line EPS. Home Inns is an excellent investment longer term, but I don’t see sustainable growth in the short term. So my reasoning for this short sell.

Home Inns Takes Loss in 1st Quarter 2008

The Shanghai, China-based Home Inns first quarter had a net loss of RMB 50.29 million or RMB 0.71 per share, compared to a net income of RMB 2.96 million or RMB 0.04 per share in the year-ago quarter.

First quarter adjusted net profit was RMB 3.8 million, excluding share-based compensation expenses of RMB 4.0 million, foreign exchange losses of RMB 50.0 million. Loss per ADS was RMB 1.42. Excluding share-based compensation expenses and foreign exchange losses, non-GAAP adjusted earnings per ADS were RMB 0.10.

Net revenues for the quarter increased to RMB 334.85 million from RMB 172.58 million in the comparable quarter of the previous year. Total operating costs and expenses increased to RMB 342.67 million from RMB 156.67 million a year ago.

As of March 31, 2008, Home Inns had an additional 131 hotels under development, which comprised 86 leased-and-operated hotels and 45 franchised-and-managed hotels. During the first quarter, the occupancy rate declined to 81.4% from 85.9% in the same quarter of the prior year.

Home Inns Outlook for Second Quarter 2008

Looking ahead, Home Inns expects to open about 200 new hotels in 2008 and anticipates its fiscal 2008-second quarter total revenues in the range of RMB 440 million or US$62.8 million - RMB 460 million or US$65.7 million.

Disclosure: Short HMIN

Comments

[Maluman]

good point about the overhye of olypics- that with 90% current occupancy levels, 100% during olympics doesn't mean a ton of upside. This stock has been the most irritating for me. Can't handle these major up-down fluctuations. Going to sell and wait for stability and solid direction before getting back in.

[John Egan]

Agree.... Good hotel chain.. And it should do well long term if you buy in the dips.. I did get out as I agree that they are already booked for the Olympics. If I recall, their P/E is a little high and their compensation for the management is obscure... However, they offer what is described as a "Holiday Inn Express" or "Comfort Inn" type of experience. Clean and professionally set up with WIFI for the business traveller. Also, I believe that they are pretty well set up in all the major locations and are now filling in in less desireable areas. However, after the Olympic rush, buying between $18 and $19 might be good for the long term... Lets face it, China isn't going away..

Thx jegan ;-)

[Invest2Success]

I've just closed my short position on HMIN. Looks like possibly to many people want in on the China action, even at their sky high PE currently. Book about an 8% profit, thanks.

[HotelInvestor]

I think the people that focus on occupancy as the major gain from the Olympics have really missed the boat when it comes to limited service hotels. Occupancy is only one factor when looking at hotel performance - and in high occupancy markets or high-occupancy segments (such as limited service hotels) it is highly irrelevant. A point or two in occupancy means little to the bottom line. This has to do with the fact that for every occupancy point gained, the associated revenues are subject to full operational expenses on owned and leased properties, and on the incentive fee portion of managed properties (incentive fees are subject to operational expenses). The only type of operation that can truly benefit 100% from occupancy gains are hotel companies that franchise their brands - as fees are paid on gross rooms revenue.

In comparison, every dollar gained on the average rate (i.e. the average price of a room night) flows through directly to the bottomline with the exception of deductions for credit card commissions and and revenue based management fees.

Thus, ADR or average daily rate is a lot more meaningful. When demand is high and occupancy is particularly strong (and this has to be across hotel classes) operators will significantly increase their rates in order to maximise profits. This means that for limited service hotels the price/value relationship is highly distorted during such periods, with limited service hotels benefitting from the price increases of higher-grade hotels. An example...try booking a limited service hotel such as the Howard Johnson Times Square during a sell-out night in New York City and you may end up paying $900 for standard room. People will still pay because they have to stay in New York City - and New Jersey is not an option. This is why a Hampton Inn in New York City is likely to run twice the average rate of an average Hampton Inn in suburban US.

Same applies to the Olympics - if there is anything we have learned from past Olympics it is that hotel operators harvest profits primarily from excessive price increases '''supported''' by strong occupancy rates. This applies to the extended Olympic period and as such I think it is foolish to not expect any upside from the Olympics (despite distribution of hotels throughout China). Look at performance of hotels in Olympic cities around the world during Olympic years and I think you will find the answer.

The real downside is what we call the fall-out after an Olympic year - which is the Olympic cities and countries becoming 'out of fashion' in the year after the Olympic Games, and lodging performance taking a hit based on year-over-year performance as you are comparing to an exceptional year. This could lead to sell-offs, with great opportunities for the value investors to move in and capitalize on the long-term prospects of the share.

I would not sell this share prior to the Olympics, in fact I just doubled my position in the recent dip at $18.00. However, I would monitor sell-offs due to the following reasons that have little to do with the actual long-term performance of the company:

- Olympic fall-out may cause year-over-year performance in 2009 to look disappointing, and thus cause downward movement in price.

- With 200 hotels to open in 2008 and similar growth expected in 2009, the company is virtually doubling in size. The portion of the additional properties that are new developments will not open 'full', and as such the ramp-up period until a stabilized performance is achieved may dillute company-wide RevPAR (Revenue per Available Room). This will result in analysts confusing real growth with growth pain (i.e. occupancy and/or RevPAR dillution on an aggregate basis) as we have already seen before with this share.

I think shorts will have a difficult time making money on this share in the near term, as this company does things right. When backing out share-based compensation charges, foreign exchange losses, and acquisition-related charges from the Top Star acquisition from the recent financial reporting, this is a pretty solid growth share with a good outlook.