Investment manager Allan Gray says now may be a good time to invest in the tourism, leisure and gaming sector, which has been battered by the Covid-19 pandemic, provided one is prepared to stomach a few years of underperformance in exchange for picking up quality stocks at bargain prices.
Varshan Maharaj, who co-manages Allan Gray’s frontier fund and analyses various sectors for its SA balanced, equity and stable funds, says stocks such as City Lodge, Tsogo Sun Gaming, Tsogo Sun Hotels and Sun International are trading at estimated enterprise values that equate to roughly a third to half of the replacement cost of their underlying assets. He says that makes them a good bet for investors willing to hold on until the economy returns to pre-pandemic levels.
“You’d have to bear two or three years of below normal earnings in exchange for paying very significant discounts today when compared to what many of the listed hotel and casino groups are worth,” Maharaj said in an interview. “That’s a very attractive proposition for someone with an investment horizon of five years or more.”
Stats SA’s latest tourism data paint a grim picture for the hospitality, leisure and gaming sectors as the Covid-19 pandemic continues to wreak havoc across the country. Foreign tourist arrivals dropped 71% from just more than 15.8-million in 2019 to less than 5-million in 2020 while the virus continues to curtail domestic travel and tourism as well. With a worsening third-wave of infections threating to result in more severe lockdown restrictions, hotel occupancy and casino utilisation rates are still some way from returning to normal levels.
Nevertheless, Maharaj says there are opportunities if one digs a little deeper into the numbers. He explains that SA hotels have typically exhibited long-term average occupancy rates of about 65%, with the historic break-even level at about 40% occupancy. But given severe headcount reductions and lower expenditure in the wake of the pandemic, Maharaj says most listed hotel groups are now breaking even at 30% occupancy.
Citing their latest results presentations, Maharaj says Tsogo Hotels’ most recent occupancy level was about 12% while for City Lodge the average occupancy was about 17%.
However, these rates are based on the total number of rooms in the two groups’ portfolios. If one excludes hotels that were closed during the various lockdowns that occurred between March 2020 and January 2021, their occupancy levels rise closer to the new break-even level of 30%.
“Listed hotel groups are running back at cash break-even levels as they’ve reduced headcount and cut back on capital expenditure during the pandemic,” said Maharaj. “As occupancy levels continue to pick up towards the normal 65% level, one would expect their profits to gradually increase.”
Another factor in favour of existing hotel groups is that interest in building or funding new hotels has all but evaporated.
“Less new supply is going to be added to the market so companies like Tsogo Sun Hotels and City Lodge should see their profits improve quite nicely as demand comes back,” says Maharaj.
“If you look at Tsogo Sun and City Lodge, you’re currently paying about a third of what it would cost to build their hotels from scratch, which means they’re very attractive from a valuation perspective.”
While Maharaj acknowledges that debt is a concern for listed hotel groups, he says their inherently asset-rich business models means they can offload noncore assets for substantial cash injections. If you doubt that, consider Tsogo Sun Hotels’ sale of its 50% stake in United Resorts and Hotels, which has assets in the Seychelles, for R465m.
While Allan Gray also holds Sun International, Maharaj says it is constrained by its greater exposure to destination venues such as Sun City and the Wild Coast Sun, which are not within an hour’s drive of any major metropolitan area. Hosken Consolidated Investments (HCI) is a nice diversification play given its exposure to media, oil and gas and technology in addition to gaming and leisure, yet it trades at a significant discount to its net asset value, like most holding companies.
“In the casino space my preferred stock is Tsogo Sun Gaming, while Tsogo Sun Hotels and City Lodge are trading at very attractive levels,” says Maharaj.
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