NDB Stockbrokers Research shares insights to key industry trends, challenges and opportunities for investors in the stock market
NDB Stockbrokers has come out with a research report on the country’s tourism sector. The report, prepared by Analyst Ranmini Vithanagama, captures some of the key developments, trends, challenges and opportunities for post-war tourism. It also provides some recommendations to investors of listed hotel and travel companies to thereby profit from the opportunity. Here are excerpts:
Sri Lanka as a potential attractive destination
Sri Lanka has been known for its scenic beauty and unique culture from olden days. However, with the outbreak of the internal conflict, the resultant insecure situation had discouraged tourists from visiting the country.
The situation reversed with the end of the conflict in May 2009. The main hindrance to the flourishing of the tourism industry removed, Sri Lanka has now entered an era of tourism sector growth.
The removal of travel restrictions placed against Sri Lanka (by Germany, Belgium, United Kingdom and the USA, for example) and the recognition of Sri Lanka as a key tourist destination (by New York Times and National Geographic, for example) have set the right tone for the industry. The government is planning to attract 2.5 Mn tourists annually by 2015.
A diverse mix of nature and culture
Sri Lanka boasts of a history of over 2,500 years, which has endowed the country with a stock of archaeological sites that are rich in historic value. Anuradhapura, Polonnaruwa, Sigiriya and Dambulla are among the most prominent of the tourist attractions of historical value. Kandy Esala Perahera tops the list of cultural wonders Sri Lanka has to offer.
The sunny and sandy beaches, summer throughout the year, the hill country with waterfalls and cool weather, plantations and wildlife sanctuaries are all part of natural beauty Sri Lanka has to offer. Increased popularity of ecotourism in Sri Lanka provides nature lovers with the opportunity of enjoying nature in its most primitive and unaffected form.
Surfing in Arugam Bay and snorkelling and diving in Trincomalee are likely to add to the variety of entertainment for tourists visiting Sri Lanka. Further, the knee deep shallow sea along the east coast is a fresh addition to the sites of attraction in Sri Lanka post war.
What is particularly special about Sri Lanka as a tourist destination is that a vast spectrum of natural and cultural diversity is available within a few hundred kilometres, a key competitive advantage against other tourist destinations in the region.
Global tourism trends
Global tourism took a hit from the financial crisis that plagued countries across the world in 2008/09. As a result, global hotel room rates on average dropped 14% YOY in 2009, and were cheaper than room rates in 2004, according to Hotel Price Index (HPI). However, in 2010H1, both European and American hotel prices have shown a modest recovery, indicating early signs of a global tourism and travel sector recovery.
Taking into account the still subdued economic conditions in the US and Europe, we believe the tourism and travel sector recovery would be slow in 2011. Discretionary expenditure is likely to recover relatively slowly even after a full economic recovery.
Tourism arrivals in Sri Lanka
Sri Lanka’s tourism industry in 2010 enjoyed the peace dividend, with total tourist arrivals in the country recorded at 654,476, up 46% YOY. We expect over 730,000 tourist arrivals for 2011.
Sri Lanka’s tourist portfolio largely consists of Western Europeans, followed closely by Asians, particularly South Asians. Furthermore, India is the largest source for Sri Lanka’s tourism industry, followed by the UK.
The International Monetary Fund (IMF) forecasts an economic growth 8.4% for India, and 8.5% as a whole for developing Asia in 2011. This contrasts with a much more subdued growth rate of 1.6% forecast for the European Union. Therefore, we believe that Asian countries are likely to have a stronger footprint on Sri Lanka’s tourist portfolio.
Therefore, it is important that Sri Lanka targets high spenders from these regions, particularly India and China. Currently, the long haul tourists from Western Europe are usually the high spenders, whereas tourists from South Asia mostly come on a limited budget.
Duration of stay
Overall, the duration of stay in Sri Lanka in 2009 has been 9.1 nights, although the average duration of stay has been 10 nights for the most part since 1978. Further, tourists from Western Europe and North America have on average stayed over 10 nights in the island, whereas Asians have averaged less than eight nights. Since a longer duration of stay is associated with increased spending, it yields higher revenue per tourist.
A seasonal aspect is inherent in the tourism industry. In Sri Lanka, the peak season for tourism is usually from late November to April, with the onset of winter in the northern hemisphere. Statistics from 1967-2009 indicate that generally May, June, September and October are the dullest months, with relatively low tourist arrivals.
In order to achieve an average annual occupancy rate of about 85% and fully utilise the limited supply of rooms, it is important to promote tourism in the off season. Therefore, special events and entertainment activities need to be organised during the off season.
Sri Lanka has a total of 249 hotels and 14,461 rooms (as of July 2010). Out of these, approximately 21% were in the 5-star category. About 39% of the room supply is situated in Colombo (22%) and Greater Colombo (17%), with a further 34% located in the South Coast. According to our estimates, the capacity for a month is about 90,000 tourists.
Therefore, even if tourism is promoted during off season, the maximum number of tourists that could be accommodated for a year would be less than one million. We believe that an addition of about 20,000-25,000 rooms is required to cater to the anticipated influx of 2.5 million tourists by 2015. In order to attract high end tourists and to raise room rates it is important to have the lower graded/ungraded rooms upgraded, in addition to investing in new rooms.
With the end of the internal conflict in May 2009, there has been a marked improvement in occupancy rates. Furthermore, occupancy rates have been highest in the 5-star category hotels in January-July 2010, closely followed by 4-star hotels. Higher demand for 5-star hotels signals the presence of high-spending tourists in Sri Lanka.
The occupancy rates in Colombo and Greater Colombo are much higher compared to the rest of the country. We expect government plans to develop Colombo into a commercial hub would help further boost occupancy rates in Colombo and Greater Colombo.
Growth in tourism will increase occupancy rates across all regions. We estimate Sri Lanka’s average occupancy rate for 2010 at approximately 66%, up from 48.4% in 2009. We expect it to further improve to about 70-75% in 2011, as the growth in tourist arrivals would increase occupancy rates.
The room rates have thus far increased by over 25% from the 2009 levels, according to industry experts. While room rates depend on a variety of factors including the star category, the product offering and the location, in general rooms located in Colombo and the South Coast have recorded a significant increase in room rates.
The Average Room Rate (ARR) is a widely used measure in the sector to indicate revenue per room. The total revenue earned from the sale of hotel rooms for a day (excluding food etc) is divided by the number of rooms that were occupied to calculate the ARR. Generally about 50-60% of room sales are through travel agents. The margins are relatively less than in walk in room sales, as a fixed rate of payment has to be made to the travel agents.
Regional competition: Malaysia
In addition to beaches, islands, wildlife and history and theme parks that attract tourists to the country, Malaysia’s capital offers metropolitan tourism with high rising buildings, premium restaurants and hotels and high end shopping experiences as well as bargain shopping experiences such as Malaysia Year End Sale (M-YES). In 2009, the total tourist arrivals to Malaysia were 23.6 Mn, with the bulk of its tourist coming from neighbouring Singapore. The country had a total of 168,844 rooms to cater to this demand.
Regional competition: Indonesia (Bali)
Indonesia, an archipelago consisting of 17,508 islands boasts of the third largest shoreline in the world. Both nature and culture of Indonesia attract tourists to the country Bali, an island with an area of 5,600 sq. km, is one of Indonesia’s most popular tourist destinations, and has been promoted internationally as a separate state.
In addition to beaches and related activities such as scuba diving, surfing and snorkelling, Bali has mountains, volcanoes, wildlife and a rich culture to attract tourists. Additionally, Bali is also widely promoted as a location for international conferences, a trend known as “Congress Tourism”.
In 2009, there were 2.2 Mn tourist arrivals in Bali. The island has a total of 639 hotels to cater to its tourism demand. Of them, about 12% belong to the 5-star category, while a further 34% belongs to the 4-star category.
Future outlook: Promoting Sri Lanka as a tourism hub
A number of positive developments are taking place to convert Sri Lanka into a tourism hub. The “One Stop Shop” introduced by the Sri Lanka Tourism Development Authority (SLTDA) has reduced time delays associated with processing of investment proposals.
Under this system, officials from seven to eight organisations (e.g. local authorities, Urban Development Authority, Department of Forestry, etc.) meet once a fortnight to decide on the eligibility of applications.
Initiatives have been taken to introduce globally known hotel chains in Sri Lanka.
- Shangri-La Group plans to build a US$ 500 million luxury hotel and apartment complex in Colombo (We estimate that approximately 50% of the investment would be for the hotel).
- Six Senses and Spa is in a 50:50 joint venture with Aitken Spence Group to develop its first property in Sri Lanka by 2012.
- Minor International (of Thailand) in partnership with Hemas Holdings plans to expand its existing property and build a new resort under the global brand “Anantara”.
- China National Aero Technology Import and Export Corporation (CATIC) plans to build a multifunctional complex comprising a five-star hotel and a shopping mall, at a combined investment of about US$ 500 million (We estimate that approximately 50% of the investment would be for the hotel).
In 2008, the government decided to develop the Kalpitiya peninsula in the Puttalam District (in the west coast of Sri Lanka) as a special tourist project (similar to the Bali concept of Indonesia). The Kalpitiya peninsula is a unique destination with a group of 14 islands of different sizes.
One island is being developed as a location exclusively for casinos, with a view to promote entertainment for tourists. Currently, bids are being called from prospective developers, with global hotel chains expected to be amongst them.
The eastern region is being developed as a tourist destination, with an area of about 500 acres identified for tourism development in Kuchchaveli in the Trincomalee District. Additionally, Mannar, Jaffna and Nandikadal in the northern part have also been identified as potential tourist destinations, and plans are underway to put up several resorts in these areas.
Steps are being taken to increase air transportation within Sri Lanka for the benefit of tourists. Sri Lankan Airlines operates six aircraft for domestic transportation which includes four sea planes. The military helicopters are also currently being used to transport tourists. Further, the Senok group of companies has been granted the license to operate a domestic helicopter service, while Deccan Aviation and Cosmos also run domestic air services.
The Government Budget proposals for 2011 have taken steps to encourage the hotel industry in the form of corporate income tax reductions from 15% to 12% on earnings from tourism and related businesses.
Additionally, custom duties and VAT on various machinery and equipment (which are not available in Sri Lanka) will also be reduced to facilitate refurbishment and expansion of hotels. Further, taxes on branded consumer durables have been lowered to popularize shopping among tourists.
Co-hosting the ICC World Cup Cricket in 2011, and the Visit Sri Lanka 2011 programme would draw international attention to Sri Lanka, and also provide the platform to showcase the cultural and natural heritage of Sri Lanka to a larger cross section of the global community.
Headroom for improvement and challenges
In comparison to Malaysia and Bali (Indonesia), Sri Lanka lags behind in terms of the quality of hotels available in the country. Malaysia, Thailand and Indonesia are all characterized by the presence of international hotel brands such as Sheraton Resorts, Westin Hotels, Marriot Hotels, Six Senses Resorts and Four Seasons, which attract high-spending tourists. Although, progress is being made in this direction, we feel that there is further room for improvement.
We also note that Sri Lanka’s hotel room rates have picked up, making Sri Lanka a relatively expensive destination. Hence, Sri Lanka needs to focus on improving the quality of the product offered (in terms of luxury hotels, ease of transport, entertainment etc) in order to further increase the rates.
We are of the opinion that it is important to improve the ease and quickness of mobility from one site of attraction to another, as well as entry into the country (the expansion of the airport). While the road network and domestic air transportation are being developed, it is still too early to gauge the success of these measures.
Sri Lanka also should focus on expanding its product offering, with a view to taking the tourism experience beyond traditional borders of nature and culture. Entertainment in the form of theme parks, shopping sprees, high-end restaurants and pubs need to be added to the stock of Sri Lanka’s tourist attractions.
The absence of private beaches (for hotels) is a competitive disadvantage for Sri Lanka (when compared with Maldives). As such, the activities of the Tourist Police need to be strengthened to ensure that tourists are not harassed by intruders.
The recent removal of ‘Visa on Arrival’ to Sri Lanka is seen by the industry as a drawback, which the government may have to reconsider. (The Government reduced the electricity tariff hike it had initially planned heeding to industry request).
The requirement for about 20,000-25,000 rooms over the next five years may require investment worth approximately US$ 3-4 billion. Although investments are trickling in, achievement of the above would be challenging. Further, it is important that the new hotel projects are in the 4-5 star-categories, if we are to attract high-spending tourists going forward.
The hotel sector index has gained substantially compared to the ASPI with the end of the civil war in May 2009. We have used the following mechanism to identify prospective investments in the hotel sector:
- Increased the occupancy rate of hotels by 5-10% (From the average for 2010) to compute the occupancy rates for 2011. The range was between 70-80% depending on the hotel.
- Increased room rates by 5-15% to compute the average rate for 2011 (compared to 2010). The range was between US $ 70–220 depending on the hotel.
- Identified the stocks with lowest P/Es based on estimated earnings for FY11/12.
- We did not consider PBV as a criterion which would be used for longer term valuations.