Strong Demand for Three to Four Star Hotels

Visitors arrival in Hong Kong increased 24% in the first 7 months (4.2% in Malaysia, 5.6% in China), with mainland travelers still contributing to most of the growth. On average, according to the tourism board, visitors spend HK$5051 on shopping and HK$ 566 on accommodation, making three- to four- hotels their top choices. We assume an 11-12% annual increase in visitor arrivals each year for the next three years (mainly contributed by PRC Individual Visitation Scheme [IVS]), but only a 5-7% annual increase in hotel supply, lifting the room rate and supporting already high occupancy of the hotels of Kosmopolito (KOMO).

Proven Track Record in Value Creation

Kosmopolito Hotels International Limited (KHI) currently operates a portfolio of 15 boutiques, value, mid-scale and upscale hotels in Hong Kong, China and Malaysia with another seven hotels in pipeline. Over the past decades, the company has focused on acquiring and converting old buildings into hotels (which was the company's main development strategy). Such strategy has been proven value accretive because of an unrealized revaluation surplus of approximately HK$ 4987 million according to the company's Property Valuers. (Total Capital Value of Hotel Portfolio: HK$ 10598 million vs Carry Value: HK$ 5611 million [30th June 2010])

Seven New Hotels in the Pipeline Warrant Further Growth

KHI is expected to further increase its number of rooms from 3889 to 6295 in the next 3 years by opening seven new hotels (4 in HK; 2 in PRC; 1: SG). Because of the coming expansion of hotel portfolio, the CAGR of earnings will reach 115% between FY 2010 – FY 2013 (high CAGR is partially resulted from the low base number of earnings in period of 2008-2009 [Financial Tsunami and Swine Flu]).

Another Driving Engine of Future Growth—Rebranding Exercise to Further Enhance Value

Currently, KHI's hotels are operated under a variety of different brands. The company is going to consolidate its portfolio into 4 major new brands through rebranding projects, so that it will not only enhancing the brand loyalty, but also facilitating the development of central reservation system. Finally, portfolio expansion progress would be accelerated through seeking hotel management projects.

Strong Earning Buffers with Diversified Hotel Portfolio

Benefited from the diversified hotel portfolio in terms of both geographical positioning aspect, the company shown a strong buffering effect during the financial tsunami and H1N1.

For positioning aspect: The company focus on mid-scale/ upscale and boutique hotels, which fill in the gap between the most luxurious and cheapest choices

For geographical aspect: Although business of HK business segment was severely impacted during the financial tsunami and H1N1 (RevPAR dropped 17.4% in FY10), the growth in PRC operations (FY 3/10 RevPAR increased by 35.4%) and less impacted Malaysian operations (FY10 RevPAR dropped 11.2%) provides a nice buffering effect.

Now KHI's would be boosted by the strong rebound of visitor traffic to HK. A historic record high of 20mn visitors visited HK (63% from PRC), according to the HK Tourism Board, this explains the strong rebound of RevPAR from HK$441 (in 1H10) to HK$ 675 (in 2H FY10).

Measurement of Profitability—Normalized EBITDA

Definition: Normalized EBIDTA = Profit before taxation, interest income, finance costs, depreciation and amortization, management fees, pre-opening expenses, change in FV of investment properties & derivative financial instruments and other non-recurring items.

The excellent profitability comes from the great cost control, reflected by the relatively low staff to room ratio as at Dec09. This is because of the effective training of employee to achieve multi-tasking and outsourcing of ancillary services (such as laundry and chauffeur services)

We estimate that the KHI's EBIDTA margin would rebound and maintain in between 44 and 50% as shown:

Valuation& Investment Thesis

We believe that the company would grasp the opportunities to fill in the demand gap of mid-scale/ boutique hotel in comings years in long term. Besides, the company would maintain a ideal level of EBIDTA margin through effect-cost control, economics of scale. In short-term trading aspect, the company may be the market focus because of the recent mainland vacation.

We believed that the company will enter a high growth era (relative to the high-end, luxurious industrial peers like Shangri- La <69.hk> (2011 PE: 22x) and HSH <45.hk> (2012 PE: 25x)) through acquisition. Therefore, the earning s in 2011 and 2012 are estimated to reach HK$ 145 Mil (EPS: 0.0775) and HK$ 280 (EPS: 0.14) Mil respectively. Our 12-month target was HK$3.5 which is equivalent to our fair estimated 2012PE 25x (2012 PE ranged from 14.57 to 19.64 based on our earnings forecast and offering price range). Yet, investors are highly recommended to be careful of the disappointing performance due to the high 2011 PE ranged from 28.13x to 37.9x (based on the earning forecast of 2011 and offering price range). Rating: Speculative Subscribe.

Peer Comparison

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