Lemon Tree’s renovation drive leaves little room for re-rating

The ongoing premiumization in the mid-market hotels space boosted Lemon Tree’s consolidated average room rate (ARR) by 12% year-on-year to ₹5,902 in the July-September quarter (Q2FY25), aiding revenue per available room—or RevPAR, a key measure of a hotel’s performance.

Meaningful ARR contribution came from Aurika Mumbai Skycity, the newest premium property in Lemon Tree’s portfolio. Aurika Mumbai, India’s largest hotel by room count (699 rooms), began operations in the October-December quarter of 2023-24 and has yet to scale up completely.

This contributed to Lemon Tree’s lower occupancy in the latest second quarter—at 68.4%, its occupancy was down by around 330 basis points year-on-year.

The lower occupancy rate was also due to 9% of Lemon Tree’s 5,800 rooms being closed for renovations during the September quarter. Lemon Tree embarked on an ambitious renovation drive in FY24, targeting 4,500 rooms where it saw potential for subsequent price increases.

Its Keys Hotels brand, which mainly operates in the economy segment, is also undergoing a major overhaul, with 25% of its portfolio currently under renovation. Post-renovations, Lemon Tree’s management expects the revenue from owned hotels to increase by 15%.

Margin squeeze

Lemon Tree plans to spend ₹300 crore on renovations over the next three years, which is likely to generate some short-term margin pain for the company. Analysts estimate the company’s Q2FY25 Ebitda margin would have been 200 basis points higher without the renovation expenses.

But its margin was still up 114 bps year-on-year at 46%, as the company reduced exposure to the low-rate cabin crew business, increased its management fee for third-party property owners, and reported robust corporate business across segments. Lemon Tree’s margin is still higher than the average hotel industry margin in India.

Moreover, the company is working on finalising around 25 weddings at its properties in the ongoing third quarter, which, along with no major renovations scheduled over the next two quarters, could buoy margins for the second half of this financial year.

A renovation overhang

But for now, ongoing renovations have weighed on the stock’s performance. Lemon Tree’s stock has returned only 3% this year so far, significantly underperforming industry heavyweights such as India Hotels Co. Ltd and EIH Ltd, which have returned 80% and 42% respectively.

“Full-scale benefits from better occupancy and higher ARR may be capped by continued renovation of the Keys portfolio and will truly reflect only FY27 onwards,” Elara Securities (India) Pvt. Ltd said in a report on 18 November.

That, along with the listing of Lemon Tree’s subsidiary, Fleur Hotels, could lead to a significant re-rating from FY27 onwards. But before that, there may be an overhang from high renovation expenses, Elara added.

Elara reiterated its ‘buy’ rating on the Lemon Tree stock and a share price target of ₹152. The stock ended Thursday’s trading on NSE nearly unchanged at ₹122.40 per share.

However, the stock’s return may outweigh Elara’s target price as the investment advisory firm did not factor in the value unlocking for Lemon Tree after the listing of Fleur Hotels.