In the eye of the storm: SA hotels, casinos and restaurants

Page created by Barbara Reyes
 
CONTINUE READING
In the eye of the storm: SA hotels, casinos and restaurants
A N A LY S I S

                                                               In the eye of the storm:
iStock-1169552292

                                                                 SA hotels, casinos and
                                                                            restaurants

                                                  Kaitlin Byrne
                                                  PORTFOLIO MANAGER

                                        i     KEY TAKE-AWAYS

                                         In the Coronavirus pandemic, the           and managing room portfolios,
                                         share prices of hotels, casinos and        restaurants have been negotiating
                                         restaurants have been among the            hard with landlords, and casinos
                                         worst punished, with some hotel            appear to be managing their debt
                                         counters losing around 70% of their        levels responsibly with funders.
                                         value at their worst levels in March.
                                                                                    Prudential doesn’t believe all these
                                         Based on our analysis, the sell-off been
                                                                                    companies will be permanently
                                         overdone based on the fundamentals
                                                                                    damaged by the pandemic, although
  Prudential Investment Managers ©

                                         and future prospects for the leisure
                                                                                    their survival may well depend on
                                         sector.
                                                                                    external factors such as the ability and
                                         Among other remedial actions, hotels       willingness of debt and equity funders
                                         have been aggressively cutting costs       to continue to support companies,

                                     Consider this QUARTER 03 2020                                                    Page 1
In the eye of the storm: SA hotels, casinos and restaurants
A N A LY S I S                                                              IN THE EYE OF THE STORM

                                            and how long the economy takes                        three were already facing risks of
                                            to re-open fully and pick up again.                   their own, but a complete shutdown
                                                                                                  for months was certainly not on the

                                       S   ince the outbreak of the Coronavirus                   cards for any one of these sectors at
                                           pandemic and economic shutdown                         the beginning of 2020.
                                        in South Africa in March 2020, three                      The accompanying graph shows how
                                        sectors in particular have found                          companies like City Lodge, Tsogo Sun
                                        themselves in the eye of the storm:                       Gaming, Sun International and Spur
                                        hotels, casinos and restaurants. The                      have seen their share prices fall much
                                        share prices of the companies in                          further than the overall market (as
                                        these sectors have certainly felt the                     measured by the Capped SWIX) during
                                        pain, underperforming the FTSE/JSE                        the downturn and have struggled to
                                        Capped SWIX Index significantly. All                      recover to the same extent as the rest of

                                                                 Leisure sector share prices hit hard
                                                                                     Based to 100
Prudential Investment Managers ©

                                   SOURCE: Refinitiv Datastream/ Prudential Investment Managers

                                   Consider this QUARTER 03 2020                                                                     Page 2
In the eye of the storm: SA hotels, casinos and restaurants
A N A LY S I S                                                  IN THE EYE OF THE STORM

                                        the market. Tsogo Sun and City Lodge          severe drought in 2018, which took
                                        have been particularly hard-hit, losing       its toll not only on international
                                        around 70% of their value at their            tourism, but interprovincial travel as
                                        worst levels from the start of the year.      well. 2020 was meant to be the year
                                        Spur was somewhat more resilient,             where Western Cape hotels finally
                                        with a decline of around 30%. This            recovered from one of their toughest
                                        dire performance is understandable            trading years and started to return to
                                        if we consider some of the drivers            more normal occupancy levels, while
                                        behind it, but has the sell-off been          also hopefully regaining the ability
                                        overdone based on the fundamentals            to price their rooms above inflation.
                                        and future prospects for the leisure          City Lodge compounded its struggles
                                        sector?                                       in South Africa by completing a multi-
                                                                                      year expansion into the rest of Africa
                                        Hotels: Aggressively cutting costs
                                                                                      where they have invested over R1bn.
                                        and managing room portfolios
                                                                                      They are more likely to see losses than
                                        The listed hotel space in South Africa
                                                                                      profits from this expansion in the next
                                        has three companies with pure hotel
                                                                                      few years.
                                        exposure - City Lodge, Tsogo Hotels and
                                        Hospitality Property Fund - although          Upon the announcement of the
                                        most of the value in Tsogo Hotels is          complete Level 5 lockdown in mid-
                                        attributable to its 59% holding in            March, all the hotel companies
                                        Hospitality Property Fund. Before             prepared to close their entire portfolios
                                        the shutdown in March, all the hotel          and embarked drastic cost-cutting
                                        companies had been struggling with            measures to save cash. Focus was on
                                        depressed occupancy levels, and as a          put on employee costs, lease expenses
                                        result, an inability to increase their room   and cleaning and laundry, as well as
                                        rates by more than inflation. Sandton         debt service costs which can be a large
                                        hotels had been hit with oversupply           part of non-operational costs.
                                        from new rooms added in the last
                                        few years, combined with a weak               While City Lodge didn’t have a high
                                        local macroeconomic environment.              amount of debt on their balance sheet
                                        The Western Cape saw major declines           at the outbreak of the pandemic, it was
Prudential Investment Managers ©

                                        in occupancy levels as a result of the        certainly higher than previous years

                                   Consider this QUARTER 03 2020                                                         Page 3
A N A LY S I S                                                IN THE EYE OF THE STORM

                                                                                    hotels that are focused on international
                                        due to the African expansion and the        travellers remaining shut.
                                        losses from the African hotels, which
                                        had started to impact their results. To     In March, City Lodge shut down
                                        manage this, they have been able to         all 62 of their hotels, then initially
                                        get debt covenant waivers from their        opened seven in order to provide
                                        lenders for their debt repayments due       accommodation for essential workers
                                        in June and December 2020, as well as       for some businesses, some for tourists
                                        securing additional liquidity. However,     not able to return home, and some
                                        they have experienced additional            for quarantine purposes. They are
                                        troubles stemming from a R750m loan         currently sitting with 21 hotels open,
                                        guarantee to their BEE partners. As         undoubtedly at reduced occupancy
                                        City Lodge shares were held as security     levels, and should continue to slowly
                                        for this loan, trouble lay ahead as the     open more as the economy starts to
                                        share price of City Lodge tumbled. As       re-open.
                                        the share price fell, so the guarantee
                                        to lenders kicked in. As a result, City     In generally, the hotel groups have
                                        Lodge have now announced a R1.2bn           done a very good job reducing cash
                                        rights issue to cover the bulk of their     costs as much as possible while their
                                        outstanding debt, as well as the BEE        properties have been closed, and
                                        loan guarantee.                             planning the reopening of their
                                                                                    portfolios in the most cost-efficient
                                        Meanwhile, Tsogo Hotels have                way. Funders have also been very
                                        successfully agreed on delaying debt        supportive so far, which is also the
                                        repayments coming due in September          advantage of having a portfolio of
                                        2020, with lenders recognising that it      hard assets (i.e, fixed property) which
                                        was difficult for the group to make         can be used as security for borrowings.
                                        payments when their hotels were
                                        not trading. More recently, now that        Restaurants: Negotiating hard with
                                        provincial travel is allowed for business   landlords, opting for delivery-only
                                        purposes, Tsogo Hotels are re-opening       in the interim
                                        key hotels in each of the main cities,      The restaurant industry also came
                                        but will more than likely be watching       under significant pressure when the
Prudential Investment Managers ©

                                        their cash burn rate very closely, with     lockdown came into effect. In mid-

                                   Consider this QUARTER 03 2020                                                       Page 4
A N A LY S I S                                                IN THE EYE OF THE STORM

                                        March the restriction on the number         negotiations with landlords, since
                                        of people allowed into a restaurant         having such a large store footprint
                                        had already created severe pressure         in the group gives them an element
                                        for restaurant earnings. Although           of bargaining power. They have also
                                        one would think that some business          given their franchisees relief in the
                                        is better than no business, this is far     form of their monthly franchise fees
                                        from the case. As Spur later announced      and marketing contributions.
                                        to the market, the full lockdown
                                        almost came as a relief to the company      Spur are starting to slowly re-open
                                        because operating with the same cost        restaurants that are able to operate
                                        base but fewer customers is more            profitably under a delivery-only
                                        damaging than operating with no             method, such as those where the rental
                                        customers at all, but with the ability      negotiations have been favourable,
                                        to significantly lower costs.               despite earning a lower margin
                                                                                    compared to sit-down restaurants.
                                        Spur operates a franchise model,            The one advantage that should come
                                        meaning they receive a set franchise fee    from this crisis is that the restaurants
                                        based on revenue from the franchisee        that are able to survive should be the
                                        who owns the restaurant. Spur have          financially stronger restaurants that
                                        over 600 restaurants which include the      are more rational with pricing. This
                                        popular brands Spur, Panarottis, Hussar     should allow the remaining restaurants
                                        Grill, John Dorys and Rocomamas.            to regain some pricing power in what
                                        The group is in a positive net-cash         should be a less-competitive industry
                                        position and therefore doesn’t face         going forward, as we have seen the
                                        the same level of financial pressure        likes of Dominos and a number of
                                        as hotels and casinos, but they do          smaller restaurants close their doors.
                                        face the risk that earnings would be
                                        permanently lowered should several          Casinos: Managing higher-than-
                                        of their franchisees go bankrupt.           usual debt levels after large
                                        Therefore, it is in the group’s best        expansions
                                        interest to ensure that franchisee          The casino industry is known for its
                                        health is maintained, which is where        multitude of risks, all of which are
Prudential Investment Managers ©

                                        the real financial pressure is felt. They   well known to industry operators, such
                                        have been able to be very firm in rental    as the potential for the government

                                   Consider this QUARTER 03 2020                                                       Page 5
A N A LY S I S                                               IN THE EYE OF THE STORM

                                        to impose gaming tax increases, VAT         had completed their large capital
                                        increases that can’t be passed on, and      spending projects, and had planned
                                        a smoking ban within the casinos.           to focus the next few years on strong
                                        However, no one ever anticipated a          cash generation to pay down the debt
                                        risk like a pandemic that would see         associated with these expansions.
                                        casinos, whose doors are barely ever
                                        closed, facing months of no revenue         However, the advent of the pandemic
                                        with a large fixed cost base.               meant this was no longer possible.
                                                                                    Both casino groups had to close all
                                        Sun International and Tsogo Gaming          their casinos, as well as their limited
                                        (split from Tsogo Hotels in 2019) are       pay-out machines (which are placed
                                        South Africa’s large listed casino          in bars and restaurants), and found
                                        companies, with Peermont being              themselves in a tight space in terms
                                        the third (unlisted) casino company.        of debt levels. Both Tsogo Gaming
                                        This shut down came at a bad time           and Sun International submitted
                                        for both Sun International and Tsogo        plans to funders on how they would
                                        Gaming in terms of how much debt            manage the crisis and cash levels, and
                                        they carried on their balance sheets.       most have been supportive thus far,
                                        Tsogo Gaming had purposefully taken         waiving covenants in the near term.
                                        on more than their share of debt            Sun International have announced
                                        when they split from Tsogo Hotels,          another rights issue to raise R1.2bn
                                        given that the casino business is more      more in capital, which will help them
                                        cash-generative than hotels with their      weather this period of very low cash
                                        heavy capital spending; therefore they      flows, and most likely keep debt
                                        should have been able to repay the          funders more comfortable.
                                        debt over a reasonable time period.
                                        Sun International still had a high          Casinos are, by nature, very cash-
                                        amount of debt on their balance             generative businesses if they do not
                                        sheet following their construction          overspend on capital projects; however,
                                        of Menlyn Casino in 2017 and 2018,          they are geared to the economy to
                                        where revenues turned out to be             a degree. The recent announcement
                                        significantly weaker than expected,         that casinos would be allowed to
Prudential Investment Managers ©

                                        resulting in a rights issue in 2018. Both   open up again at 50% occupancy is
                                        Tsogo Gaming and Sun International          very positive, despite the reduced

                                   Consider this QUARTER 03 2020                                                      Page 6
A N A LY S I S                                                           IN THE EYE OF THE STORM

                                        occupancy levels . The companies plan                financial stress; and how long the
                                        to manage costs carefully to ensure                  economy takes to pick up again. To
                                        they are cash-positive, even at a lower              date none of the companies have
                                        occupancy level.                                     encountered problems in either having
                                                                                             their debt terms eased or raising extra
                                        Any permanent damage dependent                       capital through rights issues; investors
                                        on external factors                                  and creditors have still deemed it
                                        At Prudential we are cautiously                      attractive to support them.
                                        optimistic about the medium-term
                                        future of these industries. We don’t                 Even now, three months after the
                                        believe all these companies will be                  worst of the market crash, we still
                                        permanently damaged by the impact                    see significant value in some of these
                                        of the Coronavirus pandemic, but                     companies like Sun International on a
                                        we acknowledge that they are most                    three- to five-year basis, even taking
                                        certainly high-risk businesses given                 into account further capital or debt
                                        the level of high operating leverage                 raisings. We are very cognisant of the
                                        as well as the high financial leverage               high level of risk involved in investing
                                        prevalent in some of them. Their                     in these companies as well, and are
                                        survival may well depend on several                  therefore cautious about the overall
                                        external factors, such as: government’s              size of the exposure to these three
                                        decisions around the timing of the                   sectors, as well as to any one of these
                                        full reopening of these sectors; the                 companies individually, in our client
                                        ability and willingness of debt and                  portfolios.
                                        equity funders to continue to support
                                        companies during this period of high

                                     Kaitlin joined Prudential in May 2015 as an Equity Analyst and was appointed Portfolio Manager
                                     in early 2020. She is primarily responsible for covering South African and African stocks within
                                     the Gaming and Leisure sector.Prior to joining Prudential, Kaitlin completed her articles at Ernst
                                     & Young, where she was responsible for auditing companies in the Finance, Gaming and Leisure,
                                     Real Estate and Manufacturing sectors. She currently has four years of industry experience. Kaitlin’s
Prudential Investment Managers ©

                                     qualifications include B.Acc (Stellenbosch), CA (SA), and CFA.

                                   Consider this QUARTER 03 2020                                                                      Page 7
You can also read