We initiate coverage on TPSEAL with a BUY recommendation (fair value KES 63.50, upside 32%). Our recommendation is driven by improving margins (339bp margin improvement over our forecast period) based on expected increase in occupancy levels (57.2% in FY12 to 64% FY17F) and decline in operating costs. On a relative basis, TPSEAL trades at an EV/EBITDA of 9.2x, a 25% discount to sector average of 11.33x. While we think the discount is fair based on TPSEAL’s low EBITDA margins relative to sector (at 22% vs. sector 29%), we expect TPSEAL to register improvement in margins over our forecast period and thus have assumed an exit EV/EBITDA multiple of 8.10x leading to a fair value of KES 63.42.
Earlier in the year (FY13), TPSEAL concluded the acquisition of a majority stake (50.26%) in TPS Uganda through a share swap with AKFED. Following the transaction, AKFED’s stake in TPSEAL increased to 45% from 32.44%. NSSF Uganda (the other key party in the share SWAP) is yet to conclude the transaction (on completion NSSF Uganda will have acquired 3.85% in TPSEAL and in return TPSEAL’s stake in TPS Uganda will increase to 79.19%). So what does TPS Uganda bring to the table? Higher margins (27% EBITDA margin compared to TPSEAL’s 22%), 17% increase in TPSEAL’s room capacity and diversification of business risk.
While competition for the business traveller and conference facilities is expected to intensify with the entry of international hotel chains (e.g. Radison, Crown Plaza, Best Western, Kempinski) we believe TPS is well positioned to maintain its market share - given its strong brand name and diversified product offering.
Industry performance.
In Kenya, the industry has posted 16% CAGR in revenue over the past decade. Bed occupancy has averaged 40%, touching a high of 47% in 2007 and a low of 26% in 2008 due to post election violence. Bed nights have increased by 8.7% CAGR over the past decade, driven by new entrants, primarily international chains targeting the business traveler and investments by local enterprises targeting the high-end market. Arrivals have increased 5% CAGR mainly driven by rise in travelers from new source markets (mainly from Asia). In line with expanding middle income population, increase in discretionary incomes and change in lifestyles, the role played by local tourists has increased with local tourists now accounting for 40.6% of bed nights occupied up from 25.2% in 2005.Overall, combined East Africa revenue over the past 5 years has increased 6.12% (CAGR), with Rwanda (11%) and Uganda (12%) leading the pack and Kenya trailing (3%).
Medium term earnings drivers.
We forecast increased occupancy levels (driven by continued diversification of source markets and increase in domestic tourism) and reduced operating expenses (driven by increased use of solar energy for heating and lighting which accounts for approximately 12% of total operating expenses) Longer-term, we expect TPSEAL’s growth to stem from continued integration of associate companies & acquisitions, as well as Greenfield expansion. TPSEAL has three associates TPS Rwanda, TPS Dar es salaam and Mountain lodges which are all targets for integration.
Key Risks.
The slow recovery in the European economy stands out as a key risk since the market accounts for 37% of bed nights occupied. Volatility in currencies also remains a key risk since TPSEAL revenues are mainly foreign currency denominated while cost base is local currency driven. Though market dynamics are changing, especially with Kenya increasingly becoming the hub for international companies and government agencies, the tourism sector remains one of the most exposed sectors when travel advisories are issued.
(Source: Standard Investment Bank - 08.07.2013)