“Never take your eyes off the cash flow because
it is the lifeblood of business”
– Richard Branson
Cash is an asset, which is praised by many companies, something which is often neglected by a lot of investors as a key parameter to judge a company and something which is usually found missing in the financial statements of most of the startups.
But believe it or not, it is a key ingredient required to keep the company running. It is also admired by the guru of the investing world – Warren Buffet. In his annual letter to the Berkshire Hathaway shareholders in 2010, he introduced a concept called “Free Float”, which is also a core idea of Berkshire’s success. In his own words, he described float as:
“Insurers receive premiums upfront and pay claims later. … This collect-now, pay-later model leaves us holding large sums — money we call “float” — that will eventually go to others. Meanwhile, we get to invest this float for Berkshire’s benefit.”
So, free float is the ideal money that is collected by the company and the services for the same are rendered over a certain period of time. This free money can be used by the company in its growth. Insurance companies work on this concept. They collect an excess amount in the beginning from its users in the form of premiums. Now in most of the cases, the policyholder will claim this amount after a period of time. The money kept by the insurance company until that tenure is called float. Today we are going to talk about one such company that sails in the ocean of free cash. Several smart moves taken by the company has kept it ahead in its game.
In this blog we will be discussing Mahindra Holidays and Resort India Limited. By reading the name itself, it becomes very obvious that the company is associated with tourism and hotel business.
But before diving any deeper, let us first understand how a hotel business works?
How does a hotel business work?
Initialising a hotel business starts with Identifying a vacant plot in the city or its outskirts and usually people need to buy land either in the metros or larger cities because that’s where most of the business travel happens but if it is a leisure resort, then it can be in a smaller town, city or a village.
Now, once you buy the land, it takes several years to get the hotel constructed and up and running. So this is the gestation period or the investment phase of the business. It is the phase where the business owners put the money upfront, the banks lend the money based on the collateral of the land and the building and meanwhile, during this phase, the business does not generate any positive profit.
Once the hotel business starts its operation, the company needs to appoint the staff, then to make it grow further it needs to advertise, popularise it or enter into the corporate deals to fill up the rooms of the hotel. That’s where the cash flow starts coming in or in other terms, your business starts generating cash during this phase.
This might seem good on paper but in reality, it’s too difficult to compete with other players in the same space as well. Let us look at how this business model might not provide you with stellar returns.
The initial returns are very poor because of the long gestation period. Additionally, due to cut-throat competition and price-sensitive customers, there is a problem in filling up the room. Due to this reason, most of the hotel chains run at a very low occupancy rate which affects their bottom line as well as return on equity.
The primary reason for this is the low pricing power.
Now, what is Pricing power, you may ask?
Well, pricing power refers to a company’s ability to raise prices without reducing demand for their products. The more pricing power you have, the easier it is to raise prices. If a company does not have pricing power, then an increase in product prices would lessen the demand for their products.
Also, one thing about the Hotel, Airline or Multiplex business is that the services they offer are extremely perishable. This means that if an aircraft flies with some vacant seats or even if 20% of seats of aircraft go vacant on one journey, then you can not store those empty seats. That revenue is lost forever. Following the same depiction, in multiplex, if 25% of the seats go vacant because of the IPL or whatever reason, then you cannot restore those revenues. The same thing applies to hotel rooms also, if you don’t have enough guests to fill up your room today, you cannot sell twice the number of rooms you fill-up tomorrow. That capacity is lost forever and So when you have more demand then you have a ceiling on how many rooms you can offer. And thus, this is another reason why it is a risky business.
Hotel business from an analyst’s viewpoint:
Taking a holiday or business travel is a discretionary consent. When times are bad, then people won’t cut down on toothpaste or soap consumption but people surely will cut down on dining out or people will postpone their holiday plans. So this business is highly cyclical in nature and can be further noticed as in recent times due to COVID induced pandemic, all activities were stopped and henceforth all the hotel business had reported huge losses.
Analysing the past trend you would notice that it generally takes 2 years for hotel business to get back to its escalating earnings after any turmoil has happened. The hotel stocks are not buy and hold for a longer period of time, kind of stock. They are highly cyclical in nature. Therefore it becomes critical to understand the cycle of such business. One needs to Purchase the stocks only when the industry is struggling and the prices are extremely cheap and sell once the stocks soar up or reach their previous all-time high levels. Don’t wait for greed to take over. People lose their earnings in pursuit of hoping for more than expected results.
Therefore as an investor, you will have to wait for a long duration in order to reap the profits plus any small turmoil like riots, floods, or a terrorist attack can dampen the demand of hospitality of sector,
Here we can say that investing in hotel business requires a thorough understanding of the business cycle to take the right entry and exit call.
Now let’s look at another kind of business model which is quite constituent despite operating in the hospitality industry.
In this kind of business model, shareholders don’t have to put in a lot of money, the company also does not need to raise a large debt. Here the resorts or hotel properties are financed by its customers.
Yes, Customers!
You collect upfront money from people by selling your rooms in advance for 25 years. In addition to that, you charge them fees each year and you keep your guests captive by keeping them locked up in a room and telling them to take services only from you.
So let’s look at Mahindra Holidays and Resort Limited and analyse how they do this business differently. Mahindra Holidays & Resorts sells one week of holidays consecutively for the next 25 years on an upfront payment as per the plan. These vacations are staged at their own resort or one of their affiliated resorts.
Let’s look at how Mahindra Holidays Business Model works
Mahindra Holidays and Resort works on a Unique and Resilient Business model. They own a good position in the vacation ownership business.
Now, what is this Vacation Ownership business?
In the normal hotel business, the company provides a customer with a room for the required period of time. This could be for a day, a week or even a month. Since this industry is hyper-competitive, therefore it is very difficult to maintain the occupancy level of the hotel. But what if we could rent the rooms in advance for a very long time (10 to 25 years). This would provide the companies with excess cash while maintaining their occupancy levels…
Let’s say that you love to travel and you plan to go on a vacation every year. But it becomes very hard to find a resort that suits your needs. It is also imperative that the type of resort you are looking for should fit your budget. It is also difficult to find a place for your accommodation when it is a peak season. Therefore, in this case, Mahindra Holidays comes as a single best option for you.
Club Mahindra Holidays 25 is its flagship product where it takes an upfront payment from its members. The product ranges from 2 Lacs to 20 Lacs. This membership avails them the facility to stay at any resort of Mahindra Holiday for 7 Nights and 8 Days. The interesting part is that this membership fee is taken in advance. So the company attains the money which is to be realised 25 years later in advance.
This way Club Mahindra attains a large chunk of cash from its clients in advance which can be further used in buying and repairing a resort. So the short term and long term expenses of the company are funded by its members. We will discuss more on this later in this blog.
This business model is known as the timeshare model.
Let us see the opportunity size of the Timeshare Industry:-
In the USA, the industry size of the timeshare industry is worth USD 11 Billion. As per the American Resort Development Association, there are 9.6 million families that own one or more than one vacation ownership. Wyndham, Marriott and Hilton are one of the three major players with an accumulated market cap of more than USD 10 Billion. The vacation ownership business accounts for ~6.5% share of the tourism industry.
Now in India, the vacation ownership share of the tourism industry is less than 0.5% vs the global average of 2%. Several factors like demographic, rising per capita income, disposable income, geographic profile and natural beauty of the country augur well for the sector. As per the report of Bain, India has 11.5 Million household addressable market vs the current member base of approx 3.5 Lacs members. Mahindra Holidays is one of the early entrants and the market leader in the vacation ownership business in India. After understanding what a timeshare business is we will be discussing about Mahindra Holidays and Resorts in part 2.
Click here for part 2.
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