The South African hotel landscape boasts many large, home-grown brands that have managed to remain relevant despite the arrival of several international hotel groups over the last 20 years. We discuss the South African hotel industry, its challenges and opportunities, and the outlook for two JSE-listed entities – City Lodge Hotel Group and Tsogo Sun Hotels.
Hotel economics
Despite their terrestrial orientation, hotel economics are rather similar to airlines in that they have a fixed number of openings (rooms) that need to be filled. Revenue received by hotels is therefore a function of the occupancy experience of a hotel (how full they are) and the rate charged per room. When demand (occupancy) is high, room rates will typically increase in tandem to maximise the revenue from each available room – much like the expensive last seat on an aeroplane. In times of weaker demand (lower occupancy), prices will typically decrease in an effort to fill as many rooms as possible.
Like airlines, the cost base of hotels mainly comprises fixed costs, which are incurred regardless of occupancy, as shown below (left) for Tsogo Sun Hotels. This highlights that around 70% of costs are fixed, with the largest being employee costs, property costs and depreciation. The variable costs would include room expenses (eg laundry and cleaning), food and beverages.
In South Africa, two-thirds of hotel bookings are business-related, therefore weekday occupancies tend to run at the 70%-80% level, while weekend occupancies average 40%. This results in an average industry occupancy of around 60%.
The South African hotel industry
Locally developed hotel companies including Tsogo Sun, City Lodge and Protea dominate the South African hotel landscape. Sun International owns the iconic Sun City resort and Table Bay Hotel, but the rest of its portfolio comprises mainly smaller hotels associated with its various casinos. The last 20 years has seen several of the large international hotel groups expand their footprint in South Africa:
• Marriot has been the most aggressive, acquiring Protea Hotels in 2014 for $186 million. Some of its other brands include the African Pride Collection and The Westin.
• The International Hotel Group has presence with its Holiday Inn, Crowne Plaza and Intercontinental brands.
• Accor acquired the Mantis hotel chain in 2018 and owns the Mercure hotel collection.
• The Raddison group of hotels includes Raddison Blu, Red and Park Inn.
For the 15 years post 1994, the hotel industry saw a steady increase in new hotels opening, which was matched by a greater demand for rooms as the South African economy expanded at a healthy rate. This resulted in occupancies averaging 70% and the industry operating at strong profit margins. In the build up to the 2010 FIFA World Cup, significant new capacity was created, resulting in a 9% increase in total rooms available for 2008 and 2009. This coincided with a period of weaker economic growth in 2009 and, as a result, occupancies plummeted to below 60% and hotel profitability contracted materially (above right).
Demand remained healthy in the post-2010 period and little new capacity was established. As such, occupancies began to rise as the market slowly absorbed this new capacity. Combined with rising daily room rates (chart below), this saw hotel profits recover meaningfully from the 2011 lows.
In the last three years, a new wave of capacity has come at a time when the economy has slowed. Additionally, various other temporary factors have contributed to a weaker demand outlook. These include water shortages in the Western Cape, lower government spend on travel, and new laws requiring minors to travel with unabridged birth certificates (now reversed). Consequently, the industry has seen occupancies revert to near trough levels once again, although room rates have still managed to increase, albeit at below inflation rates. We expect total hotel room growth (new capacity) of 1.3% for the next three years, which should be filled in a somewhat improved economic environment. Therefore, we foresee occupancies normalising higher as some of these factors reverse.
Technology disruption
• OTA’s – friend or foe? Online travel agencies (OTA’s), for example Booking.com, Trivago, Agoda and Expedia, enable customers to book various travel-related products online – but they charge a 15%-30% commission fee to the hotel where the booking is placed. While these websites help hotels to fill rooms, the commissions significantly lessen the hotel’s profit per OTA-booked room.
The convenience, user experience, higher marketing spend, customer reviews and additional functionality means that OTA’s are gaining the acceptance of customers, which presents a challenge for hotels. Globally, the OTA share of total bookings for hotel groups varies between 15% and 25%, up from 5%-10% seven years ago. This has provided a significant cost headwind to hotel businesses.
The response from most hotel groups has been to push their own loyalty schemes and to try to capture direct bookings through their own websites. Hilton famously launched its “Stop Clicking Around” campaign in 2016 to encourage more direct bookings.
To date, South African hotel operators have avoided extensive use of these OTA’s, but we believe OTA’s are likely to be a source of hotel margin pressure in the future as South Africa follows international trends.
• Airbnb – making the village bigger: Airbnb has added a new dimension to the scale and variety of travel accommodation available globally. It allows any of its members to list their property for rental. Airbnb has seen a significant rise in properties listed with over three million presently available worldwide, which is rising daily. Locally, Cape Town alone has 40 000 listed Airbnb properties.
Although we have seen only a partial impact of Airbnb on the South African hotel landscape, we believe that it may have a marginally more negative impact for the limited service, budget and 3-star options – given that the services and prices are more comparable.
Local is lekker
Two of South Africa’s largest hotel groups, Tsogo Sun Hotels and City Lodge Hotel Group are listed on the JSE Securities Exchange. The table below highlights the number of rooms and various brands operated by the two companies.
City Lodge Hotel Group caters predominantly for the business traveller, with a focus on a more affordable, no-frills offer. Its City Lodge and Town Lodge brands sit mainly within the 3-star category, offering limited services such as restaurants and conference centres, while the Road Lodge caters for the cost-conscious traveller.
Within South Africa, City Lodge’s hotels are predominantly based in Gauteng, which houses around 50% of its rooms. The company has recently invested significantly into its African footprint, with two new hotels in Kenya and one each in Mozambique and Tanzania. This has complimented the group’s existing footprint in Namibia, Botswana and Kenya. The initial trading of these new hotels has been disappointing, and the associated debt and related interest expense has seen group earnings compress significantly in recent periods.
Tsogo Sun Hotels owns and operates a broad hotel portfolio throughout South Africa, across a range of star grades. Its recent unbundling from the larger Tsogo Sun Gaming (casino) business in July 2019, has resulted in Tsogo Sun Hotels now being a pure-play hotel owner and operator. While Tsogo Sun Hotels is also dependent on the business traveller, it has a greater bias to the Western Cape (50% of revenue) and the tourist market. Its full-service offer caters well for larger groups and conferences, making it less dependent on the transient traveller than the City Lodge Hotel Group.
Although results outside of South Africa (14% of total rooms) have also been indicative of tough times, Tsogo Sun Hotels has a well-established presence in Africa (ex-SA) and the Middle East.
Waiting for the cycle to turn
Both hotel groups have not been immune to South Africa’s weak economic environment, with low occupancies and pressure on earnings. City Lodge Hotel Group has been more affected due to its higher business exposure and disappointing African expansion. However, as both businesses are well-run, cash generative and have strong local brands, we believe that they will benefit significantly from any improvement in occupancies and room rates when these inevitably come to pass.
