Lemon Tree Hotels Ltd

NSE:LEMONTREE

Earnings Call Analysis

Lemon Tree Hotels Reports Strong Q2 Growth

Lemon Tree Hotels celebrated its best-ever second quarter, revealing a surge in revenue, EBITDA, PBT, and PAT compared to the same period last year. This was achieved by elevating occupancy and RevPAR, with a year-on-year gross ARR increase of 7.1%. Despite a significant year-on-year PAT growth of 36.3%, net EBITDA margin declined slightly due to planned renovation costs and new property preoperative expenses, amounting to an approximated 2% reduction. The introduction of the Aurika, Mumbai Sky City, projected to be the largest hotel by room count in India, strengthens their portfolio. They also signed 11 new contracts expanding their pipeline. However, they did note that the debut of Aurika increased their debt, which they expect to recoup as the hotel begins to contribute cash flow. The management remains optimistic about industry prospects, underpinned by consistent demand and limited supply growth.

Value Proposition and Market Dynamics

The company operates in a seasonal hospitality market, with winter revenues typically being 25% higher than summer, leading to better operational leverage as costs remain relatively stable. There is an ongoing renovation strategy to enhance the quality and pricing power of the portfolio in anticipation of demand outpacing supply for the next 3-4 years. As a result, EBITDA margin has seen a 2% impact from this increased renovation activity. The company is poised to take advantage of the upcoming mid-cycle and anticipates a hockey stick shift to an upcycle with the return of other demand segments, especially international travel which remains below 50% of pre-COVID levels.

Renovation and Repositioning Efforts

The company has incurred significant renovation costs as a catch-up from the inactive COVID years, aiming to allow for significant annual repricing of the portfolio over the next four years. In the upcoming fiscal years, an additional INR 100 crores are budgeted for renovation, signaling a focus on improving the asset base to drive higher returns. This investment is expected to yield improved pricing dynamics as price-sensitive segments may move to lower-tier offerings of the brand.

Strategic Capital Allocation and Debt Management

A clear capital allocation policy is underway, focusing on debt reduction with the intent of potentially becoming debt-free. The company sets high thresholds for new capital investments, with a weighted average cost of capital (WACC) hurdle rate of 14%. Managing the ideal debt-to-equity ratio and debt-to-EBITDA is a priority, and there are plans to bring the current debt-to-EBITDA ratio down from 3x to 1x within two years. The company is expecting to be significantly free cash flow positive following these years, with decisions pending on capital distribution methods (e.g., dividends, buybacks).

Operational Efficiency and EBITDA Outlook

The Aurika MIAL hotel is expected to be EBITDA positive starting this quarter. Overall, there is an anticipation of scaling the revenue for owned hotels to INR 1,000 crores, with power and fuel expenses targeted around 7.5% of revenue. Incremental revenue from hotel operations is therefore likely to contribute positively to margins going forward.

Market Segment Performance and Strategic Price Adjustments

The company is repricing market segments to eliminate anomalies. Corporate rates have gone up by approximately 8%, while retail pricing has risen by about 3%. There is an intentional strategy to replace lower-rate segments with higher paying customers, even if it means lowering some rates to improve occupancy in certain segments. This approach should mitigate any risks associated with variations in segment pricing and consumer demand shifting between hotel tiers as company rates adjust.

Demand and Supply Outlook and Signings Strategy

Significant demand growth is expected in the near future, and the company aims to secure its position by expanding its manage/franchise segment to 70% by FY '26. Focus on conversion projects will allow for faster realization of management fees versus new constructions. Strategic moves into cities that can drive business to existing properties through network effects and airline traffic data are considered for expanding the portfolio. This may also include entering adjacent markets, such as co-living spaces, which could provide annuity revenue and diversify the business model, although this is not an immediate focus.

Upcoming Revenues and Guidance

While there is no official guidance, the company indicates a revenue potential from own hotels to reach about INR 1,000 crores, if seasonal trends hold. Also, there is a sense of optimism around the potential cash flow from the Aurika MIAL hotel starting Q4. The executive team suggests that this will offer a pleasant surprise in financial performance to stakeholders.

Earnings Call Transcript 2024-Q2

[Operator]

Ladies and gentlemen, good day, and welcome to the Lemon Tree Hotels Limited Earnings Conference Call. [Operator Instructions] Please note that this conference is being recorded.

I now hand the conference over to Mr. Anoop Poojari from CDR India. Thank you, and over to you.

[Anoop Poojari]

Thank you. Good afternoon, everyone, and thank you for joining us on Lemon Tree Hotels' Q2 and H1 FY '24 Earnings Conference Call.

We have with us Mr. Patanjali Keswani, Chairman and Managing Director; Mr. Kapil Sharma, Chief Financial Officer; and Mr. Vikramjit Singh, President of the company. We would like to begin the call with brief opening remarks from the management, following which, we'll have the forum open for an interactive question-and-answer session.

Before we start, I would like to point out that some statements made in today's call may be forward-looking in nature, and a disclaimer to this effect has been included in the results presentation that was shared with you earlier.

I will now request Mr. Keswani to make his opening remarks.

[Patanjali Keswani, executive]

Good afternoon, everyone, and thank you for joining us on the call. I will be covering the quarterly business highlights at the financial performance for Q2 FY '24, post which we will open the forum for your questions and suggestions.

In Q2, Lemon Tree continued its growth momentum from the previous year. Q2 FY '24 has been the best ever Q2 performance in terms of gross ARR revenue, EBITDA, PBT and PAT for Lemon Tree Hotels. This quarter, Lemon Tree's focus was on increasing occupancy and maximizing RevPAR. Q2 FY '24 recorded a gross ARR of INR 5,268, which increased 7.1% year-on-year and increased 0.6% quarter-on-quarter. Occupancy also increased by 542 bps year-on-year and 143 bps quarter-on-quarter. This translated into RevPAR of INR 3,678, which increased 15.9% year-on-year and 2% -- 2.6% quarter-on-quarter. Total revenue for the company in Q2 was INR 230.1 crores, which was higher by 16.6% year-on-year and 2.5% quarter-on-quarter.

The net EBITDA margin of the company in Q2 FY '24 stood at 45.5%, which decreased by 225 bps versus Q2 FY '23 and by 203 bps versus Q1 FY '24, mainly owing to planned increase in renovation expenses above that spent in Q2 FY '23 and preoperative expenses of Aurika, Mumbai Sky City. These two incremental expenses accounted for a total increase in expense of about INR 4.5 crores beyond Q2 FY '23, which translated to a reduction in EBITDA margin by about 2 percentage points on revenue. The Keys portfolio also saw a drop in EBITDA margin percentage by nearly 5 percentage points year-on-year to a significant increased investment in renovation during Q2 FY '24.

Furthermore, the closing down of New Delhi during the G20 summit also impacted our hotels here with most of the business of the event being diverted to 5 Star deluxe hotels, which is why you see a drop in our performance in New Delhi versus the industry. The PAT for Q2 FY '24 grew by 36.3% year-on-year from INR 19.6 crores to INR 26.4 crores. Our cash profit stood at INR 49 crores, which increased 10.4% year-on-year.

Fees from managed and franchise contracts for third-party owned hotels stood at INR 10.4 crores in Q2 FY '24, up 58% from INR 6.6 crores in Q2 '23. Total management fees for Lemon Tree were up 29% year-on-year at INR 24 crores compared to INR 12.1 crores (sic) [ INR 18.7 crores ] in Q2 FY '23.

Hotel-level revenue from the owned portfolio increased by 15% year-on-year on a same-store basis, while the network revenue for Lemon Tree, that is total system revenue of owned and managed/franchise hotels increased by 17% year-on-year. Total network revenues stood at INR 691 crores for H1 '24 as compared to INR 591 crores in H1 '23.

Just a correction. As far as management fee income went in the previous quarter FY '23, it was INR 18.7 crores, which increased to INR 24 crores in this quarter.

During the quarter, we signed 11 new management and franchise contracts, which added 639 rooms to our pipeline. As of 30th September 23, our operational inventory comprised 95 hotels with 8,760 rooms, and our pipeline comprised 52 hotels with 4,092 rooms. As of now, we expect our operational inventory to be over 105 hotels with over 10,000 rooms by the end of this financial year.

I'm also happy to inform you about the launch of Aurika, Mumbai Sky City, on 5th October 2023. This hotel has 669 rooms and suites and is currently the largest hotel by a number of rooms in India. Some pictures in the investor presentation will give you an idea about the hotels look and feel.

With this, I come to the end of my opening remarks. I would ask the moderator to open the forum for any questions that you may have.

[Operator]

[Operator Instructions] We have a first question from the line of Jaiveer Shekhawat from AMBIT Capital.

[Jaiveer Shekhawat, analyst]

And first of all, congratulations for opening of Aurika, Bombay. So my first question is in relation to what you had earlier -- in your earlier calls mentioned about an expectation of 15 percentage plus kind of a RevPAR growth over the next 2 to 3 years. And especially when I see your Lemon Tree Premier in Lemon Tree portfolio, you're already clocking 75%-ish plus occupancy. I think the Lemon Tree Premier, you're already touching 80% percentage. So in that context, I mean, how do you see your ability to drive, say, an ADR growth of 10% to 15% in order to meet that 15% RevPAR growth because your occupancies are already in line with what it used to be even pre-COVID levels.

[Patanjali Keswani, executive]

So see, when I spoke about this, I spoke about the system growth. That is the entire managed portfolio growth Jaiveer, so as you noticed, Aurika Hotels still is at very low occupancy levels, which is -- which was 49% in Q2 this year. If you look at the portfolio of -- Red Fox it was at 69% and Keys by Lemon Tree was 59%. So really, it's a twin strategy. We -- where possible, we will drive occupancies and where occupancies are already peaking, we will look at driving weekend occupancies and higher ARR during the weekdays. So it's the some of the parts, really, but I'm very confident that now, especially with the addition of Aurika MIAL, our own portfolio, which saw a minimum revenue growth of 15%, perhaps for the next 3 to 4 years, minimum growth.

[Jaiveer Shekhawat, analyst]

Sure. And sir, on your overall debt levels, it seems to have increased over the last year. I understand it's because of the Aurika expansion as well. So one, where do you...

[Patanjali Keswani, executive]

The real increase in debt was because of the unplanned acquisition of the CCPS. Our share of the CCPS from APG because initially, our plan was to inject assets to equalize our shareholding. But since that was not financially very viable, we instead opted for this. So that was about, how much worth it? It's about INR 170 crores. Yes. So that was the main reason. The majority of the debt increase was for that.

I had also mentioned, if I remember right, here -- I mean, 1 or 2 investor calls ago that are our debt would peak with the opening of Aurika. And then with the cash flow of Aurika, it would automatically reduce, so it's really, it's a -- let's put it this way, Aurika is not earning yet. What it can take care of the debt side. Are you getting me?

[Jaiveer Shekhawat, analyst]

Yes, yes.

[Patanjali Keswani, executive]

So it's a temporary -- think of it as the equivalent of an overdraft, till such time Aurika delivers, after which will stabilize, as I said, I would really like you to look at debt at the end of this financial year really, rather than half year.

[Jaiveer Shekhawat, analyst]

Sure. And sir, lastly, just to understand your perspective, now we understand on the supply side that it seems to be quite muted. But on the demand side, I mean how much further room do you see from current levels before it starts sort of impacting demand due to unaffordability? And are you also seeing sort of people moving from upscale and luxury categories downwards, which is sort of supporting your current demand and pricing?

[Patanjali Keswani, executive]

See, I would not look at it as movements up and down. Basically, I think with GDP growth, the percentage of discretionary consumption in the hotel space is growing. That's my broad observation. Obviously, a part of that will be luxury, a part of that will be in mid-market and a part of that will be an economy. And of course, there will be movements up and down that as and when you change pricing, then a consumer of a certain category will might decide to move down because of affordability.

I think, as I said, the good proxy to look at is airline traffic because that has a direct correlation to a hotel room demand. And I think for you, the most interesting indicator should be the number of airplanes ordered by the airlines, which implies the growth in supply, and which is obviously predicated on a growth in demand.

And then please look at the growth in supply of hotel rooms. So my best guess is that airline seat capacity will more than double in the next few years, whereas hotel capacity will probably increase by 15%. So that will automatically lead to a huge mismatch in terms of demand/supply for hotels. And which is why I'm quite sanguine that the next 4 or 5 years will be very good years for the hotel industry and across sectors. Now price hikes are a simple function of demand/supply Jaiveer. So we are only interested in selling our hotels. So if there is more demand than obviously, and naturally, we will reprice to fill our hotels and I'm not look at demand beyond that.

[Operator]

We take the next question from the line of Jinesh Joshi from Prabhudas Lilladher.

[Jinesh Joshi, analyst]

I have two questions. One is with respect to the bookings from our own website, which have increased from about 2% to 7% in this quarter. So can you highlight what has led to growth in organic traffic for us?

[Patanjali Keswani, executive]

Yes. So Jinesh, let me explain this. Over the COVID years, we had started investing a little time in looking at revamping our entire website and our loyalty program, which frankly was not really operational during COVID because, as you know, there was really no demand.

So what you are seeing is the result of our revamp of our website and our loyalty program, and this was really launched, I think, in January this year. So what you are seeing is a result really of the -- of some work in the last two years. But the output you are seeing is now really starting to show itself in our brand.com bookings. And as you would guess, it is the most efficient and cost-effective way of getting customer reservations. It is the lowest cost, and it has the highest stickiness. So it is very encouraging for us. I mean in link with -- and sync with our strategy to maximize retail traffic.

[Jinesh Joshi, analyst]

Got that. And sir, in the last quarter, you had highlighted that your power cost was high due to some power cuts in Gurgaon and hence, you had to use DG sets, where the per unit cost is high. But even if I look at this quarter, our run rate is more or less similar to what it was in 1Q. So has the situation not changed as yet? And what should be the steady-state power and fuel run rate that one should be looking at?

[Patanjali Keswani, executive]

So see, typically, excluding Aurika MIAL, I would say, as you look at last year, our winter revenue is typically, say, 1.2 -- 1.25 the summer revenue and costs more or less remained flat. In fact, power costs actually come down a little bit. So from that perspective, if -- and I'm just speaking without really getting into the math of it. If our revenue was, say, what is that total revenue, it was...

[Unknown Executive]

INR 230 crores.

[Patanjali Keswani, executive]

And in the previous quarter?

[Unknown Executive]

INR 227 crores.

[Patanjali Keswani, executive]

So it was say, INR 460 crores, then technically and I'm -- and this is not guidance, we should do INR 1,000 crores of revenue of own hotels, let's say, are you with me? Now you applied this -- it is currently 8%, our power and fuel expenses. So if you look at 8% -- then in winter, it will be 7%. And therefore, the weighted average our power and fuel expenses will be about 7.5%, which is typically where we are quite comfortable with. After that, any increase in rate will drive the percentage down, not occupancy because occupancy does lead to some level of power consumption. Am I being clear?

[Jinesh Joshi, analyst]

Yes, sir. That was pretty clear. One last question from -- with respect to Aurika. I mean, we have opened this hotel on 5th of October. So just wanted to kind of understand how the feedback, how many rooms are we operating currently? And how are the ARR trending? Because if we do a random check on some OTAs especially this time around, the ARRs appear to be higher than what we have guided for FY '26. So how should we be looking at the pricing trend as well.

[Patanjali Keswani, executive]

What I can tell you is Aurika MIAL will be EBITDA positive from this quarter for sure, okay? Now if you look at the demand, we launched this hotel on 5th of October, I think we did about 100 rooms a day, which is about 15% occupancy in October. The ARR was low for two reasons because we had very little retail traffic. For retail traffic, it is an interesting chicken and egg situation. To build retail traffic, you need retail feedback. And October did not have much retail traffic because, a, it's a new hotel, and b, it was [ different ] so on and so forth.

We think -- so we have really started building a base in this hotel of airline crew. We have about 200 rooms of airline crew in this hotel, but that's a low-rate business, typically at about, I think, about INR 7,000 to INR 7,500. So it is really think of it as a strategy to cover costs until we build our real long-term business, which is corporate and retail. My broad guess is that we will close Q3 had over 200 rooms a day average. And ARR maybe of over INR 8,500. So this ARR is deflated because of very significant section segment of this 200 rooms per day will be crew. But what I'm very sure about is that Q4 will be a showstopper for Aurika.

[Operator]

[Operator Instructions] We will take a next question from the line of Santosh Sinha from Emkay Global.

[Santosh Sinha, analyst]

So my question is regarding the margin. So in this quarter, we have seen some margin hit due to some planned expenses. My question is that, what is the outlook? And what are the margin levers that are there with the company? And how should we look at forward -- going forward?

[Patanjali Keswani, executive]

So Santosh, see -- as I said, look at it broadly as follows. So there is a fixed cost element in our business, which operates throughout the year. That is roughly half our total expenses, roughly. Then there is a variable cost, which is based on occupancy and consumption of food, and number of bookings you get from online channels. So that is roughly the other half. So I'm just doing a simple one-on-one on hotel finance.

So income in summer, and I'm again being very approximate, our income in summer is, say, INR 44 and INR 56 in winter. And your -- year-end EBITDA is, say, 50%. Then in summer, obviously, your costs will be nearly equal to your cost in winter, but your income will be 25% lower. So like in last year, I would just request you to have a look at our last year 4 quarters. And you will find our EBITDA in winter is always significantly higher than our EBITDA in summer because of seasonality. So in winter, typically, occupancy and rates are higher. So to put it simply, I would have probably on a INR 44 income in summer, an expense of, say, INR 24. And in winter, for INR 56 revenue, I would have an expense of INR 26. Does that make sense?

[Santosh Sinha, analyst]

Yes, that is very helpful.

[Patanjali Keswani, executive]

And now all I had said was, I think I said this in earlier conference -- earnings call also that we will be -- because we are pretty sure about demand outpacing supply at least for the next 3 to 4 years, we are renovating our entire portfolio because there was a -- it's a catch-up really because we didn't do anything in the two years of COVID, and we did a little bit last year. So what you are seeing in Q1, Q2, Q3, and you will see in Q4 is significant investments in renovation because ultimately, we want to reprice our portfolio up fairly significantly every year for the next four years. So that is the reason you see a 2% hit in our EBITDA margins because it is mostly due to renovation, increase in renovation. So basically, this 2% is incremental renovation beyond normal innovation.

And the part is, of course, I think a couple of crores is also makes Aurika preopening expenses in this quarter, which is again about a percentage of revenue. So Q3 and Q4 Aurika Mumbai will be a deflator of the EBITDA margin, though on an absolute basis, EBITDA rupees crores will increase because I do not expect in Q4 Aurika MIAL to have an EBITDA of more than 35%, maybe around 35%. So on a weighted average basis, it will obviously bring the EBITDA margin down.

[Santosh Sinha, analyst]

That was helpful. Just one follow-up question. Whenever some property goes renovation -- under renovation, what kind of ARR improvement we generally see for that property?

[Patanjali Keswani, executive]

After renovation?

[Santosh Sinha, analyst]

Yes.

[Patanjali Keswani, executive]

Well, we renovate on the basis of whatever we invest in renovation, we expect to recover in the following year. So really, we have a slightly different way of looking at renovation. We have what is called brand maintenance standards renovation, which is typically INR 2 lakhs, INR 3 lakhs a room averaged out. And then we have in deep markets like Hyderabad, for example, we have significant renovations, which is like INR 8 lakhs a room, which is really where we think we can reprice to recover this INR 8 lakhs per room in that next following year.

So this is a function of demand/supply and our anticipation of it. So it depends on how much we invest. Sometimes we invest in a hotel just to maintain brand standards and we do not expect to larger increase in revenue. That is in the Keys portfolio -- in half of the Keys portfolio. In other hotels like Hyderabad or Keys, Bangalore and Keys, Pune, where we will invest significant sums per room because we expect to cover that through a combination of pricing and -- of repricing and occupancy.

[Santosh Sinha, analyst]

One last question regarding CapEx. So what is your outlook on the CapEx, and sir, what kind of CapEx we can see for -- up to FY '26?

[Patanjali Keswani, executive]

FY '26, we will spend an incremental -- well, we -- I think this year, we will spend maybe INR 50 crores on renovation. Next two years, we will spend another INR 100 crores, but there will be no other CapEx.

[Santosh Sinha, analyst]

This is just for renovation or this includes construction of hotels also?

[Patanjali Keswani, executive]

No, there is no planned construction of any other hotel other than Shimla, where I think it's totally another INR 20 crores, INR 25 crores left to open the hotel. I think we've already invested INR 30 crores in Shimla, right? That is already there. So we will open Shimla. Now we'll give a specific date after we review that project because our focus was on Aurika.

The good news is Aurika MIAL, probably we would not end up spending INR 950 crores, which will be closer to INR 900 crores. And we don't have any other Capex. So now what you will see is the CapEx cycle fundamentally, Santosh, is over. And now it's all a question of sweating all these assets, specifically Aurika MIAL and that cash flow, I can -- I think, with some certainty, I assure you will be quite a pleasant surprise for next year -- from Q4 actually.

[Operator]

We have our next question from the line of Rajiv from DAM Capital.

[Rajiv Bharati, analyst]

Sir, with regard to the preopening expenses, this entire thing is charged in Q2 or there is some spillover in Q3 as well?

[Patanjali Keswani, executive]

So we charged a total of about INR 2 crores, of which the majority, about INR 1.4 crores was in Q2 to the P&L.

[Rajiv Bharati, analyst]

Sure. And with regard to the BCG project, the payout has already started or -- and how much is the quantum of the entire project?

[Patanjali Keswani, executive]

Well, that is an NDA kind of thing. Let me put it this way. The understanding is, this is the investment in setting up a platform for ultimately, which will ultimately be monetized by providing revenue management, sales and cost control services, whether to our own hotels or to managed hotels or to franchise hotel or to other hotels.

My broad understanding is that our entire investment in this project, we will look at -- and this will be over 18 to 24 months at the least, will lead to a return of 100% of investment every year. So if we invest INR 100 in this entire assignment, we expect to increase our EBITDA by INR 100, once all the levers are in place and that will really be, frankly, from FY '26. So I would not really like to talk about it today.

[Rajiv Bharati, analyst]

And with regard to your Slide 11, where you have given these market segments pickup. If you reverse with the ARRs by segment, it looks like the airline bit is the most remunerative at least for this quarter, slightly confounding. Can you explain that?

[Patanjali Keswani, executive]

Very good point. Thank you. So Rajiv, here's the interesting thing. When -- suppose airlines are price sensitive, so you can assume that this is a question of demand and supply. So because of increasing rates, some airlines are moving from 5 Stars to mid-market. Let me put it this way. So if your choice is between a branded 5 star or a branded 4 star and the branded 5-star is offering, say, INR 10,000 as a rate to you, then the airline will shift to a branded, say, Lemon Tree Premier at INR 7,000. Are you getting me?

[Rajiv Bharati, analyst]

Yes.

[Patanjali Keswani, executive]

So we are also being a little opportunistic here. The interesting thing is with the increase in demand of -- in airline traffic, airlines are now getting into wet leases, which is temporary increases in supply, as I'm sure you know, by leasing planes with crew. So those crews have to be put somewhere. And we are very happy to offer that. The advantage of that is these are also prepaid businesses. So unlike normal airline business, in wet leases, we ask for 100% payment upfront because it's a one-off, so to speak.

And I reckon that till the full supply of planes come into India, and I believe the order is over 1,000 planes or something, there will continue to be wet leases, and we will continue to offer obviously our rooms at an appropriate price to meet this demand. Once the full supply of hotels -- airlines -- aircraft are in place, then the wet lease business will disappear. But what will come instead will be a very large demand for airline crew. And my broad guess is airline crew will get repriced quite significantly and will become a relevant segment for the entire branded hotel industry 3 star upwards.

[Rajiv Bharati, analyst]

Sure. So the other point is because it's -- I mean, higher by 25% Y-o-Y in terms of pricing, how much, let's say, juice is left on this particular bit? Are we risking that they will down -- go even further?

[Patanjali Keswani, executive]

No, it will be keep getting repriced. What might happen is that if you are normally -- like it is happened in Gurgaon. That Lemon Tree -- earlier, there were some crews staying with us, for example, in Lemon Tree -- I'm just giving you an interesting example. In Lemon Tree Premier Delhi, I think last year, it moved to Lemon Tree Red Fox Delhi. This year, it has moved to Lemon Tree Sector 60 Gurgaon. Maybe two years later, it will shift to Red Fox Sector 60 Gurgaon because as the market increases in our higher-value hotels and we keep repricing. And therefore, price-sensitive businesses like airline crew will step down into a lower brand of ours because that becomes affordable.

[Rajiv Bharati, analyst]

Fair point. And just an extension on the retail side of the business, which you combine your OTA web and other FITs, let's say, on a full year basis -- Y-o-Y basis, that has increased only 5% in terms of -- so earlier the gap between, let's say, your corporate and FIT used to be 20% -- corporate and retail used to be 20% with retail being 20% premium and the premium has collapsed to 4% or 5% now. While the retail pricing is not working out?

[Patanjali Keswani, executive]

Let's put it this way. Our whole strategy is to eliminate anomalies in segmented pricing. So if you look at -- let me just give you an example. Corporate ARR in Q2 FY '23 after a 20% hike or 15% hike was as low as INR 4,600. Now in Q2 FY '24, it has become nearly INR 5,000. So it has gone up by 8%. Our retail pricing has gone up only by 3%. So what we are really doing is we are reduced -- removing anomalies. We are removing the lower price. So when I say corporate pricing has gone up, it has not mean the same corporates are using us. When you take your prices up, corporates like airlines are bulk buyers and price-sensitive.

So when you take your average grade up, some of your previous demand disappears. And the whole question is how do you substitute it? Do you substitute it with more corporates or do you substitute it with other segments? So broadly, our whole intent is to reprice our entire offerings. Segments will change when you reprice. And obviously, let me put it to you in a slightly different way. If there are two customers, one is at INR 40 and one is at INR 60, I'm quite happy to remove the INR 40 guy and replace him with INR 252 guy, by dropping INR 60 guy to [ INR 652 ]. Am I making sense?

[Rajiv Bharati, analyst]

Yes.

[Patanjali Keswani, executive]

So really, it is not static. I will be happy to drop my retail pricing to increase retail participation because the substitution, there is no cannibalization. In fact, the average increase in rate is still positive.

[Rajiv Bharati, analyst]

So the question was because this -- the gap between, let's say, corporate and retailers collapse, the mix change benefit which you were getting, let's say, for the last three quarters incrementally won't get. So now it's only basically if you get, let's say, corporate rate hikes and retail would basically catch up on the same side...

[Patanjali Keswani, executive]

What you are not taking into account is risk management. All my retail business is because of my brand. Most of my corporate business is because of my price. So as long as I keep increasing my retail demand, it is actually a risk mitigation strategy because these are customers who are sticky with me, whereas corporates are not sticky.

[Operator]

We have a next question from the line of Sumant Kumar from Motilal Oswal.

[Sumant Kumar, analyst]

Can you talk about the INR 4.4 crores bifurcation for operating expense for Aurika Mumbai.

[Patanjali Keswani, executive]

INR 4.4 crores, which number are we talking about?

[Sumant Kumar, analyst]

We have additional cost what your -- as per the notes of account and PPT, INR 4.4 crores we have additional costs for renovation and Aurika Hotel...

[Patanjali Keswani, executive]

Okay. INR 1.4 crores is preop, and INR 3 crores is the increase in renovation expenses beyond Q2, what we spent in Q2 F '23.

[Sumant Kumar, analyst]

Okay. And what is the employee -- the employee cost has increased Q-o-Q, so what is the additional in employee costs for the Aurika Hotel this quarter?

[Patanjali Keswani, executive]

Well, most of this would be employee costs. See the reason are, if you see our waterfall, the reason payroll is showing a significant hike and therefore, reducing the flow through, I'm referring to Slide 15, is multiple reasons, change in minimum wages, which affects our salary because of profit, our bonus payouts have increased from, I think, 8.33% to 20%. We have also hired some more people in some departments, which are linked to either revenue or to business development. And we have fitment. We have done an ongoing fitment of wages because of inflation, and I think also because we did not do much in the three years, last three years. So it's a combination of all this.

[Sumant Kumar, analyst]

Okay. What is the incremental cost of Aurika this quarter?

[Patanjali Keswani, executive]

In terms of staffing?

[Sumant Kumar, analyst]

Employee. Yes, yes. Staff cost.

[Patanjali Keswani, executive]

We have about -- I don't have the exact number off that, but it should be about INR 4 crores.

[Sumant Kumar, analyst]

Okay. Okay. And overall ARR growth for Lemon Tree, when we talked about compared to other industry players, 7% ARR and other players are reporting double-digit growth. So is it because of the lower end of the hotels or you say budget hotel has a lesser pricing power at the juncture compared to luxury so this is the main reason for lower price ARR increase for this quarter?

[Patanjali Keswani, executive]

No. It is to catch up on occupancy, show that side. Let me show you show that slide of STR report. So there is -- all India, [indiscernible] there is a slide increase in ARR versus -- yes, please go to Slide 12, Sumant.

[Sumant Kumar, analyst]

Okay. Yes, sir.

[Patanjali Keswani, executive]

Now, Is the -- is our strategy clearer here?

[Sumant Kumar, analyst]

Yes.

[Patanjali Keswani, executive]

So if you look at it last year, we increased our prices more than competition. This year, we increased our occupancy by increasing price less than competition, but we achieved the same RevPAR, right? So what is the purpose? The purpose is that when last year we increased prices, as I was explaining a little earlier, a bunch of our customers dropped off. The price-sensitive, a lot. So then you have to find new customers. Now these new customers are here at this price point, which is whatever it is. Next year, my expectation is we will have a much stronger ability to reprice because the customers we have, are less price-sensitive and [ inelastic ].

[Operator]

We have our next question from the line of Sumit Kumar from JM Financial.

[Sumit Kumar, analyst]

Congratulations on the opening of Aurika Hotel. My question, one of them got answered in the previous ones. My second question is, since you've already mentioned that debt will be peaking out and it will reduce from now on, which is basically the opening of the Aurika Hotel -- yes. So I was asking about how you're looking at newer acquisitions in your own portfolio going forward since you've mentioned that debt has peaked out and will be going down post opening of the Mumbai Aurika.

[Patanjali Keswani, executive]

So that's a bit of a tricky question in the sense we are right now in the middle of defining a very clear capital allocation policy. So I think our Board has been asking that now that your current CapEx cycle is over because we've deployed -- including Aurika, we have deployed or operationalize roughly INR 2,500 crores of what used to be CWIP between the new Lemon Tree Premier, the acquisition [indiscernible] and the opening of Aurika, please note all these operationalization came into play in one year before COVID and now 1.5 years after COVID.

So now we need to sweat these INR 2,500 crores. The way we look at it is, we need to define a very clear policy as to what is the hurdle rate under which we will not make any investments in capital assets and we would prefer to write off our debt. What is the ideal debt-to-equity ratio, we feel mitigates all forms of risk, what is the ideal debt-to-EBITDA ratio, and how will we deploy -- because we expect to be significantly free cash flow positive from the following year onwards. So how will we deploy this cash? Will we distribute it? If so, how will we distribute it? Will it be dividends, share buybacks, what is tax effective, will we -- how much will we write our debt down to and so on.

Broadly, without it being [indiscernible], let me say, that the view is that we will bring our debt down as far as possible, maybe even to being debt free. And then any capital that we delay in asset acquisitions should meet our weighted average cost of capital hurdle rate. Currently, the WACC is, I think, 14% based on a debt-to-equity ratio, currently, I think it's about [ 1.3 is to 1 ]. But we reckon our debt-to-equity ratio will drop dramatically in the next two years. And our debt-to-EBITDA will equalize also in the next two years. So basically, what we are saying is that today, our debt-to-EBITDA is a little over 3x. We intend to bring it down to 2x and then 1x hopefully in the next two years. And then after that, of course, the question is how do we do with the free cash flow beyond that.

[Sumit Kumar, analyst]

Sure, sir. My second question, if I may. What are -- what is your sense on the Udaipur Aurika Hotel, are you comfortable with the current rate of operations? And what would be your strategy around that property.

[Patanjali Keswani, executive]

So see Aurika Udaipur, unlike most of our portfolio is highly seasonal. So in our portfolio, I can say with some degree of certainty, winter revenue is 1.25x of summer revenue. In Aurika, I can say with certainty, it is at least 2x of summer revenue. Because it gets so much business in winter and relatively less in summer. So I am quite pleased frankly with Aurika's performance. There is still a catch-up because it is a new brand. It is operating in a space different to Lemon Tree's normal space.

But on an aggregate basis, although we focused on finding the right price, so our average daily rate is over INR 11,000 in summer in Aurika and we've increased the occupancy to 50%, which I'm told is a 10% premium over the industry in Udaipur at this level. So I think it's pretty good progress. And I would urge you to wait for Aurika's performance of the full year to have a look at it to get a better idea.

[Operator]

We have our next question from the line of Jayesh Shah from Ohm Portfolio Equi Research.

[Jayesh Shah, analyst]

Mr. Keswani, congratulations for great results. My question, first of all, on renovation. Why is it that the renovation is kicking in 2Q and 3Q, which are relatively -- this year season compared to 1Q, which should be lowest for you?

[Patanjali Keswani, executive]

So normally Jayesh, Q2 is the lowest season. Last year was an anomaly where we did better in Q2 than Q1. Number two, our renovation is not that we shut a hotel down. We are quite selective. I know in the past, certain I think analysts had mentioned that by shutting down inventory, we are likely to suffer a drop in occupancy. But if you notice our occupancy, although we shut, I think we shut 1,000 rooms this year. We did in such a way that our occupancy actually went up by 5.5%.

So see, we are very careful about renovation vis-a-vis lost opportunity cost. And if I say we will continue renovation in Q3 and Q4, it will be in those hotels, which perhaps have higher demand in H1 than H2. For example, our Bangalore Keys Hotel. We had a lot of IT employees in summer and less in winter. So therefore, that renovation will continue on a larger scale. Some hotels like Delhi and -- well Delhi certainly, which has high demand summer, winter, we will be more careful about the number of rooms we shut and how we shut them. So this is a mix and match combination. We try and do it without incurring a significant opportunity cost in terms of loss business or turn away business.

[Jayesh Shah, analyst]

Okay. So I think you've answered my associated question on occupancy which have -- bit confused me. Coming back to the second one is, are you happy with the Keys Hotel performance because we've not seen much improvement? I understand your rationale for Keys earlier. But if the other hotels continue to be a drag, will you continue to spend on renovation? Right now, what are your thoughts on Keys?

[Patanjali Keswani, executive]

See, my point is that Keys to me is two portfolios. One is the juicy portfolio and one is the non-juicy portfolio. The juicy portfolio is 380 rooms in Bangalore and 100 rooms in Pune. The medium juicy portfolio is 100 rooms at Visakhapatnam. And the non-juicy is the Cochin, Ludhiana and Trivandrum, which is another 350 rooms. We are allocating investment in terms of renovation. In all these hotels basis, our expected return from that investment.

The only hygiene factor, we are after is to ensure that the brand standards are met, even if a hotel is not likely to give a great return. From a brand perspective, it must have a minimum standard.

As far as Keys goes, the way I look at it is that we invested INR 600 crores in it. I'm not taking into account holding costs because if I do that, then any investment because of COVID would look odd. And we are going to invest roughly, I would say, about INR 40 crores in the Keys portfolio. Last year, we did a bit this year, next year and the following year. When this entire investment is made I start -- I would expect that the Keys portfolio should give me a minimum return of 15% or INR 100 crores EBITDA. And I think you will see that starting to play out in another 6 to 9 months, when we start opening these renovated rooms and enough number of these renovated rooms across this portfolio.

So to put it simply, our target is to achieve INR 100 crore EBITDA from Keys within the next -- in a run rate. So 12 to 18 months from now, you will keep seeing an improvement in performance. In fact, even now, if you look at Keys, in the few hotels and floors, which we renovated, there is somewhat increase in occupancy. And you can see it from the last year, we haven't been able to really reprice the product, but we've been able to increase the occupancy. And going forward, I think you will see a combination of both. Once occupancy cost is say, 65%, you will see the gross ARR probably jumping to current, what's it called, the Red Fox level.

[Jayesh Shah, analyst]

Right. That's very helpful. The third and the last macro question is last year, you focused on price line. This year, you focused on occupancy. What would be the focus next year? Then does it mean that by next year, we are into the mid-cycle of the industry?

[Patanjali Keswani, executive]

Yes, I think we are getting into the mid-cycle, but I think there will be a hockey stick shift into upcycle. That will happen when some other demand segments which are still extremely low compared to pre-COVID also kick in. So when I look at demand segments, the foreign demand segment, which used to be 10%, 12% of our business is still I would reckon -- I don't have numbers, but I would say it is certainly less than 50% of pre-COVID. So that's a further hike in demand of 5%, 6% on inventory, probably more for Aurikas.

I also expect there will be a fairly significant increase. In corporate travel, once this work-from-home stuff completely stops which I think will happen now perhaps in the next 6 to 9 months. I also generally, as the GDP grows, there will be increase in consumption of mid-market hotel rooms has happened in China between 2008 and '15. So when all these levers come in, there is an increase in demand. And once we hit an occupancy, stable occupancy level of about 75%, we will look at repricing far more aggressively than we are doing today. And I think that should happen in the next -- as I said, by next winter.

[Jayesh Shah, analyst]

And finally, will you accelerate your pace of signings of new hotels now because the run rate -- will you accelerate the pace of your signing of the new hotels because of -- you're pretty impressive in the last quarter.

[Patanjali Keswani, executive]

Yes. So we are actually going to -- well, internally, our business development team says that they will give us 15,000 rooms in the next three years, which is actually very little, in my opinion. But our view is very simple. We have said that our strategy is that by '26, 70% of our portfolio should be manage/franchise, which means since our own portfolio is close to 6,000 rooms, there are 14,000 manage/franchise rooms in the pipeline.

What we are really looking at is typically, in India, if you look at signings in the last 6 months, 50% of the signings are for what are called greenfield projects, which means you are signing the hotel today, but the management fees will come after 5 years because these hotels have to be built. Then there is brownfield projects where you really have a -- say, a 2-year, 2.5-year window before you earn fees and then conversion, which is typically under 1 year.

So our focus is, obviously, in the sense that we are looking at all three segments to size, we are also focusing a little more specifically on conversions, so that those fees flow in earlier. And we are looking at strategic locations or cities where due to an assessment based on airline traffic, based on network effect based on say, if we go to a city like hypothetically Kanpur which flows gives a lot of business to cities where we have hotels based on airline traffic data, then strategically, we would like to be physically present in those cities to drive that outbound traffic.

So it's a combination of anything. And while we are opportunistic in the sense that any query that comes to us, we reactively go all out for it, and there are plenty of such queries. We are also proactive in reaching out to those cities, locations and hotels where it makes sense for us to have a flag immediately and we get the fees fast. Does that answer the question?

[Operator]

We have a next question from the line of Pallavi Deshpande from Sameeksha Capital.

[Pallavi Deshpande, analyst]

So just wanted to understand the issue in Delhi, I understand. But how come it's not affected the Gurgaon properties?

[Patanjali Keswani, executive]

Because in -- during G20, they shut down Delhi, airport to the city. Gurgaon is South. But from the airport to the center of the city or Lutyens' Delhi, it was like -- I don't know, it was a deserted city.

[Pallavi Deshpande, analyst]

Fine. Sir, and in Calcutta, how many rooms do we have last year and how many rooms do you have this year?

[Patanjali Keswani, executive]

Calcutta. We have the same. We have 139 -- 142-room or -- how many room do we? 142-room hotel. And that's the same it is today as it was last year.

[Pallavi Deshpande, analyst]

Good, sir. Then what would explain the decline in the ARR?

[Patanjali Keswani, executive]

In where?

[Pallavi Deshpande, analyst]

Calcutta.

[Patanjali Keswani, executive]

In Calcutta. Well, I think in Calcutta, we were looking at some level of occupancy increase or something. There was some -- it was a new hotel. Calcutta, I think we opened in 1 year before COVID and we were trying to build up demand and it is generally a price-sensitive market, but I must tell you that I was quite pleased to see that now in the last couple of months, Calcutta has shown, well, certainly in October, a significant increase in ARR. So something is working, we are -- I'm not sure exactly what.

[Operator]

We'll take the next question from the line of Nihal Mahesh Jham from Nuvama.

[Nihal Jham, analyst]

A couple of questions. One was, in terms of our capital allocation, once we're done with the renovation of the Keys portfolio, are you looking at launching further hotels under the Keys brand or this is what we have to focus on?

[Patanjali Keswani, executive]

Are you saying -- see, Nihal, are you asking, are we looking at building -- owning more Key hotels or just growing the portfolio?

[Nihal Jham, analyst]

Maybe building our own franchises, preferably building from a capital allocation perspective.

[Patanjali Keswani, executive]

For capital allocation, there will be 0 capital deployed. It is only looking at expanding the Keys portfolio via the franchise route to those hotels where we feel the more stringent brand standards of Lemon Tree cannot be applied.

[Nihal Jham, analyst]

Got that. And the second question was that pre-COVID, we had tied up for a student housing JV, which obviously, during COVID happens, we put on the back zone. Is there a thought of getting that back or any other initiatives in the future?

[Patanjali Keswani, executive]

See, we are looking at it. But I think our main focus, as I mentioned earlier too, in the last 18 months has been on recovering from COVID, catching up in renovation in terms of product quality, opening Aurika MIAL and growing the business development portfolio. So I think that kind of captured the entire bandwidth of our management.

Now student -- more than student living, co-living is a very interesting segment. And there are -- it's -- well, I would say an adjoining segment to where we are and could -- and we could brand that also with the Lemon Tree brand, especially with built to purpose. So we are kind of -- we have some data on it. But I don't think our focus is on it immediately. We may look at it maybe 6, 9, 10 months later because unlike the hotel segment, the advantage of co-living is that it's more of an annuity business. So it actually risk mitigates your volatility of earnings in the hotel business. So from that perspective, I can say with some certainty, we are going to look at it, but not right now.

[Operator]

Ladies and gentlemen, that was the last question for today. I would now like to hand the conference over to management for closing comments. Over to you.

[Patanjali Keswani, executive]

So thank you, everybody for listening in and for the questions and suggestions. I look forward to our interaction. Actually even more I'm really looking forward to an interaction after Q4 when I can show you something about how Aurika Bombay performs.

[Operator]

On behalf of Lemon Tree Hotels, that concludes this conference. Thank you for joining us, and you may now disconnect your lines.