Last week I took a short holiday to New Zealand’s South Island. Queenstown, Milford Sound, then a road-trip through the Otago’s highlands to the Hooker Valley track at Mt Cook to finish. Spectacular scenery.
In Queenstown I had a brief vision of getting a block amongst the mountains just staying there. Wouldn’t that be nice. But a local property magazine brought me back to earth – it’s worse than Sydney – so clearly a few visitors had the same idea. This brought me to reflect on the economic power of a captivating natural environment. As a tourist in another country it’s quickly apparent, but we may forget just how powerful it is for Australia as well.
As readers of this week’s The View “Regulators late to the debt party” would note, home price appreciation in New Zealand and Australia has outpaced other developed countries by quite a margin since 1980. Of course debt-fuelled home price appreciation is a global phenomenon, but particularly so in “destination” places in Australia and New Zealand due to foreign investor demand.
On the flip side, the pristine natural environments of Australia and New Zealand foster strong brands for tourism and agricultural products, especially in neighbouring Asia where the middle class is set to double in global share from about 30% now to over 60% by 2030, largely driven by China’s transition to a services economy.
In terms of tourism, Australia and New Zealand have traditionally exchanged the highest proportion of each other’s international arrivals, however China is a key driver of international tourism spend in both countries and is set to dwarf the spend of other countries of origin in the next 10 years.
Indeed, a 2016 national survey by the Chinese Tourism Academy across outbound Chinese tourists found New Zealand and Australia, respectively, are the number one and number three destinations by visitor satisfaction. This enviable position in a massive and growing market should support healthy secular growth for many years.
The following RBA chart illustrates the changing composition of our arrivals and expenditure by international market, as forecasted by Tourism Research Australia (TRA). The chart is slightly outdated as the forecasts were prior to the China-Australia Free Trade Agreement (Dec 2015) and recent air services agreements, but the expected trends still hold.
Australia’s Inbound Leisure Market forecast
Figure 1. Australia’s Inbound Leisure Market forecast
Source. RBA, TRA
Based on TRA’s 2016 forecasts, domestic tourism expenditure is growing at about 5% (in real terms) and is expected to average about 3% growth over the next 10 years. However international tourism is booming. Total inbound expenditure is growing at 15% and expected to average about 7% over the next 10 years. The inbound share of total tourism is expected to increase from 31% in 2015 to 41% in 2025, with China alone driving 60% of the growth in total expenditure.
This all translates to a positive outlook for hotels and leisure operators, with higher industry occupancy room rates, and revenue per available room (RevPAR) forecasted for the near-term.
Hotel performance outlook, 2015 to 2018
Figure 2. Hotel performance outlook, 2015 to 2018
Source. TRA
These broad tailwinds provide fertile grounds for selective investment. Within this theme in particular we look for strong brands with unique assets in popular locations. Financially we look for highly cash generative businesses with strong management teams and balance sheets providing scope for opportunistic investment. For us, two companies that fit this mould are leisure and commercial properties investor Elanor Investors Group (ENN), and hotels operator Mantra Group (MTR).
Elanor invests in tourism, leisure and commercial property assets as manager of third-party-owned funds and syndicates, and through direct investments on its balance sheet, which include assets held for funds origination as well as special situation investments.
The company’s main focus is on scaling funds management operations to grow annuity-type management fee revenue (fees are typically 1 percent of gross assets), which should be coupled with margin expansion via operating leverage on its largely fixed-cost base. It also collects an asset acquisition fee for each addition to its managed funds, typically 1.5 percent of the purchase price. ENN co-invests in its funds to retain underlying exposures and align its interests with investors.
ENN growth in funds under management
Figure 3. ENN growth in funds under management
Source. ENN
Over half of ENN’s balance sheet investments (direct and funds) and about 40% of funds under management are hotels and tourism related, providing strong leverage to broad tourism fundamentals. Portfolio jewels include the iconic Peppers Cradle Mountain lodge and the Featherdale Wildlife Park.
Peppers Cradle Mountain Resort
Figure 4. Peppers Cradle Mountain Resort
Source. ENN
The balance sheet recently moved to a net cash position, with cash likely to build further post a pending divestment of its Merrylands asset (which we understand is currently under offer). This positions the group well to invest in new opportunities whilst co-investing in new/existing product(s).
The Merrylands Property sale is in advanced negotiations. This property is currently held on balance sheet at $16.6m cost. In our view, this asset will likely be sold to a property development group for between $40m and $50m. For context ENN’s market value is $188m.
ENN is trading on a healthy yield of about 7.2% (at a current price of $2.13) and about 13 times FY17 earnings. We believe this is modest against the company’s capacity and demonstrated ability to grow.
Mantra Group
Mantra Group is the leading Australian-based hotel and resort operator with a portfolio of 128 properties and over 21,500 rooms across Australia, New Zealand, Indonesia, and, most recently, Hawaii.
In contrast to ENN, which is a property investment and funds management business, MTR provides accommodation and property management services through long term agreements with property owners.
Mantra locations
Figure 5. MTR locations
Source. MTR
Properties in MTR’s portfolio range from luxury retreats and coastal resorts to serviced apartments and hotels in CBD and key leisure destinations. Mantra Group operates the properties in its portfolio under three key brands: Peppers (Luxury) Mantra (Premium) and BreakFree (Affordable).
Presently the business is a ‘tale of two divisions’ with revenues and earnings split roughly equally between slow growth CBDs and booming Resorts. Within the CBD segment aggregate supply is approximately matched by demand whereas Resorts is experiencing significantly higher demand and little supply growth, leading to improving occupancy and room rates. Ultimately this translates to higher margins. Supply growth is markedly slow in regional Queensland, which hosts almost two thirds of MTR’s Resorts portfolios, as shown in the next chart.
Hotel Room Supply Growth by city
Figure 6. Hotel Room Supply Growth by city
Source. CBRE Hotels. Note: Percentages are aggregate over a 4-year period to 2019, not per annum
Recently MTR’s share price fell from elevated levels above $5. For a business set to generate double digit growth for the next 3 years we think it is currently fairly priced at $2.94, reflecting a forward price earnings ratio of about 15 times and a forward yield approaching 5%.
However, expected growth doesn’t include potentially material acquisitions, which is a focus for management given MTR’s balance sheet capacity with net debt at 0.9 times EBITDA.
Should you be planning on getting out and about in the pristine natural environments of Australia or New Zealand during the upcoming Easter holiday break, take it all in, breathe the fresh air, and enjoy the natural wonder our region has to offer.