Description

The COVID19 crisis provides new opportunities for investors to cheaply buy quality assets. The hospitality industry is one of the most beaten down sectors of the global economy. My investment idea relies on the assumption that industry will return to normal sooner than expected. In addition, certain companies in the industry, as well as some countries, have numerous advantages over others for reasons I will lay out below.

Business overview

Valamar Riviera (ticker:RIVP) is the largest Croatian tourist group, owning and operating 12% of categorized tourist accommodations in Croatia. Its assets include 36 hotels and camping resorts across Croatian coast (including a small hotel in Austrian Alps) which can take approximately 58 thousand guests daily. The company was founded in 1953 during the communist era and was privatized in the 90-ies.  I shall not dwell on a rather complicated history of the company after the year 2000 because as it is not relevant for the investment idea. Just to mention that in its current form Valamar operates since 2014, after the merger of three related companies. Valamar's stock trades on the Zagreb Stock exchange at  an average daily turnover of 600 thousand kunas(“HRK“,“kn“). It has a market cap of HRK2.85bn or $450 million dollars. Valamar Riviera has been voted  the stock of the year for 7 years in a row due to its performance and transparency( since March of 2009 the stock had annual return of 26.3% without the dividend despite the drop in the last 5 months). The largest owners of Valamar are two Austrian family funds, holding 40% of shares combined, effectively controlling the company.

 Same as other hotel companies around the world, Valamar experienced significant decline in share price since the beginning of COVID19 pandemic. The current price of HRK23.4 represents a good entry point for value investors, especially for those aimed at geographical diversification and trying to find opportunities in frontier markets.

This year is going to be a total disaster for the hospitality industry. Valamar is no exception to that. Over the first 6 months of this year, revenue declined by 81% compared to the same period of last year. Due to steep drop in demand, ADR declined from 500kn to 410kn and the company operated with a loss of HRK300 million. The rest of the year is expected to improve a bit, because Valamar’s properties are no longer closed as they were from March to middle May ( during June and July Valamar gradually opened 21 hotels and resorts and all  of its 15 camps) and at the moment  there are around 30 thousand guests ( vs. about 60k capacity). Given the epidemiological situation in Croatia right now (on average 50-60 cases per day), in the month of August the situation is expected to either improve  or, at least, stay at the same level as July. Anyhow, 2020 should just be forgotten.

https://valamar-riviera.com/media/374475/quarterly-report-for-2q-2020-consolidated-pdf.pdf

https://valamar-riviera.com/media/374380/annual-report-for-2019-consolidated-pdf.pdf

There is a high probability that next year things may return to normal and since the value of the company reflects discounted cash flows until the judgment day (which for Valamar isn’t near), 40% decline in the stock price since the late February has no justification in fundamentals.   

The company has gone through a major investment cycle over  the last 6 years. Capex has increased from HRK250 million in 2013 to HRK950 million in 2019. Mostly, it went to upgrading the existing portfolio, (focusing on the premium segment and higher added value products) acquisitions and increased capacity. The share of premium and upscale segment is increasing on a yearly basis. Those investments led to doubling the revenue in 5 years, from 1bn to more than 2 bn kunas. Between 2014-2019  RevPAR increased by 50%, from 160kn to 240kn, not just as a result of higher ADRs but also due to higher annual occupancy . Namely, Croatian tourism, especially in the coastal area, shows strong seasonality.  Croatia is one of the most attractive locations of Mediterranean with 21 million tourist per year of which 18 million are from abroad.  Due to beauty of its indented coast and warm sea, tourists visit it during the summer leaving hotel rooms nearly empty in the winter. Valamar Riviera earns only 2 percent of annual revenue in Q1 and more than 60% in q3. It is the result of the fact that Croatia is north of  Spain and Greece so it has less sunny days and season is shorter, but  also the consequence of communist era when offering only sun&sea without high added products was considered a good enough tourist strategy.  
The seasonality led to a poor use of company’s resources. However, this is changing. In 2014, annual occupancy was 121 days or 32.5%. Since than it increased to 139 days or 38%.  Most of the growth is still coming from the summer season but less than before.  This is improvement, given the high fixed costs of the industry. Therefore, no wonder that a lot of the growth went straight to the bottom line. While revenue doubled in the last 5-years, EBITDA nearly tripled and EBITDA margin has increased from 26.5% in 2013 to 34% in 2019. 

One of the biggest advantages Valamar has over global competitors in the current environment is the proximity of its hotels, resorts and campsites to large markets like Germany and other European countries. Additional advantage is the fact that most of its guests use cars  for transport to their tourist destinations, not air traffic that is going to be impaired for quite some time. The only exception to this rule are Valamar’s hotels and resorts in Dubrovnik and southern parts of Croatia. Over 95% of the Valamar's guests are coming from other countries: Germany, Austria, Netherlands Slovenia, Italy, Hungary, Czech Republic, and Poland. In addition, COVID19 pandemic will have long-term effect on business travel. Conferences, in-person meetings and other business-oriented events will considerably shift to online events.  On the other hand, leisure travel and real experiences are here to stay. This benefits Valamar since the vast majority of Valamar’s guests are leisure travellers.

Industry overview

Valamar is the largest Croatian hotel chain, followed by other domestic chains like Maistra, Plava Laguna, Arenaturist,.... Croatia actually does not have many hotels compared to other Mediterranean countries. Hotels make 16% of all tourist beds in the country. According to Eurostat, in terms of nights spent, hotels share is 28%. By both of these indicators, Croatia is at the bottom on the EU list. In fact, share of nights spent in hotels in Croatia is at 1/3 of European average. It is mostly the result of regulatory environment and tax incentives  which favors private accommodation (owners pay around 100 euros per bed for a full year no matter how many guests they’ll have during the year) over hotels. In the the long run, regulation and tax incentives should change in favor of hotel chains. Even government’s tourist strategy documents predict this shift because hotel accommodation is more value added, but due to the fact that many citizens and voters are in this business, this will change gradually and move closer to EU average with time. In addition, private accommodation is often not up to the standard  and in recent years huge private accommodation bubble was formed when many decided to use  tax incentives and embarked on the business for easy profit. From 2011 more than 82% of increased bed capacity came from private accommodation. Despite this unfavorable environment, hotel industry did much better. The occupancy and ADRs of hotels is increasing, while those of private renters are falling.  Hotel groups invested heavily in repositioning their properties toward premium and upper scale segment,as seen below.
 The hotel industry will benefit from it and take much bigger share of the market. 


 Valamar operates an assets heavy owner-operator model which includes ownership of real estate, brands and operations but lately it made first steps towards an asset light model, by forming joint companies with pension funds. Two of those companies are Imperial (Valamar’s stake is 48%) listed on stock exchange with a market cap of HRK1bn and Helios Faros (Valamar owns 20%). Valamar operates both of them and collects hefty fees for it. I expect them to continue moving toward assets light model in the future.

Net debt has increased from 2.2bn at the end of 2019 to 2.76bn now. Therefore, net debt/2019 EBITDA is no longer below 3. However, despite relatively high debt, default risk is still very low, in my opinion,  for at least three  reason: a) we live in very low interest environment b) numerous government measures like grants for jobs preservation, reduction and deferred payments on various fees and suppliers as well as loan moratorium makes thing less painful c)  the company has very valuable real estate which could be easily monetized or used as a collateral. In fact, I believe that due to valuable assets Valamar could afford much more debt.

With regards to measures taken during the pandemic, Valamar decided to revoke 1kn dividend per share this year, significantly reduce Capex and defer payments, which should secure liquidity until 2021. The construction of new resort in Istria worth HRK800 million is postponed as well.
All these measures were taken so the company could achieve EV/EBITDA below 3.0 in 2021.

Country risks

As a member of EU and NATO, Croatia is a safe country for investors. It has a stable centrist/centre-right, pro-EU, pro-western government that was just formed a week ago. As of 2023, Croatia is going to adopt euro as official currency. Until then, HRK will be fixed to euro at 7.5 exchange rate, which is basically guaranteed by the ECB since March of this year when the Croatian central bank and the ECB have set up a €2bn swap line.  Due to the fact that the company relies mostly on EU guests, I would argue that Valamar’s risk is lower than the country risk.  

Valuation

The stock is trading at 10-11 times 2021 EPS and at EV/2021 EBITDA of 7. Given the high revenue and EBITDA growth over the last decade, the long-term prospects of hotel industry in Croatia, as well as switching toward premium segment, higher ADRs and annual occupany,  valuable assets that could be monetized, competitive advantages of being close to the European markets in COVID and post-COVID environment makes these multiples pretty cheap. I expect that awful 2020 results will be looked at only as a bump on the road.

My assessment is that 2024 revenue is going to be 30%-40% higher than in 2019, let’s say 3bn and EBITDA of 1.1bn. Historically, the company traded at P/S between 2.4-3.3 and EV/EBITDA of 9-16. Therefore, we are talking about  stock that has a potential to be a multibagger in next few years.

Catalyst

Quarterly results, better than expected tourist data, covid19 vaccine, European macro data