City Lodge trading update

Oh dear, we had City Lodge Hotels coming out with a disappointing trading update yesterday announcing that normalised headline earnings per share are anticipated to be between 30%-36% lower than the previous financial year. They don't go into anymore details other than that results will be released on or about the 12 August where we will get all the details. However it is our job to take this info and analyze it straight away, especially for a recommended stock like City Lodge.

Firstly let's look at the numbers so we can we know what to expect. Normalised headline earnings per share were down 17% for the half year so this did not come as too much of a surprise to the market. Basically they are having a similar decrease to what was experienced in the first half of the year. Last year they made R4.55 a share, take away 33% from that and we should expect around R3.05. For a stock trading R65.45 that is a PE of over 20. Looking expensive?

This is more an earnings story, it is a NAV play too. Remember in our recommendation thesis we noted that management valued the replacement cost of their properties at R3.5bn. At this current share price the market values the company at R2.8bn. This means that the stock is trading at a 20% discount to fixed asset value. According to accounting practices however it is a lot easier to write down an asset than to appreciate it therefore on the financial statements these management resale values will not necessarily be reflected.

But why are earnings declining? Because without returns these assets deserve the discount. Remember that this year is comparative to a World Cup year. This event definitely inflated earnings. Not only did it inflate earnings but it encouraged all the hotel groups, City Lodge included to expand their portfolio. This increase in competition came at a time when the global economy was hit by the financial crisis. We are experiencing a slow recovery with an excess in hotel room supply.

What to do with the stock? We remain patient. The business cycle is turning and City Lodge is perfectly geared for this. We are dubbed the gateway to Africa and business people around the world are coming to our shores to seek returns from the 'final frontier' of double digit growth. Our tourism industry has also taken a huge boost following the World Cup. The combination of these two factors plus the turning of the business cycle should position City Lodge fantastically going forward. Especially with room capacity increased by 24%.