Mahindra Holidays’ cash-focussed business model sets it apart from peers. In investing, as in life, there is a thin line between taking a calculated risk and being foolhardy. So when the street started chasing the “unlock” or “what if?” trade-in stressed sectors--travel, hospitality and aviation mainly—we began scouting for resilience and true value. We were surprised at some of our findings: a company whose profits grew 47 percent in the first quarter of the year, despite income declining by 26 percent. That firm is Mahindra Holidays & Resorts.

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To understand how it managed this, let’s take a look at the business model.

The Moat

Mahindra Holidays is a timeshare company with a difference. Traditional timeshare companies offer ownership rights to members of occupancy time at their resorts (a week a year). In comparison, Mahindra Holidays only offers a right-of-use for the period of membership (a standard of 25 years). So, at the end of 25 years, the rights lapse and the company can sell the rights again for another 25 years. This is an important factor to consider when valuing the company, as a fair number of lapses are expected in 3-4 years from now. Its brand “Club Mahindra”, business model and leadership position—around 3.7x revenues of Thomas Cook owned Sterling Resorts—provide it a strong moat. Despite challenges from new trends like holiday renting (read AirBnB) in the holiday sector, the company has managed to achieve steady growth in rooms and memberships—the two core pillars of its business.

It’s all about money, honey

Now, to the business. To figure out what makes Mahindra Holidays tick, you need to understand how its cash flows. The company has three main streams of revenues (cash flows). The first is the membership fee paid when a customer signs on—called Vacation Ownership. The amount varies with the nature of membership (season chosen and size of accommodation) and ranges from about Rs 3.5 lakh to Rs 20 lakh. This money is recognized as income over the period of the membership, so if the tenure is 25 years, Rs 4 of every Rs 100 received is recognized as income in each year. What this implies is, that the cash is received up-front but 96 percent in the first year will sit on the balance sheet and not reflect in the profit and loss statement. This, I like. Much of this money is used to build resorts/rooms and take care of costs related to new customer acquisitions. A small bit remains on the table after meeting these costs and adds to the bottom line each year.

The next revenue stream is the annual fee income—like an annual membership fee—which is used to meet the running expenses and customer servicing costs of the business. To give you a sense, a Rs 4 lakh membership scheme could come with a Rs 15,000 annual fee, which gets reset every year linked to inflation (using external benchmarks). So, the operating costs get addressed through such income. Then comes the revenues from resorts (mostly food and beverages), which the company looks to enhance through higher resort time spent (activities and events to engage members). A significant portion of this goes straight to profits. So, when the resorts are running (past occupancy trend of 80-85 percent) it boosts earnings and cash flows.

Given the nature of the above model, cash that comes in is used to fund CAPEX and operations without the company having to borrow for these requirements. Meaning: no leverage. Instead, the company earns interest on the money invested (and on EMIs of up to 48 months offered to members to pay the vacation ownership fee), which also adds to profits.

A cash machine

Simply put, Mahindra Holidays is a well-oiled cash-generating machine. And this is what helped it generate about Rs 50 crore of surplus cash (on fund flow basis) in the first quarter of the current year when the industry was under severe stress and resort income was almost zero.

As the economy opens up, business is coming back. In fact, in a state like Rajasthan where the lock-down was significantly ahead of other states, the occupancy levels are back at 70 percent. The company presently has 24 resorts which are operational and this is expected to go up to 32 in a few weeks (the company has 59 domestic resorts and 51 international), which should further aid cash generation. The fall in memberships, from over 3,000 per quarter to just 1,270 is worrying analysts, as it is a high-value discretionary spend. To address this, the company has been pushing its three-year Gozest membership (fee of about Rs 1 lakh), and these memberships, which are seeing some traction, could account for a large chunk of the sales in the next few quarters. What the company is hoping to do, once the COVID stress eases, is to upgrade these members to the standard 25-year Club Mahindra plan.

Valuation at steady state

For the not very financially savvy, the reported numbers of Mahindra Holidays post- new accounting standards can be baffling. To cut out the vagaries of accrual accounting, my suggestion is for investors to focus on the cash flows. Cash never lies.

Assume that the company’s free cash flows grow at ~5 percent every year, without accounting for lapses that are expected to come up, and net off its Rs 780 crore cash from its current market capitalization of about Rs 2,470 crore. Use a 16-year average residual period of memberships (based on a back-of-envelope computation using the Rs 5,400 crore of deferred revenues from memberships) along with a very conservative terminal asset realization value of Rs 3,000 crore. Doing this, the present value of the standalone business works out to Rs 2,800-3,300 crore (based on what annual FCF number you use). This present value assumes a 12 percent expected return on capital, which is twice the rate offered by 10-year fixed deposits at 5.5-6.0 percent.

What is not included in this valuation is the value of its Finnish subsidiary Holiday Club Resorts, the largest vacation stay company in Europe, which has a new CEO at the helm and is likely to start adding to profits in the next 3-5 years. If we assume the €70 million acquisition price paid by Mahindra Holidays as the fair value of the business, you could add another ~Rs 600 crore to the above valuation. Which, put another way, suggests that the core business of Mahindra Holiday's is valued at Rs 1,000 crore after netting off the value of Holiday Club Resorts and the cash on the books.

The valuation, therefore, offers a safety net for investors looking to bet on a revival in travel and tourism—much of which is likely to be driven by the leisure segment, as people give in to their wanderlust after a long confinement. But remember, there are always risks with COVID not out of the way and discretionary spends likely to take a while to return, given the recent job losses and economic stress.

So, tread cautiously. But if you want to play the “unlock” theme, bet on the more resilient of the lot.

First Published:Aug 23, 2020 6:54 PM IST