Tokyo-listed AB Hotel Co is a small-cap Japanese company that operates hotel chains. AB Hotel provides lodging, catering, meeting arrangements, and restaurant services in Japan. As at the end of 2024, the company has 36 hotels under operation, spanning over 4,600 rooms. AB Hotel started its hotel operating business in November 1999 and has continued to expand its presence across Japan. The company demerged from Tokyo-listed property and sports club operator Tosho Co in October 2014 to focus solely on hotel operations.
The thesis for investing in AB Hotel is the minimal coverage of the company. This implies that the financial information may not truly reflect the company’s worth and is undervalued.
A key qualitative aspect of the company is that it mainly operates hotels in key business areas, such as public transport stations and near major interchanges. Also, most of the hotels have a single-room design, which goes well with the previous point in terms of location. Both these points reflect a wellthought-out business strategy regarding the target market.
Japan’s consumer economy continues to recover slowly post-pandemic, which affects consumer discretionary service providers such as AB Hotel. The depreciation of the yen, along with labour shortages in Japan, also negatively affects the hotel industry and occupancy rates.
Like most businesses that survive and sustain, AB Hotel’s management has addressed this issue by implementing new business directives. This includes travel discount campaigns implemented by each prefecture in which AB Hotel has a presence to improve the occupancy rate.
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“AB Hotel will expand our business as an accommodation-oriented hotel, providing the classy atmosphere of high-class hotels and reasonable pricing of budget hotels to meet the guests’ satisfaction,” says president Kazuki Kutsuna. Measures to secure repeat customers were also implemented, such as reviewing and revamping meal menus.
A key point to consider is that customer satisfaction can be elastic in consumer discretionary industries but depends on the business’s culture and target market. AB Hotel’s measures were effective as they adapted well post-pandemic, reflected by almost double-digit improvement in occupancy rates from 2022 to 2023. These measures resulted in strong sales of business customers, AB Hotel’s primary customers, and increased inbound and domestic travel demand.
Last year, Japan welcomed the most visitors in history, partly thanks to a favourable currency. According to the Japan National Tourism Organization, more than 36.8 million people visited the country. The previous record was in 201X with nearly 32 million visitors and in 2023 with 25.07 million visitors. Visitors last year spent JPY8.14 trillion ($71 billion), up 53% from 2023.
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Moving forward, AB Hotel continues to do well business-wise and just recently announced the launch of its three-year medium-term management plan, starting with the fiscal year ending March 2025. This management plan will focus on the social responsibility aspect of the business and environmental issues, such as the establishment of an in-house sustainability and environmental committee to potentially attract international patrons and demand. Overall, the qualitative aspect of the business is good, to say the least.
AB Hotel’s most recent 1HFY2024 results improved its y-o-y net sales, operating profit and net profit by 6.9%, 8.9% and 9.1%, respectively. Guidance-wise, for the full year, net sales, operating profit, and earnings per share are expected to increase by 3.5%, 2.1% and 0.3% y-o-y.
Although the numbers may seem a bit lower in comparison to the current period’s performance, it must be noted that AB Hotel did tremendously well from FY2022 to FY2023 due to success in its business adaptation measures, reflected by y-o-y improvement of around 50% for its operating and net profits. However, the share price has fallen over 30% over the past year despite a minimal improvement from a windfall year, supporting our thesis that the company is undervalued.
Financials-wise, AB Hotel has had 10 years of positive operating cash flow, with great profitability despite being in the usual saturated consumer discretionary industry. The company’s business focus and strategy were successful post-pandemic, reflected by its increase in return on equity from 5.3% in 1HFY2021 to 23.4% in 1HFY2024. Current margins for operating and net income are 37.2% and 22.9%, respectively.
The company’s financial health is good, too, with a cash and current ratio above one times, reflecting strong liquidity and a net debt to equity of 37% with over 50 times interest cover, representing excellent solvency. Relative valuations-wise, AB Hotel is attractive as it trades at a 38%, 53% and 29% discount to domestic peers for its forward PE, EV/Ebitda and P/B ratios.
There is no analyst coverage on the company, which would likely make sentiment on the company more erratic. We believe the true and fair value of the company would be achieved through “random walks” in the fluctuation of the share price. Based on our in-house valuations (see Charts 1a and 1b), we think the fair value for the company is JPY1,905, above its current trading price of JPY1,500.
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