South Africa’s tourism boom and how investors can benefit

South Africa is projected to experience a tourism boom over the next few years, and investors could capitalise on this growth by investing in the companies that will benefit from it.

A recent World Travel and Tourism Council report revealed that South Africa’s tourism sector is expected to grow by around 8% a year over the next decade. 

This comes after the sector has been in recovery post-Covid and has only now started to return to pre-pandemic levels.

Allan Gray portfolio manager Varshan Maharaj said in a recent Kaya Biz interview that it is important to remember that the hospitality sector is cyclical, and its performance is often tied to when new supply enters the market. 

For example, when a new hotel opens up, occupancy and average room rates typically drop, which can pressure profits. Conversely, if demand picks up, occupancy rates and room rates tend to rise, boosting profits.

In South Africa, the pandemic and lockdowns placed many hotels under significant stress. 

However, Maharaj said that, over the last 12 to 18 months, the market has been in recovery, with occupancies, room rates and profits improving. 

Therefore, he said Allan Gray is bullish on this market.

For local investors, listed hotel groups they could buy include Southern Sun and City Lodge. These companies both own and manage hotels, the majority being in South Africa. 

Maharaj explained in an article that hotel profit is driven by the number of rooms, occupancy of these rooms, and average room rates (ARRs). 

Furthermore, ARRs move together with occupancies, leading to large swings in earnings over the hotel cycle. 

Maharaj looked at Southern Sun’s financial performance to illustrate the value these stocks could offer.

The hotel group recently reported earnings of 25 cents per share for the first half of their financial year. 

Historically, their profits are seasonal, meaning one-third of earnings are made in the first half and two-thirds in the second. Therefore, Maharaj projects 75 cents per share for the year. 

Using a conservative 12-times multiple, that translates to 900 cents per share. He explained that since the current share price is below this, the stock offers value.

In addition, this current level of earnings is being achieved at an occupancy rate of just 59%, compared to a long-term average closer to 65%. 

Therefore, as demand grows, Maharaj expects occupancy rates and room rates to rise, which should boost profits further. 

In addition, with limited new hotel developments during Covid-19, these businesses are well-positioned to capitalize on increased demand for the next few years.

There are also opportunities available offshore for investors looking to capitalise on an expected worldwide tourism boom.

Maharaj identified two US-listed companies, Marriott and Hilton. He described them as asset-light business models and said they are very different from listed South African hotel groups.

This is because the local groups own the hotels, unlike Marriott and Hilton, where around 99% of their hotels are owned by third parties. 

Marriott and Hilton sell their brands, systems, and hotel management expertise to these hotel owners in exchange for a fee linked to the revenue and profits of the hotels. 

Both groups own many brands, which cover most segments of the market. They also have large and popular loyalty programmes, which drive direct bookings and improve margins. 

Maharaj explained that this capital-light model allows them to grow earnings faster than the hotel sector as a whole. 

While these companies trade at high multiples, he said their growth justifies it, offering value to investors.

“The key determinants of investment success are the price one pays, and the value you get from earnings growth, and the hospitality sector currently offers attractive opportunities at both ends of the spectrum,” he said.