What do shareholders own a slice of?

Elegant owns seven upmarket hotels with a total of 588 rooms making it the biggest owner and operator in this sector in Barbados.

With the exception of the Turtle Beach - which is on the south coast of the island - the hotels are all located along Barbados' prestigious west coast alongside the Caribbean Sea. It is known as the "Platinum Coast". Speaking from personal experience, this is a very nice part of the world to spend your holiday and also very expensive.

The cost of staying in these 4-5 star hotels doesn't come cheaply. To sum it up, if you have to ask the price of the drinks or the meals you probably can't afford it. 80% of Elegant's customer base is made up of reasonably to very affluent Brits who want somewhere upmarket to soak up the sun during the British winter.

The company also owns a posh Italian restaurant called Daphne's which is also located along the Platinum coast. The Daphne's name is courtesy of a franchise agreement with Caprice Holdings which expired a few years ago and doesn't seem to have been renewed (well I can't find anywhere saying it has). Elegant does own the freehold of the restaurant though.

Elegant also earns income from a management contract to run a hotel in Antigua and a sale and marketing contract with another hotel.

The business is very seasonal and makes the bulk of its money between September and March with peak revenues in the UK winter months.

Where's the profit growth going to come from?

Elegant is clearly going through a bit of a rough patch. But this could change if sterling continues to strengthen against the US dollar which it has so far this year.

The company does seem to have some sources of profits growth which can help offset some of the current tough trading conditions.

The Waves hotel which was bought in 2016 has been refurbished and is seeing a pick up in trading which should help. The Treasure Beach - bought this year - will reopen in November and should provide a nice boost in time for the peak season. There is the extra income to come through from the hotel management contract in Antigua.

These have been factored into analyst forecasts which suggest that growth in profits could start picking up in 2018.

The company also has improvements planned at a number of its existing hotels. This also has the potential to improve REVPAR if the market conditions are helpful.

Buying other hotels in Barbados or elsewhere in the Caribbean is also a possibility.

However, it is difficult to get away from the fact that hotels are quite asset intensive. You have to spend money to hold on to your existing profits before you can think about growing them.

As an outsider, it is always difficult to know how much money is needed to keep existing assets in good condition. What we can see is that capex spending is rising as a percentage of sales.

Some of this is spending on new assets such as The Wave but you can't help thinking that there is an element of catch-up spending on the rest of the hotels. On a TTM basis, capex to sales is running at 18% and free cash flow has just turned negative.

Spending enough money is the right thing to do for the long term health of the business but it does beg the following question.

Is the valuation of Elegant shares attractive?

Elegant shares are currently changing hands for less than the balance sheet value of its net assets.

At 31 March 2017, the value of the hotels were stated on the balance sheet at $173.8m. Total equity was $118.26m which equates to just over 100p per share at an exchange rate of £1=$1.326. As I write, the share price is 86p.

My first check on asset value is to look at the value in use by comparing the profits generated with their balance sheet value. My quick test is to look for a ROCE of roughly 8% or more.

Elegant passes that test in 2016 but profits have since trended lower on a TTM basis and ROCE has fallen to under 7% as a result. This suggests that the asset value is questionable and might be lower but if trading picks up there are grounds for arguing that it is a reasonable proxy for the hotel's value in use.

There could also be considerable substantial land value in the hotel assets. In 2015, CBRE (the international commercial property group) valued the hotel assets at $235m excluding Waves which was valued at $22m in 2016. Daphne's was valued at just over $5m by CBRE using an EV/Sales multiple of two times. If this valuation is true then Elegant would appear to be substantially undervalued at a current share price of 86p; it would imply a NAV per share of around 167p at current exchange rates.

But is it a reasonable valuation?

My view is that it is not.

The trading performance of most of the hotels has deteriorated quite a bit since the valuation was made in spring 2015. The long-term occupancy rates assumed by CBRE at the time are significantly above current levels.

As a result, I would say the property value of $257m cited in the 2017 interim results presentation looks a bit too optimistic at the moment. If management believe it to be true then they should stop paying dividends immediately and start aggressively repurchasing shares on the open market as this would make shareholders richer. This is not happening.

That said, I think Elegant is an interesting share which is certainly not pricing in a bullish outlook and could be worth a bit more research by enterprising investors.