Apple Hospitality REIT, Inc.
Q1 2020 Earnings Call Transcript

Published: 19 May 2020

[Operator:]

Greetings and welcome to the Apple Hospitality REIT First Quarter 2020 Earnings Conference Call. At this time, all participants are in a listen-only mode. A question-and-answer session will follow the formal presentation. As a reminder, this conference is being recorded. It is now my pleasure to introduce your host, Kelly Clarke, Vice President, Investor Relations. Thank you. You may begin.

[Kelly Clarke:]

Thank you and good morning. We welcome you to Apple Hospitality REIT's first quarter 2020 earnings call on this the 19th day of May 2020. Today's call will be based on the first quarter 2020 earnings release, Form 10-Q and COVID-19 supplements which were distributed and filed yesterday afternoon.

[Justin Knight:]

Thank you, Kelly. Good morning everyone, and thank you for joining us today. I sincerely hope that each of you and your loved ones are staying safe and healthy during these challenging times. My heart goes out to all those who have been directly affected by the coronavirus. I would like to express my sincere gratitude to all first responders, healthcare workers, and everyone on the frontlines of this pandemic. With travel restrictions and stay-at-home orders in place across most of our nation since mid-March, COVID-19 has disrupted every aspect of our daily lives and it's been particularly challenging for the hotel industry. The pandemic and efforts to mitigate it have dramatically reduced both business and leisure demand and required us to make meaningful changes to the way we operate.

[Liz Perkins:]

Thank you, Justin, and thank you everyone for joining us this morning. These are incredibly challenging times for our industry. I want to take this opportunity to thank our team at Apple Hospitality, the operators at our hotels and management companies, the brand, our banking team and our industry colleagues. Together, we have been working diligently to explore and implement initiatives to minimize costs, operate efficiently, strengthen our liquidity position and safeguard the health and well-being of our teams and guests so that we are well positioned both during this crisis and for a strong recovery as travel resume.

[Operator:]

Our first question comes from the line of Neil Malkin with Capital One Securities.

[Neil Malkin:]

First off, you guys are one of the largest owner of select services in the country and I know you guys sit on a lot of the brand committees or boards of the largest brands as well. Wondering, if you could just talk about sort of how you see the relationship between the brands and the owners evolving over the next 6 to 12 months? Some of your peers have generally commented on that. Just given your wide reach with several select-service brands, you probably had some good view on that. So, how do you kind of see that playing out? And do you think the pendulum has kind of shifted back in favor of owners? And maybe talk about any permanent changes that you see happening to the operating model going forward?

[Justin Knight:]

Thanks and I'll take a stab at it and Liz can fill in if she'd like an addition. Both of us sit on advisory boards within Hilton and Marriott. To date, both companies and again, we only own one Hyatt, but Hyatt has been equally good. But both Hilton and Marriott have actively engaged with owners in dialogue related to how we deal with the current pandemic and the nuances associated with it and how we look at modeling our business for the future. I think there's heightened sensitivity to say, the need to make some near-term adjustments in order to ensure the safety of our guest and associates. But there's also I think increased recognition of a need to look at our business model in order to ensure long-term profitability. And so, in those conversations, we're looking at everything and with fresh eyes, and I'd say that the conversations have been productive. So, there's been a tremendous openness on their side to hear the feedback and commentary from the ownership community. And I think there was a sentiment, that's potentially with consolidation on the brand side and significant pipeline growth with both Hilton and Marriott that the pendulum had shifted away from ownership. Generally speaking, our relationship has been viewed from our perspective as collaborative always. And we've seen both of our major partners as working with us to achieve the common goal of long-term profitability. So, I'd say there are a lot of things in flux right now. So, there's a lot of attention being paid to those issues that are most important, both now and as we move into an environment where guests begin returning en masse to our hotels.

[Liz Perkins:]

And, Neil, the second part of your question about what you thought might stick long-term. I think that that's still yet to be determined. It's obvious in the near-term that guests have different expectations and needs, and how long that persist or what that looks like going forward from a long-term perspective. Those are the conversations that we're having with the various brands to help figure out what's the best model for today, but what does that look like going forward to and so those are active conversations. I think that as far as the balance of power goes there, regardless of who might have a slight advantage of any one point in time, it's mutually beneficial that we get this right for everybody. We want to be relevant with guests. We want the brands to be successful. But in order to do that, we have to make money as well. So, I think that getting this right will be a balance between the brands and ownership.

[Neil Malkin:]

Thanks. I appreciate your commentary. You've talked about rates being impacted in the first -- in March and April. Some of your full scale peers use more of an occupancy, less of a rate. I'm wondering if, how do you explain or what do you think that that drop is attributable to? Is it because, you guys essentially all your hotels were open whereas a lot of those full service more coastal focused players shut a majority or all of their -- almost all of their hotels. Was just more of just taking OTAs you think that'd be less of an issue given the brand's nature, any thoughts or commentary on that? And maybe how your select-service model kind of ebbs and flows with lower demand and with OpEx changes, things like that?

[Justin Knight:]

Liz commented in her prepared remarks that the majority of the shift we saw, as we rounded out the month of March, was really the result in changes in business mix. So, a move away from transient both business and leisure towards the negotiated business, which is generally discounted business. And given the low occupancy level, the bulk of the business in our hotels as we round out March and April fit into that category with a significant amount of first responders, national guard business of that type in addition to other business clients, what we've seen and we've highlighted in Carolina Beach example is, in those markets where we're seeing a leisure, transient return we're seeing an ability to get in push rates as occupancies get closer to sell out or are we just kind of higher ranges. But as we look forward, in the near term the decrease in rates has been largely attributable to the mix of business, I think our expectation is that as we begin to ramp occupancy at least in the early stages, markets will be incredibly competitive and we're working with our management companies to ensure that we're maximizing rates wherever possible, recognizing that we will still be competing for a smaller number of guests in many of our markets, and they need to make adjustments to rate in order to build back base occupancy. But what we've seen to-date is largely a mix of business related and the other is more expectation for the future.

[Neil Malkin:]

Last one for me if I could, you talked about your balance sheet being very strong and leading to opportunities should they present themselves ostensibly. This would lead to you guys being more active or looking at more things in the near term. Do you think you're going to have more success or more interest in stabilized assets or newer more recently constructed assets?

[Justin Knight:]

It's a great question. And, you know I think we have the luxury of being able to look back on two earlier cycles where we were active participants in the market as the market recovered. In both instances, we were successful in acquiring existing assets at discounts to their long-term value. But at the same time, locking in pricing on development fields, which would be delivered in future years, which enabled us to essentially ensure that as values increase, we were acquiring assets attractive pricing. Now, this cycle is radically different than past cycles and may play out differently. But our expectation is that in the early phases of recovery, there will be an increase in the number of opportunities that would be attractive to us. Our first preference though is getting back to cash positive, right. So, I think it would be reasonable for us to assume that while we are eager to pursue opportunities from a capital allocation standpoint, which would drive shareholder value. Our number one priority at this point is getting back to a position where we're producing positive cash flow from operations. And until we get to that point, I think it's fair to say that we would be conservative in pursuing optional uses of cash.

[Operator:]

Thank you. Our next question comes from Austin Wurschmidt with KeyBanc. Please proceed with your question.

[Austin Wurschmidt:]

If you could help us understand the difference between, a hotel suspending operations versus kind of a clustering strategy that you guys have pursued, and kind of quantify what that the benefit is where you're staying open to maybe not physically accepting, yes, and if that's just provides another source of demand, I guess generator or marketing, I guess benefit to some extent. Could you just help us understand that dynamic a little bit?

[Justin Knight:]

Absolutely, and I'll take a stab again, and Liz can correct me where necessary. But really, I think it's important to look first at the decisions we’ve made for those assets that are in markets by themselves. So, we have universally decided to keep our hotels open. We went through a very detailed analysis to come to that conclusion, and at the end of the day, the reality is one of the benefits of the select-service model is that our assets can be operated with very little staff. Our staff is cross-trained, our managers, our salespeople have the capacity to do laundry and clean in turn rooms, provide food service and things of that sort, which is a major differentiator and I think has going to be a huge advantage. As we looked at what we anticipated to be the duration of at least the most challenging portion of the current pandemic. We assess each of our properties individually -- and decided that the difference in costs to stay open versus closed was immaterial, given a desire on our part, to maintain sufficient staff in the assets to ensure that you didn't have a water leak or a system breakdown because long-term damage to the assets. On average, that means having one to two people on property at any point in time. And what we found is that, that was sufficient staff to essentially operate the hotel at minimal occupancy levels. So then moving beyond that, in markets where we own multiple hotels, and we have some occupancy, we've been able to gain incremental benefits from a cost standpoint, by concentrating the guest in a single hotel asset. And then in some markets that's very easy, where we earn dual branded asset or two hotels that are immediately across the parking lot from each other. That the nuances that reservation systems are open for all hotels, and they're accepting guests. We're just concentrating the guests in one hotel so that we can better service them and serve them more efficiently.

[Liz Perkins:]

I think another benefit is that, we continue to have, as Justin mentioned, the reservation systems open but we also continue to retain managers and in most cases, a salesperson. So 80% to 90% of our hotels have retained some sort of sales effort. And so, the momentum that we have, as we come out of this, we think will be an advantage across the portfolio whether consolidated or not. And so in an effort to keep sort of the high performing talent and managers that that we have across our portfolio, the decision to completely close a reservation system and closed the hotel versus keep it open and keep momentum going, and keep the asset protected and maintained. The benefits outweigh the costs were, as Justin mentioned, given our model, unless we thought that this was going to last for an extended period of time, and we would make further labor cuts, and really just bring in security and not be as focused on asset protection or sales efforts and things of the sort, the difference in cost was fairly minimal. And again, the benefits far outweighs, far outweighs that.

[Austin Wurschmidt:]

That's helpful. Could you break out what the recent week occupancy detail is between your extended stay and suites products which is over half of the portfolio? And then what it is for sort of a balance of the portfolio?

[Liz Perkins:]

I would say that extended stay whether it's the current week or even the trend for the past four weeks has been a 20 point occupancy premium. Now, keep in mind, we have -- where we've consolidated operations we've consolidated into extended stay property by and large. And so, that that helps that two or three hotels occupancy your reservations and one. But again that, that type of product is definitely well suited for the type of business that that we're getting at the moment, with many retail and restaurants closed across the country with social distancing with extended say, business being really what's in markets right now, that specific product is a huge advantage for us. The sweet products and extended stay product and other select-service are operating a little more similarly, although the bigger footprints and having microwave and things like that and other sweet products certainly is benefiting, but the big differential is the extended stay properties.

[Austin Wurschmidt:]

That's very helpful. And then just last, I was curious, did you guys did you incur any sort of one-time severance or furlough cost that you don't expect on a go forward basis that you could try for us?

[Justin Knight:]

Yes, in the quarter, we incurred just over a $1.5 million in one-time for low costs related to transition, which we would not anticipate would recur.

[Liz Perkins:]

At least at this point.

[Operator:]

Our next question comes from Bryan Maher with B. Riley FBR.

[Bryan Maher:]

When it comes to the waivers that you're hoping to get completed. I think you mentioned it and maybe this is a better question for Liz distribution restrictions, and I'm assuming that would be on the dividends. Is that kind of an all or nothing restriction? Or is there going to be some formula in there that you could take in at a later date, maybe in the first half of 2021, or at some lower level?

[Liz Perkins:]

I'll think broadly, but, because we don't have anything officially completed, I won't be able to speak too much to it. But in general, our lenders definitely understand our REIT status, and that we need to pay out 90% of our taxable income. So I think that there will be some flexibility at a point in time where we're making money and would need to pay dividends, but I wouldn't imagine that we would be able to, during the waiver period, pay out that distribution beyond that.

[Bryan Maher:]

And then when we think about your ability to drive rate, as markets start to reopen, and I suspect is the full service has helped competitors in your market start to reopen their specific hotels. My guess is that rate competitions going to be pretty intense. How are you guys thinking about focusing on marketing for the next one to two quarters via the brands, via the internet, via your sales managers, how are you planning to address that?

[Justin Knight:]

I'd say yes to all…

[Liz Perkins:]

All the above.

[Justin Knight:]

Liz highlighted the fact that we've reaching sales staff at the property levels. Our management companies have also retained sales staff and are actively doing direct sales efforts folks looking for business in the near-term and courting potential clients for future business. I think we have signaled over the past several calls, a move within our company towards for online marketing, and we'll continue those efforts as well. Especially to the extent, we feel we can attract to leisure customers for our hotels, which many of our locations are ideally positioned for that. But I think, it's fair to assume that we will be leveraging all available sales channels as we build back occupancy. One of the advantages we've had historically as we come out of more challenging economic periods, such as hotels have had an exceptional value proposition for a variety of guests both leisure and business and appeal to a very broad group. We've signal that our position within the flat service spectrum is particularly advantageous, being kind of at a midpoint where, during periods of economic prosperity, people trade off in center assets. And during periods of economic difficulties, they have a tendency to trade down which has enabled us to maintain stronger occupancy throughout cycles. We anticipate that will continue and we'll be aided in part by what we anticipate to be a significant reduction in new supply over the next several years.

[Bryan Maher:]

And it just lasts for me. I think you mentioned the Carolina Beach hotel last weekend were sold out and I think instead of $200 rate. As we sit here kind of real-time and kind of mid delay May and people antsy to get out, what are you guys seeing coming in the bookings for similar type assets that you might hold it? Is it just something that's giving you optimism as we approached June and July? Or was that kind of a one off?

[Liz Perkins:]

I think as far as looking position goes, it's last minute. And so it would to stretch into June and July would be maybe a little bit premature. But we are starting to see, even if I just look at what actualized in the past week, we are starting to see especially in the Southeast, in North Carolina, South Carolina, even Atlanta and some Florida markets where occupancy -- weekend occupancy is taking up. And so that's encouraged -- that's encouraging. I think across the country as restrictions are loosened, I think that people, who are willing to travel will and they will get out. And so I think there may be more drive driving traffic than, people getting on airplanes. But by and large weekend business, I think into Memorial Day and beyond, particularly in the Southeast where we're feeling a little bit encouraged.

[Operator:]

Thank you. Our next question comes from Anthony Powell Barclays. Please proceed with your question.

[Anthony Powell:]

Following up on that question, in some of these markets where you're seeing reopening, are you seeing any weekday business return? Or is it still social really to see that kind of business for our corporate travelers from that?

[Liz Perkins:]

I think the notable difference is the uptick in the weekends. In those markets, it's not to say we don't have some base business, but it's still from sort of the sectors we mentioned in our opening remarks. It's project business, recovery business, medical, traveling nurses, things of the sort. And so, I wouldn't say that we're seeing really an uptick in BT at this point.

[Anthony Powell:]

What was the occupancy as of week ended May 16th, if you have it?

[Liz Perkins:]

We have not shared that but it is, as we mentioned in the prepared remarks, we had several days that were higher than the week ending May 9.

[Anthony Powell:]

Okay.

[Liz Perkins:]

But then we're still trending more positively.

[Anthony Powell:]

Different topics to the Courtyard Denver, what drove the decision to not go forward with that acquisition? Did the developer, I guess, delay the project. And then, what's your kind of overall commentary on how developers using the environment now? Are you seeing cancellations, more owners financing? What's kind of the overall environment there?

[Justin Knight:]

So, the Denver project specifically, we had been working with the developer for a significant period of time. So that developers, the same developer, that's building the Tempe assets and the Madison assets for us. There had been complications in that project. And we were continuing to work through nuances associated with that adjusting room count because of the amount of land available, shrinking and other things. Because that project had not yet started, we had some additional flexibility to cancel. And we worked with the developer to essentially put that project on hold until the market stabilizes, and we have a better sense for more costly, long term. I think, as we interact with others in the industry, broadly speaking, financing for new development projects is as difficult as we ever seen it to come by. And for the most part, developers are waiting right now, in anticipation that the costs will eventually come down. And they're also waiting to see where markets settle. So to better understand, what deals will make sense in the new environment. I think we are seeing some slowing in projects that are already under construction, depending on specific markets and restrictions that are being put in place relative to work crews, but also related to delivery of products from out of the country. But on a go forward basis, so I think it will take longer for deals that are under construction to be delivered. But the bigger impact for us will be that -- our expectation is that developers generally speaking will be sitting on the sidelines for a period of time until markets begin to stabilize and they're better able to underwrite, both the costs and expected profitability of individual projects.

[Anthony Powell:]

Do you expect to kind of a permanent change in how these deals are financed? Do you expect developers just have to put up more equity? Could it kind of more of a longer-term headwind to hotel development generally as a result of this event?

[Justin Knight:]

We have, yes and we've been in this business for 20 years to see anything in the way of permanent change, but we have seen extended periods of time where it's more difficult to obtain financing. And our expectation is that in the early phases of recovery, consistent with the past few cycles that we've been through, it will be more difficult for developers, especially new hotel developers, so chain financing. Construction -- new construction tends to be viewed by lenders as higher risk because you have market risk and development risk. And our expectation is that in the near term, vendors will be much more focused on working through nuances of deals they already have and less focus on signing up new deals.

[Operator:]

Thank you. Our next question comes from the line of Michael Bellisario of Baird. Please proceed with your question.

[Michael Bellisario:]

Just on that same topic, can we drill into the Madison deal? Maybe where is that project in terms of development timeline? And then I think you mentioned at 21 delivery but should we be thinking about it as early 21 delivery or late 21 delivery kind of balance the potential cash outflow you might have in the near term?

[Justin Knight:]

That particular project was earlier in development when the pandemic hit. There were also nuances associated with the sites that had push potential delivery towards the very end of this year, even prior to the pandemic. Our current expectations are that it would be delivered to the very end of the first quarter or beginning of the second quarter. And again, Madison is one of those markets that it seems slightly tighter restrictions as well, which is adding to the potential delays there.

[Michael Bellisario:]

So, is it fair to assume you're going to move forward with that project irrespective of the environments mainly because you don't have the same elements like you did for the Denver deal?

[Justin Knight:]

That's correct. The remaining development deals that we have under contract have specific performance language and absent an end-of-the-world situation where we became insolvent as a company, it's our expectation that we would close on those assets.

[Michael Bellisario:]

And then just thinking about the sources of capital, I know you have a large cash balance today, but the plan was to always sell hotels, the lower growth non-core properties to fund these deals. How are you balancing the sources and uses going forward given that the transaction market is pretty much at a standstill today and probably likely to be at a standstill 3 to 6 months from now?

[Justin Knight:]

For year-to-date, we're perfectly balanced with the or nearly perfectly balanced with the first quarter sales funding, essentially the 8th project. We're continuing to receive inbound inquiries. I think there's renewed interest in the hospitality space. Pricing isn't where we needed to be. And I think it will take a while for the market to settle out. We take a long-term view towards capital allocation. And it's still, in our view, long-term debt that we will pull it up funding are development deals with disposition proceeds. So the timing of those trades may not perfectly align. I think, looking at what we currently have under contract and in our expected burn rate, on a go forward basis, we feel very comfortable that we can manage our commitments, and maintain the operations and the integrity of our company.

[Michael Bellisario:]

And then just lastly, maybe a high level commentary on your management company, you have a handful of more regional local focus operators, can you give us an update on the health of your third party managers? And then just if there are any weaker ones, any conversations you've had about maybe transition and then the impact that might have on property performance, near-term or intermediate term?

[Justin Knight:]

Absolutely. And really, first, we, as you might imagine, in nearly constant dialogue with our various management company partners, we have 20 management companies, we work with. A portion of them are national and portion of them are regional. We've been incredibly impressed with their ability to react quickly to the changes in the current environment, and to effectively reduce costs dramatically across the board, both in terms of property level expenditures, and corporate allocations, so we get for various services from them. As we've interacted with them, they're in amazingly good spirits. And generally, our conversations around longevity and financial status have been very positive. Internally, we've developed contingency plans, in the unlikely event that that any of them, became solvent because of the duration of the current crisis. But the reality is, we have four of our management companies coming to us, and telling us, they would love an opportunity to take on additional management contracts the extent we had a need, and we have management companies coming to us and telling us that they're in a bad position. We were not as a company able to take advantage of government aid in the form of PPP loans. A number of our management companies were able to take advantage of the government programs, which has also helped to stabilize them in the current environment and enable them at the corporate level to retain employees as they might otherwise have to furlough.

[Operator:]

Our next question comes from Tyler Batory with Janney Capital Markets. Please proceed with your question.

[Tyler Batory:]

Questions just in terms of CapEx spending right now, I mean, your pretty minimal levels and I imagine the competition in your markets are doing the same. Can you remind us the average age of your portfolio? And is it possible that the quality of your properties compared to the competition is a little bit higher heading into this crisis? And maybe it's an opportunity for you to take some market share?

[Justin Knight:]

So, the easy answer is the first and that's the average ages is approximately 14 years. We monitor effective age as well and coming into the crisis, effective age meaning time since filter last renovated was four years for our portfolio. As you highlighted, we've significantly reduced the number of major renovations that we anticipate completing this year, cutting essentially 20 major renovations, which were anticipated to happen in the summer and towards the back half of the year. That said, we also in many markets are running very low occupancy. And so in the near-term, the wear and tear on those assets is not what it would ordinarily be which will help from a preservation standpoint, but not in a way that we want to continue long-term, obviously. We've been very strategic and acquiring assets that are well positioned within their individual markets that have advantages either from a location standpoint for a build out in terms of actual amenities, and most cases have both advantages. We've continued to refine our portfolio through selective acquisitions and dispositions and feel really that we're exceptionally well positioned. So because of the properties we have, but as I highlighted in response to an earlier question, because of the management teams that we have on property to gain market share as we recover. The fact that we've remained open and servicing guests provides a great signal to local accounts especially that we are a long-term partner willing to work with them. And we think we'll provide us with a meaningful advantage as we begin a more robust recovery.

[Tyler Batory:]

And then, what percentage of your mix or your room count are located in markets that you think should appeal to the leisure transient, drive-to guests or markets that you can sort of be more vacation oriented similar to that Carolina Beach Courtyard for example?

[Liz Perkins:]

Interesting question, I think, from a drive-to standpoint we, in thinking about, I mean, most of our markets have a component of local negotiated business or inbound somewhat leisure weekend business. So I think many of our markets will appeal just from a drive-to and leisure standpoint, now to what degree will depend on the leisure attractions. I think, we certainly don't have a large percentage of our portfolio that has direct access to beaches, but we do have some and we have a lot of Florida markets and a lot of California markets and access to beaches here in Virginia, South Carolina and North Carolina. So, I think we do have a strong presence. I think one of the things to think through too is just the urban versus suburban mix of our portfolio. We have seen strong outperformance relative basis I guess with our suburban versus urban portfolio. And the industry has seen the same thing, suburban having the highest, absolute occupancy for both the industry and us. So, I think that's a big differentiator as well as the makeup of extended stay.

[Operator:]

Thank you. There are no further questions at this time. So I'd like to pass the floor back over to Mr. Knight for any additional closing comments.

[Justin Knight:]

Thank you. We really appreciate everybody joining us this morning. I've highlighted in the past, but I'll do it again today, to the extent you are traveling and we hope that you are or will shortly. We hope you take the opportunity to stay with us at one of our hotels. Be safe, be well. We look forward to talking to you again shortly.

[Operator:]

Ladies and gentlemen, this does conclude today's teleconference. We thank you for your participation and you may disconnect your lines at this time.