Service Properties Trust
Q2 2013 Earnings Call Transcript

Published: 6 Aug 2013

[Operator:]

All right. Good day, ladies and gentlemen, and welcome to the Hospitality Properties Trust Second Quarter Financial Results Conference Call. This call is being recorded. At this time, for opening remarks and introductions, I would like to turn the call over to the Vice President of Investor Relations, Mr. Tim Bonang. Please go ahead, sir.

[Timothy A. Bonang:]

Thank you, and good afternoon. Joining me on today's call are John Murray, President; and Mark Kleifges, Chief Financial Officer. John and Mark will make a short presentation, which will be followed by a question-and-answer session. I would note that the recording, retransmission and transcription of today's conference call is strictly prohibited without the prior written consent of HPT. Before we begin today's call, I would like to read our Safe Harbor statement. Today's conference call contains forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995 and other securities laws. These forward-looking statements are based on HPT's present beliefs and expectations as of today, August 6, 2013. The company undertakes no obligation to revise or publicly release the results of any revision to the forward-looking statements made in today's conference call, other than through filings with the Securities and Exchange Commission or SEC. In addition, this call may contain non-GAAP financial measures, including normalized funds from operations or normalized FFO. A reconciliation of normalized FFO and adjusted EBITDA to net income, as well as components to calculate AFFO are available in our supplemental package found in the Investor Relations section of the company's website. Actual results may differ materially from those projected in any forward-looking statements. Additional information concerning factors that could cause those differences is contained in our Form 10-Q to be filed with the SEC and in our supplemental operating and financial data package found on our website at www.hptreit.com. Investors are cautioned not to place undue reliance on any forward-looking statements. Now I'd like to turn the call over to John.

[John G. Murray:]

Thank you, Tim. Good afternoon, and welcome to our second quarter 2013 earnings call. Today, HPT reported second quarter normalized FFO of $0.78 per share. Focusing first on our travel center investments. This morning, TA reported second quarter EBITDAR of $86.6 million, an 8% decrease from the 2012 quarter. Second quarter 2013 performance reflects both reduced fuel volumes sold, down 5.3%, and reduced per gallon fuel margins, down 4.3% for diesel and 13.6% for gasoline. Non-fuel sales and gross margin were up 4.5% and 2.6%, respectively, compared to the 2012 quarter. Despite the weaker performance this quarter versus last year, TA's property level coverage of HPT's rents remained strong at approximately 1.8x. Turning to HPT's hotel investments. Second quarter RevPAR was up 7.1% this quarter across HPT's 287 comparable hotels. Ongoing hotel renovations continue to impact our results. Excluding the 3 acquisition and 42 renovation hotels, RevPAR was up 8.7% this quarter. The strong top line performance, which was comprised of both occupancy and rate gains, reflects strong results at 189 hotels that completed renovations since 2010 through the first quarter of 2013, with RevPAR gains of 14.1%. This helped to offset revenue performance at our 42 renovation hotels this quarter, which experienced RevPAR declines of 6.7%, all from lost occupancy. While our 39 conversion hotels continue to negatively impact overall performance, beginning this quarter, we will not be discussing that impact separately because those hotels have or about to reach their 1-year anniversary since conversion and many are beginning renovations. A useful comparable discussions, therefore, challenging without going hotel by hotel. The conversion hotels are included in our comparable hotel statistics. For the third consecutive quarter, HPT's hotel performance post-renovation offset the effects of ongoing renovation activity, and allowed our portfolio to exceed industry average performance. The strong performance has been driven largely by our Candlewood Suites, Staybridge Suites and Residence Inn and Extended Stay hotels, which are renovated in 2012, and our Courtyard, SpringHill Suites and Crowne Plaza Hotels renovated in 2011 and 2012. Extended Stay hotel renovations accounted for over 3 quarters of hotels under renovation in 2012. We expect 34 hotels will be under renovation during all or part of the third quarter, and 33 in the fourth quarter of 2013. Renovation activity throughout the balance of 2013 will be principally at our Sonesta and Wyndham Hotels. We expect to renovate 33 hotels next year, primarily in the first and second quarters. 2013 RevPAR forecast for our hotel portfolios vary from small declines expected at our conversion hotel portfolios to a double-digit increase at our IHG portfolio, where most of the hotels have completed their renovations. The average is between a 7% and 8% increase. Similarly, forecast GOP changes ranged from a decline for conversion hotels to double-digit gains at IHG. The average is between a 6% and 7% increase. Based on June 2013 year-to-date comparable RevPAR growth of 7.4% and a GOP increase of 9.3% in considering the strength of our renovated hotels, these forecasts seem reasonable. Turning to acquisition activity. In May, we acquired a 426-room Sonesta Gwinnett Place in north suburban Atlanta for $29.7 million and combined it with our Sonesta portfolio. The purchase price of $29.7 million represents an 11.6% cap rate on 2012 EBITDA at this hotel. We expect to invest approximately $5 million on renovations at this hotel in the next 12 months. On June 28, we acquired the fee interest in the Royal Sonesta on Bourbon Street in New Orleans, Louisiana for $120.5 million. This hotel was leased by us from a third party, but the lease had only 12 years remaining and its rent was based on the hotel's net income less capital expenditures. As rents based on income are not requalified, this lease was in a TRS and our income from the hotel is subject to taxation. In connection with the purchase, we terminated the lease and entered a new management agreement with this hotel on terms consistent with HPT's other full service hotels managed by Sonesta, and added it to the pooling agreement so that all Sonesta management contracts are now part of what we refer to as the Sonesta portfolio. The combined $120.5 million purchase price plussed a 2012 $31.5 million investment in the leasehold interest, represents a 7.25% cap rate on forecast 2013 EBITDA, assuming no third-party lease at this hotel. HPT expects to renovate the Royal Sonesta New Orleans in 2013 and 2014, but the extent of that investment has not been finalized at this time. On August 1, 2013, we required the 219-room Hamilton Park Hotel & Conference Center in Florham Park, New Jersey to $52.75 million, and rebranded it as the Wyndham Hamilton Park Hotel & Conference Center. The hotel has 27,000 square feet of meeting space and is adjacent to Fairleigh Dickinson University and The Green at Florham Park development, which includes a number of important demand generators. Wyndham's headquarters is located nearby Parsippany, New Jersey, and Wyndham-related business generates thousands of room night in the market. This acquisition by HPT and Wyndham's agreement to brand and manage the hotel will allow Wyndham to become a significant source of business to this hotel. The hotel has been added to the Wyndham portfolio of contract, and the annual owner's priority of return was increased by $4.2 million. In connection with the acquisition, HPT agreed to provide up to $10 million for renovations over the next 3 years. HPT is no longer under letter of intent with NH Hoteles regarding the previously announced possible hotel investments in Latin America, Europe and New York. Efforts to find an acceptable alternative structure for that transaction were unsuccessful and discussions have ceased. We continue to see a healthy pipeline of hotel acquisition opportunities. We face a competitive landscape with other REITs and institutional investors also seeking acquisitions, while we expect to continue to generate accretive acquisition growth. We remain optimistic about this lodging cycle due to the continued low room supply growth and steady demand. This allows for increases in room rates and GOP improvement, particularly as we continue to move towards the full renovated portfolio. I will now turn the presentation over to Mark to provide further detail on our financial results.

[Mark Lawrence Kleifges:]

Thanks, John. First, I'll review second quarter operating results for our hotel properties. Operating results at our 287 comparable hotels were strong this quarter, with RevPAR up 7.1% and 100 basis point increase in GOP margin percentage. We achieved these results despite a decline in quarter-over-quarter performance at the 39 hotels we've rebranded in the second and third quarters of 2012, and the negative impact of our renovation activities. In the 2013 second quarter, we had 42 of our comparable hotels under renovation for all or part of the quarter, including 18 of the rebranded hotels. This compares to 55 hotels in the 2012 second quarter. RevPAR for our 42 comparable hotels under renovation during the quarter was down 6.7% on a 5.4% -- a 5.4 point drop in occupancy and an ADR increase of slightly less than 1%. RevPAR at our 245 comparable hotels not under renovation this quarter was up 8.7% versus the prior year quarter on a 5.2 percentage point increase in occupancy and ADR growth of 1.5%. This significant RevPAR increase was driven in large part by the performance of the 55 hotels that completed renovations during the 2012 second quarter, with RevPAR up 25.7% at these hotels on occupancy and ADR gains of 13.4 points and 5.2%, respectively. Our portfolios with the highest RevPAR growth this quarter were IHG and Marriott 234 portfolios, with quarter-over-quarter increases of 19.7% and 11.7%, respectively. Although our renovation and rebranding activities also had a negative impact on hotel profitability this quarter, these declines were more than offset by improved results at our remaining hotels. Gross operating profit for our 287 comparable hotels increased $12.2 million or 9% quarter-over-quarter, and GOP margin percentage increased 100 basis points to 40.3%. Turning to 2013 second quarter coverage. Cash flow available to pay our minimum returns and rents increased $3.4 million or 3.3% quarter-over-quarter. Coverage exceeded 1x for 4 of our 9 agreements this quarter, and coverage improved on a trailing 12-month basis from the prior quarter for 6 of our agreements this quarter. Information regarding all of our security deposit and guaranteed balances at quarter end is included in our Q2 supplemental and our Form 10-Q, which we will file tomorrow. Turning to our travel center portfolio. Property level EBITDAR this quarter at our 185 travel centers declined $12 million or 11% from the 2012 quarter. For the quarter, fuel volumes declined 5.3% and fuel gross margin declined 10.5%. TA attributed the volume decline to the continuing fuel conservation efforts by its trucking customers, as well as the decision to see certain lower margin fuel sales. The decline in fuel gross margin was due to the lower sales volume and a lower per gallon margin versus the prior year quarter due to unfavorable market conditions. The trend for nonfuel revenues and gross margin were positive, with quarter-over-quarter increases of 4.5% and 2.6%, respectively. Property level net coverage for the 2013 second quarter was 1.8x for our TA centers and 1.7x for our Petro centers. Earlier today, TA reported second quarter 2013 EBITDAR of approximately $86.6 million, an 8% decline from the 2012 quarter. Despite this decline, TA's EBITDAR coverage of cash rents and interest remained strong at 1.28x on a trailing 12-month basis. Turning to HPT's consolidated operating results for the quarter. This morning, we reported normalized FFO of $108.6 million or $0.78 per share. This compares to second quarter 2012 normalized FFO of $93 million or $0.75 per share. The 16.8% increase in normalized FFO from the 2012 quarter is due primarily to the increase in our minimum returns and rents as a result of our funding of improvements to our properties, our hotel acquisitions and the benefit of lower income tax expense. Our Marriott No. 1 portfolio converted from leased to managed at the start of 2013, and is now impacted by seasonality. 2013 second quarter results also benefited from the recovery of $3.7 million of minimum return shortfalls from the first quarter. We paid a $0.47 per share dividend in the quarter, and our normalized FFO payout ratio was approximately 61%. Adjusted EBITDA was $152.7 million in the 2013 second quarter, and our adjusted EBITDA to total fixed charges coverage ratio for the quarter improved to 3.5x. Turning to our recent capital market activities and liquidity. In June, we issued $300 million or 4.5% unsecured senior notes due 2023. Net proceeds from this offering of $297 million were used for the acquisition of the Royal Sonesta New Orleans Hotel and to fund the redemption of our Series C preferred shares on July 1. Next, I'll provide our quarterly update on where HPT stands with its capital funding commitments and liquidity at quarter end. We've agreed to fund $126.1 million from renovations to the 68 hotels in our Marriott 234 agreement. To date, we have funded $106.9 million, and we expect to fund the remaining $19.2 million later this year. We have agreed to fund up to $290 million from renovations to the 91 hotels in our InterContinental agreement. To date, we have funded $213 million, and we expect to fund an additional $63 million this year and the remaining $14 million in 2014. We have agreed to fund up to $103 million for renovations to the 22 hotels in our Wyndham agreement. To date, we have funded $27.4 million, and we expect to fund $67.1 million at the remainder of this year and the final $8.5 million over the following 2 years. We have agreed to fund up to $200 million from renovations to the 22 hotels included in our Sonesta agreement. To date, we have funded $58.5 million, and we expect to fund an additional $79 million in 2013 and the balance of approximately $62.5 million in 2014. Finally, we funded $45.2 million for improvements to our travel centers during the first 2 quarters of 2013, and we expect to fund another $35 million for improvements over the remainder of 2013. With respect to our liquidity, at quarter end, we had approximately $201 million of cash, which excludes $34.8 million of cash escrowed for improvements to our hotels. Much of the cash balance held at quarter end was in preparation for the Series C preferred redemption on July 1. Our debt-to-total book capitalization at the end of the quarter was 47.6%, and we had only $90 million drawn under our $750 million revolving credit facility. In closing, we remain optimistic about the prospect of continued strong operating results, as well as the positive impact our extensive renovation program is having on the performance of our hotels. Operator, we're ready to open it up for questions.

[Operator:]

[Operator Instructions] That will come from the line of David Loeb with Baird.

[David Loeb:]

I wanted to ask a little bit more depth about the Florham Park acquisition. You mentioned in the release that the Wyndham guaranty increased. That's about an 8% return. Is that what you expect to earn, or do you think this hotel has more potential beyond that?

[John G. Murray:]

Well, we always hope that and expected there's greater potential beyond the initial 8% yield or whatever the initial yield is on other transactions. Wyndham doesn't have a corporate headquarters hotel in Northern New Jersey today -- well, they do today, but they didn't up until we made this acquisition. And most of the room nights that they generate in the market, which is a substantial amount, have stated a variety of different hotels in Northern New Jersey. So we expect that there will be some lift to the property's performance as a result of the affiliation with Wyndham. We also expect that because the hotel was run as an independent previously and is now going to be under well-recognized brand that, that will also lead to improved performance. Finally, we're expecting to, over the next few years, to put about $10 million in renovations into the property, which, too, should improve performance. So the short answer is, we expect improve -- we expect the property's performance to improve quite a bit from where it is today as we move forward.

[David Loeb:]

Okay. On TA, the market seems particularly concerned about TA's own performance. It seems to me that your lease, the way it's structured now, your agreements with TA are pretty secured. Do you have any concerns about the credit there?

[John G. Murray:]

No, I think that we're very comfortable with how TA has been performing. I think if you listen to the call today, that they're very optimistic about their outlook. There are some unusual events this quarter because of some competitive pressures because one of their -- the chief competitor has been cited for cheating some of their customers. And so there's been a lot of press about that and a lot of questions about if TA and other truck stop operators might steal business. It's a very competitive business. Normally, it's increasingly competitive because of that chain of events that's unfolded recently. So I think this is just an aberration that's going -- I'm not sure how long it's going to last, but long-term, we are very confident about TA's potential. And I think it's important to focus on the fact that our coverages, I think around 1.8x across the 2 portfolios this quarter. So I don't think HPT investors should be concerned about the fact. And last year's quarter for TA was as very strong -- unusually strong quarter. So anyway, I don't think investors should read anything too negative into this quarter for TA.

[David Loeb:]

Okay. And then finally, Mark, you talked about the return on New Orleans for the entire property being 7.25%. Is that on the EBITDA or in the NOI? So is that basically an EBITDA yield or is that after the CapEx cost?

[John G. Murray:]

That was me, David, and that was an EBITDA number.

[David Loeb:]

That is EBITDA yield, okay. And you guys sound exactly alike, so I'm sorry about that. And then can you give a little more color on the incremental return on the land purchase? Did you say that was above or below that average?

[Mark Lawrence Kleifges:]

Sorry, can you ask that question?

[David Loeb:]

Yes. On the land purchase itself, on what you just did, was that -- what was that -- what do you expect that return to be for -- based on 2013 results? And if you can give an exact number directionally, better than that average 7.25% or less.

[Mark Lawrence Kleifges:]

I think my guess statement to be it's a better and that the average is 7.25%.

[David Loeb:]

Okay. And that's on the $120.5 million that you just put in, that's what I'm asking, as opposed to the combined purchase price of everything?

[John G. Murray:]

Honestly, I didn't look at the -- I didn't do my math that way, so...

[Mark Lawrence Kleifges:]

[indiscernible] Well, I think the leasehold is -- was about -- probably about 20% of the total purchase price, and the land about 80%. Before, we had 25% of the cash flow. So that would say that the yield on the lease was slightly higher, but not much.

[Operator:]

[Operator Instructions] Next, we'll go to the line of Wes Golladay.

[Wes Golladay:]

Looking at your Wyndham agreement, it looks like you guys had an increase of $20.5 million for the guaranty from Wyndham as a result of the acquisition. How should we view this? Can you comment on why it was such a large increase? Will it take a while for this property to stabilize with the renovation?

[Mark Lawrence Kleifges:]

It increased $6.7 million to the $35 million. Not by, not by.

[Wes Golladay:]

Okay. Got you, okay. And looking at your Extended Stay hotels, have you recaptured your typical customer there? I know you had mentioned in the past that you have to go more of a shorter-term customer during the renovation?

[John G. Murray:]

It's still a work in process. I think that in connection with prepping for the renovations, the length of stay will shorten up. And once the renovations have been completed, the -- our operators have been trying to extend out the average length of stay. In some cases, they're right spot on in their progress. In some cases, they've actually gone too far and have maybe too much what we call Tier 4, too much -- very long stays with potentially less ability to be nimble about rate. And so it's still a work in process getting to the right balance. But the performance, the RevPAR growth and margins have been very strong post-renovation and all of the Extended Stay properties. So we're very optimistic that they're going to continue to perform well.

[Wes Golladay:]

Okay. So maybe going forward, more of a rate-driven RevPAR increase is what we can expect?

[John G. Murray:]

Yes. I think that they've done a good job of ramping up their occupancy, but they're still fine-tuning the mix between the week or less and month or more and tiers in the middle. So yes, I think over time, you'll see more rate and less occupancy growth there, but continued RevPAR growth.

[Operator:]

We'll hear from the line of Jeff Donnelly.

[Jeffrey J. Donnelly:]

I'm curious, how many years do you think you can see outsized growth from the portfolio post-renovation?

[John G. Murray:]

That's a good question. We're certainly confident that it's going to be strong performance this year, strong performance next year. But I think things have to revert back towards the mean, so it won't last at this level forever because much of the gains that we're seeing are coming on the occupancy side. We're seeing rate gains also, but it's the combination of strong occupancy gains and rate that's leading to the good performance. So it won't continue at this high pace forever, I think. But I think we should expect outsized performance relative to the industry averages throughout the balance of this year and next.

[Jeffrey J. Donnelly:]

And then just a follow-up question. I'm actually curious, because you guys tend to be always in the market, or in the past, it's always been a market for kind of chunkier portfolio. There's some talk out there of somebody's larger platforms, like La Quinta and the Extended Stay America returning to the marketplace. Any interest on your part in trying to slower sort of a larger transaction there, or is that -- would you say it's off the table?

[John G. Murray:]

Well, we never comment on specific transaction activity. But historically, we've been very interested in portfolio transaction, so I think we'll continue to be interested in any portfolios that we see out there. I think Extended Stay America filed for an IPO within the last week or so, so I don't see that coming around to -- as just a sale anytime soon. But that could change, I suppose. But we're always in the market looking at opportunities and we'd like portfolios. So if we see opportunities, we'll take a look.

[Operator:]

And we will go now to the line of David Loeb.

[David Loeb:]

Just one quick follow-up. With all this investment activity, I have to ask the proverbial dividend question. Is this likely to create upward pressure on your taxable income, such that you will need to distribute more?

[Mark Lawrence Kleifges:]

No, where we sit today, we don't think that we'll be forced into raising the dividend from gains that income tax distribution department so [ph].

[Operator:]

And there are no further questions in queue. I will now turn the call back over to John Murray for closing comments.

[John G. Murray:]

Thank you very much for joining us today. Have a good rest of the day. Thanks.

[Operator:]

Thank you. Ladies and gentlemen, that concludes your conference today. We appreciate your participation and your using AT&T Executive Teleconference. And you may now disconnect.