Service Properties Trust
Q3 2014 Earnings Call Transcript

Published: 4 Nov 2014

[Operator:]

Good day, everyone, and welcome to the Hospitality Properties Trust Third Quarter Financial Results Conference Call. This call is being recorded. I would like to turn the call over to the Vice President of Investor Relations, Tim Bonang, for opening remarks and introductions. Please go ahead.

[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, November 4, 2014. 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 on our supplemental package found in the Investor Relations section of the company's website. Actual results may differ materially from those projected in these 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 found in our website at www.hptreit.com. Investors are cautioned not to place undue reliance upon any forward-looking statements. Before I turn the call over to John and Mark, you should be aware that TravelCenters of America's third quarter 2014 report on Form 10-Q will not be filed until later this month. And accordingly, the company's remarks today with respect to TA's operating results will be limited to the results through June 30, 2014, and we will not respond to questions related to TA's third quarter 2014 performance. Now I'd like to turn the call over to John Murray.

[John G. Murray:]

Thank you, Tim. Good afternoon, and welcome to our third quarter 2014 earnings call. Today, HPT reported third quarter normalized FFO of $0.86 per share as we continue to reap the benefits of the extensive hotel renovation program that began in 2011. As Tim noted, we are not yet able to update you on TA's performance for the third quarter of 2014 because TA has not yet reported their results for this quarter. The second quarter was strong for HPT's TA sites, with increased per gallon fuel margins more than offsetting lower fuel volumes sold. Nonfuel margins and operating expenses were up modestly. As a result, property level EBITDA increased 3%, and TA's coverage of our rents in the second quarter of 2014 was 1.79x, up from the 2000 second quarter despite higher rent in 2014. The third quarter is generally a seasonally good one for TA, so we are expecting their solid performance to continue. Turning to HPT's hotel investments. Third quarter RevPAR was up 11.8% across HPT's 289 comparable hotels. Our hotel renovation program continues to impact our results, primarily in a positive way. Excluding noncomparable hotels and the 21 hotels under renovation during the quarter, RevPAR was up 12.9% this quarter. The strong top line performance, which was comprised of both occupancy and rate gains, reflects strong results at the 61 hotels that completed renovations during 2013 with RevPAR gains of 20.3% and 120 hotels that completed renovations during 2012 with RevPAR gains of 11.9%. These seasonally offset performance at our 16 hotels under renovation this quarter, which experienced RevPAR declines of 3.8%, all from lost occupancy. Our portfolios comprised principally of hotels catering to business travel, and business trends in travel continues to be the driver of our growth. However, this quarter, we saw increased group business as a result of many of our full service hotels having completed renovations and increased leisure business as our hotels have done a better job selling in weekend nights. Improving group trends generally have led to increased compression, which has benefited our near urban select service hotels. 15 of the 16 comparable hotels under renovation this quarter were Sonesta-branded hotels. We have now completed 8 Sonesta renovations, each of which has been well-received in its market. For the quarter, the Sonesta portfolio revenue was up $6.6 million or approximately 13% versus third quarter 2013. And hotel level EBITDA was up $4.8 million, representing 73% flow-through. However, with 15 hotels in the portfolio impacted by renovations this quarter, there's still a lot of noise in the portfolio's results. Sonesta continues to make steady progress but still has a way to go before their performance is where we or they want it. We are hopeful that the current renovation program, coupled with Sonesta's efforts to increase brand awareness, will lead to continued meaningful occupancy and rate gains in the fourth quarter of 2014 and in 2015. The third quarter continued the positive momentum we have developed over the past several quarters. The strong RevPAR performance was broad-based. Our Wyndham portfolio had a very strong quarter, with RevPAR growth of 33% and GOP margin percentage up 10.5 percentage points versus third quarter 2013, as management's focus has shifted from completing renovations to driving performance. We expect strong results to continue for this portfolio. Improving group dynamics will also benefit the Wyndham portfolio's full service hotels. While the hotels renovated during 2013 had the most significant positive impact on third quarter 2014 performance as they ramp back up, we are encouraged that our hotels renovated in earlier periods continued to experience above market level growth as well. For example, excluding the 55 hotels renovated since the third quarter of 2013, the remaining 234 hotels grew RevPAR 11.1% and improved GOP margin percentage by 220 basis points to 43%. Also, our comparable non-renovation portfolio's strong performance continues to be balanced across property types. RevPAR and gross profit margin percentage among our comparable non-renovation full service hotels were up 15.2% and 600 basis points. Our select service hotels were up 10.3% and 170 basis points. And our extended stay hotels were up 13.2% and 210 basis points, respectively, this quarter. While our extensive portfolio renovation program is nearly complete, we expect 17 hotels will be under renovation during the fourth quarter and 7 in 2015. This renovation activity will be principally at our Sonesta hotels. Of course, when you own 291 hotels, there is a constant renovation process which recurs on the cycle. There will be other hotels renovated in 2015 using FF&E reserves, but the numbers I have just stated summarize the final stages of the full renovation of our Marriott, IHG, Wyndham and Sonesta-branded hotels. Looking forward, our operators are optimistic about the balance of 2014 as high occupancies and continued steady demand enables strong rate growth. With 3 quarters now complete, our operators are forecasting full year RevPAR growth of 9% to 10% and GOP margin percentage improvement of 225 to 250 basis points versus 2013. We are currently in the midst of the 2015 budgeting process, and it's too early to say exactly where our managers are going to forecast RevPAR growth and margin improvement for 2015. As industry consultants like Smith Travel, PwC and PKF are projecting 5% to 7% RevPAR growth, I expect our managers will be targeting their guidance in the 6% to 7% range. If the past 8 quarters are a guide, our portfolio will be near the high end of that range or above it. Turning to disposition and acquisition activity. We continue to see a healthy pipeline of hotel acquisition opportunities. However, competition is substantial, especially in large cities along the coast. The debt markets are very liquid for hotel financing, reminiscent of 2007, in some cases. We are seeing buyers able to get up to 80% to 85% leverage, with mezzanine loans and the cost of mezzanine financing is in historically low levels. We intend to remain disciplined. We remain optimistic about the lodging cycle due to steady demand as economic growth continues. We expect continued rate growth and GOP margin improvement, particularly with a nearly fully renovated hotel portfolio. We are monitoring supply growth, which is back near historic run rates but not yet a headwind. As our portfolio performance continues to improve, more contracts reach or exceed 1x coverage and our renovation capitals needs subside, there should be more confidence to increase our dividend as we did most recently in April 2014. I will now turn the call over to Mark.

[Mark Lawrence Kleifges:]

Thanks, John. Operating results at our 289 comparable hotels were strong this quarter, with RevPAR up 11.8% and a 320-basis-point increase in GOP margin percentage. Hotel renovations continued to have an impact on hotel operations this quarter. RevPAR at our 273 comparable hotels not under renovation this quarter was up 12.9% versus the prior year quarter out of 4.4-percentage-point increase in occupancy and ADR growth of 6.7%. This quarter's results benefited from the RevPAR outperformance of the 8 hotels that were under renovation during the 2013 third quarter, with RevPAR up almost 34% at these hotels on occupancy and ADR gains of 13.2 points and 10.2%, respectively, in the current quarter. This strong performance was partially offset by the weak results of the 16 hotels under renovation this quarter, with RevPAR down 3.8% at these hotels on lower occupancy. Our portfolios with the highest RevPAR growth this quarter were our Wyndham, Carlson and IHG portfolios, with increases of 33%, 13.6% and 12.1%, respectively, versus the prior year quarter. Growth in hotel profitability was also strong this quarter, with gross operating profit for our 289 comparable hotels up $29.8 million or 21.3% from the 2013 quarter and GOP margin percentage up 320 basis points to 40.6%. Our InterContinental portfolio had another strong quarter, with gross operating profit up almost 18% and GOP margin percentage up 210 basis points versus the 2013 quarter. Hotel cash flow available to pay our minimum returns and rents this quarter increased $21.3 million or 21.2% from the 2013 quarter. As a result of this growth, coverage for the quarter under 8 of our 9 agreements improved versus the prior year quarter, and portfolio-wide coverage for our hotels increased to 1.06x compared to 0.91x in the 2013 quarter. Importantly, 6 of our 9 hotel agreements, which account for 78% of our total hotel minimum returns and rents, had coverage above 1x for the 2014 third quarter. Turning to HPT's consolidated operating results for the third quarter. This morning, we reported normalized FFO of $129.2 million compared to normalized FFO of $106.6 million in the 2013 third quarter. The 21% increase in normalized FFO from the 2013 quarter is due primarily to the $11.2 million or 7% increase in minimum returns and rents earned this quarter, a $6.4 million increase in hotel manager FF&E reserve contributions and the $3.7 million decrease in interest expense as a result of our recent debt refinancings. On a per share basis, third quarter 2014 normalized FFO was $0.86, a 13.2% increase from the 2013 third quarter. We paid a $0.49 per share common dividend in the quarter, and our normalized FFO payout ratio was only 57%. Adjusted EBITDA was $170.5 million in the 2014 third quarter, a 12.4% increase from the 2013 quarter. Our adjusted EBITDA to total fixed charges coverage ratio for the quarter remained strong at 4.3x, and debt to adjusted EBITDA was only 4.2x at quarter end. In July, we redeemed at par our $280 million of 5 1/8% senior notes due in 2015. And in September, we issued $350 million of 4.5% on secured senior notes due in March 2025. Turning to our capital commitments and liquidity at quarter end. We funded approximately $45 million of hotel improvements in the third quarter. To complete our hotel renovation program, we expect to make additional fundings of $41 million in the fourth quarter and another $41 million in 2015. In addition to our hotel renovation fundings, we funded $20 million of improvements to our TravelCenters this quarter and expect to fund up to an additional $28 million in the fourth quarter. With respect to our balance sheet and liquidity, at September 30, we had approximately $19.1 million of cash, which excludes $30.6 million of cash escrowed for improvements to our hotels, and we had only $15 million outstanding under our $750 million revolving credit facility. Our debt to total booked capitalization at the end of the quarter was 48.6%. Operator, that concludes our prepared remarks. We're ready to open it up for questions.

[Operator:]

[Operator Instructions] And we'll go to the line of Bryan Maher with Craig-Hallum.

[Bryan A. Maher:]

The -- can you give us a little bit more color on the acquisition front? I mean, you guys have a big portfolio. You have significant access to capital to invest. I heard what you said about the coast being expensive. We're starting to hear that more and more from the other lodging companies we cover. And then after that, could you address what your thoughts are on the TA properties possibly acquiring some of them as some of the earlier acquisitions approach stabilization?

[John G. Murray:]

Okay. Well, as I'm sure you've seen in the market over the first few quarters of this year and last year, there've been a reasonable number of one-off full service hotels that have traded, and there've been several, a handful anyway, of portfolios of select service assets that have traded. HPT thus far this year has bought 1 hotel on the beach in Fort Lauderdale. We've bid on a number of individual hotels, but we were only the successful bidder on that one. We've looked at -- we've done the underwriting on a number of the other portfolios and -- as well as other one-off assets. And in many cases, we've opted not to bid because we thought the pricing was too aggressive for the types of assets or the types of transaction structures that were at play. And so we've been continuing to see strong growth from our existing portfolio, and we've been -- if we invest $100 million in renovating our existing hotels, which we think are a good brands and good locations, we get the same return as we would if we invested -- oftentimes a higher return than if we invested in the portfolios that are available in the market today. So we've been content to remain disciplined, focusing on reinvesting in our existing properties and reaping the rewards of that and letting other people get overly aggressive. We just -- we're just not comfortable with where some of the pricing is. So we're continuing, we're very actively looking at several transactions currently, and they include 1 and 2 one-off-type assets as well as a large portfolio. So we remain very active, but we're not going to buy hotels just so we could tell people we bought hotels. We want to do it in a way where we're comfortable that we're going to get satisfactory returns for our shareholders. In terms of the second part of your question related to TA, we've been very happy with the performance of our TravelCenters. We know that not everybody likes the multiple types of property types in our holdings, but we have had good performance from our TravelCenters. And TA has been buying -- as you know, TA has been buying sites where they could build out the offerings, adding truck service and more expansive restaurant capabilities. And so many of the TravelCenters that they purchased were turnaround and picks-up-type properties. And as those mature, then I think HPT is not against investing in more TravelCenters. We haven't -- thus far, we haven't gotten a request from TA to do so, but we would certainly consider if they asked us.

[Bryan A. Maher:]

That's good to hear that they had that option. One last thing. On -- we listened to Marriott and Hyatt and Hilton and Starwood talk about their development pipeline. It seems like everybody's bragging that they have more than the next guy. So we know that this supply is kind of building. Have you guys talked to or thought about teaming with any of the developers of those properties, whereby not taking on a development risk but having kind of the option to buy those properties once they're open and stabilized? Or is that something you don't want to pursue?

[John G. Murray:]

We are aware that all of the large brand companies are expanding, and they're doing so by having their franchisees develop hotels. And in many cases, some of the larger brands are establishing their own programs to build out hotels. And we've been asked in a number of situations to make proposals for development programs where we might build out 10, 20 or more properties where we provide take-out financing as the hotels were open with a certificate of occupancy. We've been evaluating that type of transaction, but we are not currently in the midst of discussions on anything like that at the current time. We're monitoring the cycle and having yet gotten comfortable with the idea of doing that.

[Operator:]

[Operator Instructions] And we'll go to Ryan Meliker with MLV & Co.

[Ryan Meliker:]

Just one question I had for you. And I guess similar with Bryan was just asking with regards to opportunities for growth. It seems like the renovation program is winding down now and you're going to have incremental capital that you might be able to put to work through other means or in the future, paying out the dividend and raising the dividend or through other growth orientations. I'm just trying to think about how you guys are thinking about growth of the acquisition. One thought that came to mind in a recent meeting with an investor is what about the idea of -- or how would you approach the idea, I guess, of helping your affiliate acquire a portfolio with a brand? If your affiliate were to take the brand, you guys took the portfolio, the thought being that it might improve the overall brand reputation of Sonesta, which could then overall drive stronger RevPAR at your existing owned asset, even though the costs of the portfolio may come in higher than you might be willing to pay, but all in all, it ends up driving value for your company. Are you looking at opportunities like that, that might create long value for your company even if the specific acquisitions aren't what's driving that value?

[John G. Murray:]

We are not looking at any brand acquisitions for Sonesta. I would say that -- just to make sure we're all on the same page, we think Sonesta has a very good reputation. They don't have enough awareness, and they're working on building the awareness and -- but we think that a lot of that responsibility for building awareness is Sonesta's, and it's not for HPT to go around buying multiple brands to make that company's awareness grow faster. If we see the right opportunity, sure, we would consider it, just as we would consider it if we were approached by other brands regarding a large brand transaction. We've considered some in -- over the past couple of years. There were some private equity transactions that -- where brands were being spun off, and we were not together with other brand families. We're not able to get to the right pricing for the sellers, so it didn't happen. But we are -- we're the second largest lodging REIT. If there's a brand out there that puts itself on the market, we are one of the logical buyers to consider that type of a transaction as long as there's real estate involved. And so we're regularly in the mix if -- when there's a transaction like that, but we are not considering anything like that for Sonesta at this time.

[Ryan Meliker:]

Okay, that's helpful. And then the second question I had with regards to growth is just, obviously, assets are increasing value, cap rates are coming down, it's getting harder to find the right deals, as you guys point out. Have you looked at potentially doing any type of mezz lending program, where you might have the option to take out the developer once the asset is stabilized?

[John G. Murray:]

No. We've not considered lending of any type, whether it's first mortgage or mezzanine. We've just been focused on acquiring assets. And I think that, that's how we'll keep it.

[Operator:]

And to the presenters on the call, no further questions.

[John G. Murray:]

Well, thank you very much for joining us today. We look forward to hopefully seeing many of you at NAREIT in the next couple of days. Thank you.

[Operator:]

Ladies and gentlemen, that does conclude your conference for today. Thank you for your participation. You may now disconnect.