Service Properties Trust (filed as Hospitality Properties Trust): Q2 2018 Form 10-Q
Reporting period: Quarter and six months ended June 30, 2018. The filing identifies the registrant as Hospitality Properties Trust (HPT). Unless stated otherwise, amounts below are in millions of dollars.
Business context and financial results
HPT was a REIT owning 325 hotels and 199 travel centers at quarter-end. Most hotels were operated by third-party managers through HPT subsidiaries; all travel centers were leased to TravelCenters of America (TA). HPT reported hotel operating revenue and rental income from leased properties.
| Metric | Q2 2018 | Q2 2017 | Six months 2018 | Six months 2017 |
|---|---|---|---|---|
| Total revenue | $612.0 | $570.6 | $1,140.6 | $1,059.2 |
| Operating income | $125.1 | $105.6 | $227.4 | $185.6 |
| Net income | $97.3 | $60.7 | $177.5 | $97.9 |
| Net income available to common shareholders per share | $0.59 | $0.37 | $1.08 | $0.53 |
| FFO per diluted share | $1.20 | $0.95 | $2.29 | $1.68 |
| Normalized FFO per diluted share | $1.07 | $1.06 | $2.02 | $1.96 |
Q2 operating margin was approximately 20.4%, versus 18.5% a year earlier; first-half operating margin was approximately 19.9%, versus 17.5%. These are calculated from reported revenue and operating income. The reported net income increase also reflects unrealized gains on equity securities of $20.9 million in Q2 and $45.9 million year to date, recorded in earnings under newly adopted accounting guidance.
- Q2 hotel operating revenue rose 8.3%; first-half revenue rose 8.6%. Acquisitions contributed materially, alongside some improvement in hotel revenue.
- Hotel operating expenses increased 10.2% in Q2 and 10.7% in the first half, faster than revenue, reflecting acquisitions, labor and other operating costs, and replenishment of hotel guarantees and security deposits.
- General and administrative expense declined substantially year over year because no 2018 business-management incentive fee was accrued for the periods shown; 2017 expenses included estimated incentive fees.
- Normalized FFO per share was nearly flat in Q2 and increased 3.1% for the first half. Normalized FFO excludes unrealized equity-security gains and certain other items; it is a non-GAAP measure, not cash flow.
Cash flow, debt and liquidity
- First-half operating cash flow was $263.4 million, down from $291.1 million. Investing used $200.1 million, compared with $459.8 million, primarily reflecting lower acquisition spending. Financing used $70.9 million, versus $205.9 million provided in the prior-year period.
- Cash and cash equivalents were $16.5 million at June 30; restricted cash was $73.3 million. First-half common distributions paid were $172.6 million. The May 2018 quarterly distribution was $0.53 per share; a further $0.53 distribution was declared in July.
- Debt principal outstanding was approximately $4.172 billion: $122 million under the revolver, a $400 million term loan, and $3.650 billion of senior notes. Balance-sheet carrying amounts were lower due to discounts, premiums and issuance costs. Total liabilities were $4.465 billion.
- At June 30, $878 million remained available under the $1.0 billion revolving credit facility. The May amendment extended revolver maturity to July 2022 and term-loan maturity to July 2023, and reduced the applicable LIBOR spreads. HPT reported covenant compliance.
- In February, HPT issued $400 million of 4.375% notes due 2030; net proceeds were $386.4 million. Fixed-rate senior notes had no scheduled principal payments before maturity; maturities range from 2021 to 2030.
Material changes, outlook and risks
- All-hotel Q2 ADR rose 2.4% to $132.78, but occupancy fell 2.0 percentage points to 78.0% and RevPAR declined 0.1% to $103.57. For the first half, ADR rose 2.2%, occupancy declined 1.4 points and RevPAR increased 0.3%. HPT said comparable-hotel RevPAR growth lagged the industry, citing renovation disruption, new room supply in some markets and lower business activity in certain areas.
- Two hotels were acquired in June for approximately $91.5 million in total. HPT also terminated its Morgans lease for The Clift Hotel, took back the property and added it to its Sonesta management portfolio.
- Management said available operating sources and the revolver were expected to fund operations, debt service, capital spending and distributions for the next 12 months and foreseeable future. This is conditional on managers and tenants continuing to meet obligations; no earnings or FFO guidance was provided.
- HPT expected about $145.4 million of hotel renovation and improvement spending in the second half of 2018 and $143.6 million in 2019, plus approximately $22.8 million of potential 2018 travel-center improvements for TA. Renovation costs, disruption and returns on funded improvements may differ from expectations.
- Hotel minimum-return coverage for the trailing 12 months was below 1.0x under Sonesta and Wyndham agreements (0.71x and 0.79x). Wyndham’s guarantee was depleted; it paid 85% of minimum returns in the period, but HPT cautioned that future payments are uncertain. HPT has no guarantee or security deposit for minimum returns under its Marriott No. 1 or Sonesta agreements.
- TA was HPT’s largest tenant and leased all travel centers; HPT also held approximately 8.6% of TA’s shares. HPT disclosed related-party relationships involving TA, Sonesta, its manager RMR LLC and others. The filing warns that conflicts, operator performance, economic conditions, competition, interest rates, capital-market access and REIT qualification could affect cash flows and distributions.
- Marriott had notified HPT it would not renew the lease for the Kauai hotel when it expires December 31, 2019; discussions about the property’s future had begun. HPT said the outcome and resulting cash flows were uncertain.
Important facts for investors to verify
- Whether hotel occupancy, comparable-hotel RevPAR and coverage improve, particularly at Sonesta- and Wyndham-managed properties.
- Whether managers and tenants pay contractual returns and rents in cash, and the remaining capacity and duration of guarantees and security deposits.
- Actual renovation and travel-center capital spending, property disruption, and whether resulting operating gains support the higher contractual returns or rents.
- Debt refinancing costs and sensitivity to floating rates: HPT estimated that a 1 percentage-point rate increase would raise annual floating-rate interest expense by about $5.2 million at then-current borrowings.
- The effect of the Kauai lease ending in 2019 and the treatment of TA deferred rent obligations under the applicable lease terms.
- How much reported earnings growth reflects recurring property operations versus fair-value gains; compare GAAP income with FFO, Normalized FFO and operating cash flow.