Business Context and Reporting Period
Company: Sunstone Hotel Investors, Inc. (Sunstone)
Filing Type: Form 10-K (Annual Report)
Period Ended: December 31, 2006
Business Overview: Sunstone is a Maryland corporation operating as a Real Estate Investment Trust (REIT). It owns, acquires, and renovates primarily luxury, upper upscale, and upscale full-service hotels in the United States. As of December 31, 2006, the portfolio consisted of 49 hotels with 15,758 rooms located in 13 states and Washington, D.C. The company utilizes a Taxable REIT Subsidiary (TRS) structure to lease properties to third-party managers, including Sunstone Hotel Properties, Inc. (a division of Interstate Hotels & Resorts), Marriott, Hyatt, Hilton, Fairmont, and Starwood.
Key Financial Metrics
| Metric | 2006 | 2005 |
|---|---|---|
| Total Revenues | $903.1 million | $586.5 million |
| Operating Income | $134.5 million | $79.7 million |
| Net Income | $53.2 million | $30.2 million |
| Income Available to Common Stockholders | $33.6 million | $19.2 million |
| Diluted EPS (Common) | $0.58 | $0.47 |
| Cash Flow from Operating Activities | $163.1 million | $113.4 million |
| Total Debt (Notes Payable) | $1,499.8 million | $1,181.2 million |
| Total Assets | $2,760.4 million | $2,249.2 million |
| Stockholders' Equity | $1,037.8 million | $859.9 million |
Operating Statistics (2006 vs. 2005):
- Occupancy: 74.4% (vs. 73.4%)
- Average Daily Rate (ADR): $141.28 (vs. $131.70)
- Revenue Per Available Room (RevPAR): $105.11 (vs. $96.67)
Material Changes vs. Prior Period
- Revenue Growth: Total revenues increased 54.0% to $903.1 million, driven primarily by the acquisition of 13 hotels since January 1, 2005, which contributed approximately $287.5 million in combined revenue. Organic growth in the existing portfolio also contributed to increases in room, food and beverage, and other operating revenues.
- Expense Increases: Total operating expenses rose 51.7% to $768.5 million. Interest expense increased 69.9% to $96.1 million due to higher outstanding loan balances financing acquisitions and a $10.0 million loss on early extinguishment of debt related to refinancing activities.
- Portfolio Activity: The company acquired four hotels in 2006 (W Hotel San Diego, Embassy Suites La Jolla, Hilton Times Square, Del Mar Marriott) for approximately $522.2 million. Conversely, it sold 15 hotels in 2006, generating net proceeds of $157.7 million. These dispositions are reported as discontinued operations.
- Performance Guarantee: A significant portion of "Other operating revenue" in 2006 ($17.4 million) was derived from a performance guarantee provided by Hyatt Corporation for the Hyatt Regency Century Plaza. The company expects to fully utilize the remaining $2.8 million of this $27.0 million guarantee in 2007, which may result in lower other operating revenues in future periods.
Guidance, Outlook, and Risks
Outlook and Capital Strategy:
Sunstone expects to continue its strategy of selective acquisitions, capital redeployment, and opportunistic hotel redevelopment. The company anticipates capital expenditures of approximately $120.0 million to $130.0 million for the twelve months following December 31, 2006, funded by operating cash flow and reserve accounts. Management believes its capital structure, including a $200.0 million revolving credit facility (with $188.4 million available as of year-end) and cash flow from operations, provides sufficient liquidity for the foreseeable future.
Key Risks and Contingencies:
- Debt and Refinancing: With approximately $1.5 billion in outstanding debt, the company faces risks related to refinancing on favorable terms. A majority of debt is secured by first deeds of trust, and defaults could lead to foreclosure. The company has no variable rate debt as of year-end, mitigating interest rate risk.
- Geographic Concentration: Approximately 37.7% of 2006 revenues were generated from hotels in California. Economic downturns or natural disasters in this region could disproportionately harm results.
- Franchise and Management Agreements: The company relies on third-party managers and franchisors. Termination of franchise agreements or failure to meet Property Improvement Plans (PIPs) could lead to loss of brand affiliation and potential default on debt covenants.
- REIT Status: Failure to qualify as a REIT would subject the company to corporate-level taxation, significantly reducing cash available for distributions.
- Legal Proceedings: A settlement of $537,500 was reached regarding a Legionella bacteria lawsuit; the company expects this to be covered by insurance.
Investor Verification Checklist
- Debt Maturities: Verify the schedule of debt maturities, noting that $23.2 million is due within one year and significant portions mature in 2010 and 2011.
- Performance Guarantee Utilization: Confirm the impact of the full utilization of the Hyatt Regency Century Plaza performance guarantee in 2007 on future "Other operating revenue."
- Capital Expenditure Budget: Monitor actual capital expenditures against the $120-$130 million budget for 2007 to ensure liquidity is not strained.
- Refinancing Terms: Track the terms of refinancing for the $1.5 billion debt portfolio, particularly given the fixed-rate nature of current debt and the potential for higher rates upon maturity.
- Discontinued Operations: Review the impact of the 15 hotel dispositions on future cash flows and the classification of these assets as discontinued operations.
- California Exposure: Assess the economic health of the California market, which accounts for nearly 38% of revenue and 45% of the hotel count.