Business context and reporting period
Sunstone Hotel Investors, Inc. (a REIT) owns, asset-manages and renovates hotels leased to its taxable REIT subsidiary and managed by third parties. This unaudited Form 10-Q covers the quarter and six months ended June 30, 2016. At quarter-end, the company held interests in 28 hotels; its comparable portfolio comprised 27 hotels.
Financial performance and position
Amounts below are in millions of dollars unless otherwise noted. Comparisons are with the corresponding 2015 period.
| Metric | Q2 2016 | Q2 2015 | First half 2016 | First half 2015 |
|---|---|---|---|---|
| Revenue | $322.2 | $339.3 | $596.5 | $623.7 |
| Operating income | $63.4 | $69.4 | $84.5 | $87.0 |
| Net income | $65.7 | $53.7 | $67.0 | $54.9 |
| Income attributable to common stockholders | $57.3 | $48.9 | $54.1 | $45.6 |
| Reported diluted EPS | $0.26 | $0.23 | $0.25 | $0.22 |
| Operating margin | 19.7% | 20.4% | 14.2% | 14.0% |
| Adjusted EBITDA | $101.1 | $110.4 | $163.0 | $176.1 |
| Adjusted FFO attributable to common stockholders | $83.2 | $89.6 | $127.4 | $134.6 |
Operating cash flow was $149.2 million for the first half, versus $137.4 million a year earlier. Investing activities used $63.2 million, including $100.0 million of hotel renovations and additions; financing activities used $230.3 million. Cash and cash equivalents were $354.7 million at June 30, with a further $62.3 million of restricted cash.
Debt totaled $1.008 billion at quarter-end, down from $1.101 billion at year-end 2015. The filing reports $252.9 million of principal due within one year. About 77.8% of debt was fixed-rate or swapped to fixed rates; weighted-average interest rate was 4.3%, and weighted-average debt maturity was approximately four years. A 100-basis-point change in variable rates was estimated to affect future earnings and cash flow by about $1.6 million after the Hilton San Diego Bayfront noncontrolling interest.
Comparable-portfolio RevPAR increased 1.3% in Q2 and 1.3% for the first half. Q2 occupancy was 87.1% and ADR was $206.26 for the comparable portfolio. The company declared common distributions of $0.05 per share in Q2 ($0.10 for the first half).
Material changes versus prior periods
- Reported Q2 revenue fell 5.0%, and first-half revenue fell 4.4%. The declines primarily reflect hotel dispositions and the September 2015 sale of BuyEfficient; revenue at the existing hotel portfolio increased in both periods.
- Q2 net income rose 22.5%, but included an $18.2 million gain on the Sheraton Cerritos sale. Common-stockholder income also benefited from lower noncontrolling-interest income, while preferred dividends and a redemption charge increased.
- Adjusted EBITDA declined $9.3 million in Q2 and $13.1 million in the first half; Adjusted FFO declined $6.4 million and $7.2 million, respectively. Management cited asset sales, weaker Chicago conditions, renovation disruption at Boston Park Plaza and Wailea Beach Marriott, and higher costs at San Diego hotels.
- First-half interest expense rose 3.7% despite lower debt-related interest costs, largely because derivative losses increased to $9.2 million from $0.01 million in the prior-year period.
- The company issued $115.0 million of 6.95% Series E preferred stock and $75.0 million of 6.45% Series F preferred stock, and redeemed $115.0 million of 8.0% Series D preferred stock. The Series D redemption generated a $4.1 million charge to common stockholders.
- Debt actions included drawing a $100.0 million unsecured term loan, repaying the $114.2 million Boston Park Plaza loan and repaying $72.6 million of Renaissance Orlando at SeaWorld debt. The company sold the Sheraton Cerritos for net proceeds of $41.2 million and purchased Renaissance Harborplace air rights for $2.4 million.
Outlook, commentary, risks and contingencies
The filing provides no specific earnings or RevPAR guidance. Management described the lodging cycle as mature/late-stage, with demand improving but at a moderating pace. Its stated priorities are focused asset management, disciplined capital recycling, selective acquisitions and dispositions, and maintaining low leverage and balance-sheet flexibility. Management expects U.S. hotel supply to increase, with above-average new openings in markets including New York City, Washington, D.C. and Chicago.
Renovations at Boston Park Plaza and Wailea Beach Marriott displaced an estimated $2.5 million of room revenue in Q2 and $3.3 million in the first half. The company invested $100.0 million in capital improvements during the first half and had $77.5 million of remaining construction commitments at June 30. Six of its 28 hotels were subject to ground, building or air leases. Other risks identified include hotel demand and competition, operating-cost inflation, brand and manager relationships, renovation impacts, debt and covenant obligations, interest rates, REIT qualification, cyber risks, and geographic concentration.
The company disclosed customary environmental indemnities without a stated term or damages cap, $0.6 million of letters of credit for workers’ compensation obligations, and routine legal matters; management did not expect aggregate uninsured legal liabilities to materially affect financial condition or results. No hotel-property impairment indicators were identified for the periods reported. Disclosure controls were deemed effective, and the filing reported no material change in internal control over financial reporting.
Important facts for investors to verify
- How much of the reported earnings increase depends on the Sheraton Cerritos gain, and how comparable operating results trend excluding dispositions and other adjustments.
- Whether RevPAR growth and hotel-level cost control can offset weaker markets, renovation disruption and expense inflation; review the decline in Adjusted EBITDA and Adjusted FFO.
- The timing and funding plan for the $252.9 million of principal shown due within one year, alongside $77.5 million of construction commitments and planned capital spending.
- The future cost and terms of preferred stock, including dividend obligations, relative to common-stockholder returns and liquidity.
- Exposure to derivative valuation changes and variable-rate debt, plus the impact of hotel concentration, new supply and lease obligations.