Service Properties Trust (Nasdaq: SVC) — Q3 2020 Form 10-Q
Reporting period: Three and nine months ended September 30, 2020. Unaudited results; dollar amounts below are USD millions unless stated otherwise. SVC is a REIT invested in hotels and net-lease service-oriented retail properties. At quarter-end it owned 329 hotels and 804 net-lease properties.
Financial performance and position
| Metric | Q3 2020 | Q3 2019 | Nine months 2020 | Nine months 2019 |
|---|---|---|---|---|
| Total revenue | $296.5 | $599.8 | $995.2 | $1,735.2 |
| Net income (loss) | $(102.6) | $40.1 | $(173.6) | $274.6 |
| Net income (loss) per share | $(0.62) | $0.24 | $(1.06) | $1.67 |
| Operating cash flow | Not separately reported for quarter | Not separately reported for quarter | $65.5 | $432.5 |
| FFO per share | $0.14 | $0.90 | $1.61 | $2.80 |
| Normalized FFO per share | $0.14 | $0.95 | $1.37 | $2.85 |
Revenue and margins: Q3 hotel operating revenue fell 62.0% to $199.7 million; rental income rose 31.5% to $96.8 million, primarily reflecting properties acquired in the 2019 SMTA transaction. Nine-month hotel operating revenue declined 54.0%, while rental income increased 39.9%. Net margin, calculated as net income (loss) divided by revenue, was approximately (34.6)% in Q3 2020 versus 6.7% in Q3 2019, and (17.4)% for the first nine months versus 15.8% a year earlier.
Unusual items: Nine-month results included a $62.4 million insurance settlement gain related to the San Juan hotel, a $55.5 million asset impairment loss, a $9.7 million loss on real estate sales, and a $7.0 million debt-extinguishment loss. The insurance gain also resulted in a $15.7 million deferred tax liability. Q3 impairment expense was $10.2 million.
Cash, debt and liquidity: At September 30, cash and cash equivalents were $47.8 million and restricted cash was $38.1 million. Nine-month operating cash flow was $65.5 million; cash, including restricted cash, increased to $86.0 million from $81.3 million. At quarter-end, debt principal comprised $5.8 billion of senior notes, a $400 million term loan and $80.1 million drawn on the $1.0 billion revolver. Debt carrying value was approximately $6.2 billion. The company issued $800 million of 7.50% notes due 2025 and repurchased $350 million principal amount of 4.25% notes due 2021. On November 5, it repaid the term loan using the revolver; on November 6, revolver borrowings were $475.6 million, with $524.4 million available, subject to a $125 million minimum-liquidity requirement.
At September 30, the senior-note debt-service coverage ratio was 2.05x, above the 1.50x covenant minimum; management expected it could fall below the threshold in Q1 2021, restricting additional debt issuance. A November 5 credit amendment waived existing financial covenants through the revolving facility’s July 15, 2022 term, while retaining liquidity and other restrictions. The amendment increased the revolver spread, required additional collateral—including first mortgage liens on 74 properties—and generally directs asset-sale and financing proceeds to debt repayment. Management stated that available liquidity, net-lease cash flows and completed or expected asset sales should cover obligations for at least 12 months; this is a forward-looking assessment.
Material changes and portfolio indicators
- Hotels: All-hotel Q3 occupancy was 43.6%, down 33.4 percentage points year over year; ADR fell 30.0% to $89.88 and RevPAR fell 60.3% to $39.19. Nine-month RevPAR fell 54.2%. Nineteen hotels suspended operations during the spring; 17 had reopened by November 6.
- Hotel operator defaults and transitions: IHG defaulted, and SVC used its $75.7 million security deposit. Marriott did not fund required shortfalls after its $33.4 million deposit and $30 million limited guaranty were exhausted. SVC issued termination notices to both and planned to transition most affected hotels to Sonesta, subject to sales and transition arrangements. These transitions may disrupt operations and require capital spending.
- Sonesta exposure: SVC held an approximately 34% interest in Sonesta, which managed 56 hotels at quarter-end. SVC expected Sonesta to operate 257 of its 329 hotels after planned transitions. Sonesta arrangements have no security deposit or guarantee; hotel cash flows may not support stated minimum returns.
- Net lease portfolio: The portfolio was 98% occupied, with $369.8 million of annual minimum rent and an 11-year weighted average remaining lease term. Reported rent coverage was 2.12x. TA leased 179 travel centers and represented 25.6% of SVC’s total annual minimum returns and rents. TA was current on rent as of early November. SVC collected 87.2% of Q3 rents from other net-lease tenants and 87.4% of October rents; it had deferred $13.4 million for 51 tenants.
- Distributions and investment: The quarterly common-share distribution fell from $0.54 to $0.01 beginning in Q2, reducing quarterly cash distributions by about $87.2 million. SVC expected the reduced rate to continue, subject to REIT requirements and financing restrictions. Investment and capital spending were curtailed and prioritized toward maintenance, work in progress and contractual obligations.
Outlook, risks and contingencies
Management cited the pandemic’s uncertain duration and economic effects as significant risks to hotel demand, tenant operations, rent and return collection, property values, cash flow and access to capital. It warned that operators and tenants may seek further relief or default, and that guarantees and deposits may be exhausted. SVC’s hotel operating agreements had aggregate coverage of (0.04)x for the quarter, versus 0.90x a year earlier, highlighting the gap between hotel-level cash generation and minimum returns. Net-lease rent coverage relies partly on tenant information that may be unaudited or estimated.
SVC had agreements to sell 39 hotels for a stated aggregate price of $218.0 million and one net-lease property for $0.8 million; completion was expected in Q4 2020 but remained subject to conditions and could be delayed or fail. Related-party relationships—including with manager RMR, tenant TA and hotel manager/investee Sonesta—are also material considerations. The company reported effective disclosure controls and no material change in internal control over financial reporting during the quarter.
Important facts for investors to verify
- Whether IHG and Marriott terminations and planned Sonesta transitions were completed on the expected dates, and the resulting hotel operating performance and capital needs.
- Actual availability under the amended revolver, compliance with the $125 million minimum-liquidity requirement, covenant status and any subsequent financing amendments.
- Whether the proposed hotel and net-lease sales closed, at what proceeds, and how proceeds were applied to debt.
- Subsequent hotel occupancy, RevPAR, operator payments and guaranty capacity; and net-lease rent collections, deferrals, tenant defaults and TA’s ability to meet rent obligations.
- Future distribution decisions, asset impairment charges, and the degree to which FFO and cash flow exclude or depend on unusual items and noncash adjustments.