Sunstone Hotel Investors, Inc. — Q2 2015 Form 10-Q
Business context and reporting period. Sunstone is a self-managed REIT that owns and asset-manages hotels, which are leased to its taxable REIT subsidiary and operated by third-party managers. At June 30, 2015, it held interests in 30 hotels. This filing reports the three and six months ended June 30, 2015; financial statements are unaudited. Amounts below are in millions unless otherwise stated.
Financial performance and position
| Metric | Q2 2015 | Q2 2014 | First half 2015 | First half 2014 |
|---|---|---|---|---|
| Revenue | $339.3 | $300.9 | $623.7 | $544.3 |
| Operating income | $69.4 | $55.9 | $87.0 | $70.2 |
| Net income | $53.7 | $43.5 | $54.9 | $40.0 |
| Income attributable to common stockholders | $48.9 | $39.6 | $45.6 | $31.5 |
| Diluted EPS | $0.23 | $0.22 | $0.22 | $0.17 |
| Operating cash flow | Not provided separately | Not provided separately | $128.2 | $117.8 |
- Q2 revenue increased 12.8%; operating income rose 24.1%. Operating margin was approximately 20.4%, compared with 18.6% a year earlier. First-half operating margin was approximately 14.0%, versus 12.9%.
- Comparable portfolio RevPAR increased 6.8% in Q2 and 6.7% for the first half. Q2 occupancy was 86.8% (up 60 basis points) and ADR was $212.04 (up 6.0%). First-half occupancy was 83.2% (up 90 basis points) and ADR was $200.89 (up 5.5%).
- Adjusted EBITDA was $110.4 million in Q2 versus $94.4 million; first-half Adjusted EBITDA was $176.1 million versus $143.8 million. Adjusted FFO attributable to common stockholders was $89.6 million versus $72.2 million in Q2 and $134.6 million versus $99.8 million for the first half. These are non-GAAP measures defined by the company.
- For the first half, investing cash outflow was $81.1 million and financing cash outflow was $170.4 million. Capital improvements to hotels were $73.0 million. Operating cash flow less hotel renovations and additions was approximately $55.2 million, a simple derived measure, not a company-reported free-cash-flow metric.
- At June 30, cash and cash equivalents were $98.8 million, restricted cash was $88.5 million, and total debt was $1.319 billion. Debt was 69.4% fixed-rate; the weighted-average debt rate was 4.4%. The new $400 million unsecured credit facility had no outstanding balance.
- Current liabilities were $254.4 million. Management identified $115.8 million of debt maturities over the next 12 months and said it expected cash, operating cash flow, capital-market access, the credit facility and unencumbered hotels to cover foreseeable needs. Common dividends declared were $0.05 per share in Q2 and $0.10 per share for the first half; the Series D preferred stock pays an 8% annual dividend.
Material changes versus the prior comparable period
- Revenue growth reflected stronger hotel performance and the July 2014 acquisition of the Wailea Beach Marriott Resort & Spa, which contributed $11.1 million of Q2 room revenue and $25.2 million for the first half. The portfolio comprised 30 hotels at June 30, 2015, versus 29 a year earlier.
- Comparable RevPAR gains were driven by higher ADR and occupancy. Management cited improved results at hotels that had undergone major renovations in 2014, partly offset by renovation disruption at Boston Park Plaza in 2015.
- Q2 2014 and first-half 2014 net income included $5.2 million of discontinued-operations income related to the Rochester portfolio sale; 2015 reported no discontinued-operations income for these periods. First-half 2015 common-stockholder income also included approximately $6.9 million of costs related to the former CEO’s departure, including stock-compensation amortization.
- Effective January 1, 2015, adoption of the lodging industry’s revised Uniform System of Accounts changed the classification of mandatory banquet and event service charges. This increased reported food-and-beverage revenue and expense; management quantified the revenue effect at $5.0 million in Q2 and $9.5 million for the first half, limiting direct comparability.
- In April, Sunstone replaced its $150 million unsecured credit facility with a $400 million facility, with pricing of 155–230 basis points over LIBOR and an accordion option up to $800 million. In May, it repaid $99.1 million of mortgages secured by four hotels, bringing its unencumbered hotel count to 18.
Outlook, commentary, risks and unusual items
- Management said lodging demand had continued to improve and expected demand to remain strong if the U.S. economy and employment continued to grow. It provided no specific financial guidance in the supplied filing text.
- Management characterized the lodging cycle as middle-to-mature and emphasized disciplined capital recycling, balance-sheet flexibility and low leverage. It expected near-term acquisitions to be funded largely with equity.
- Renovation and construction commitments totaled $75.7 million; $59.4 million was held in hotel furniture, fixtures and equipment reserve accounts. Management invested $73.0 million in hotel improvements in the first half.
- On July 24, 2015, Sunstone sold its $25.0 million Rochester preferred equity investment and settled a $3.7 million working-capital loan for $16.0 million plus accrued interest. It expected to recognize a $16.0 million gain in Q3 2015 discontinued operations.
- Risks include economic and lodging-demand weakness, new hotel supply (including in New York, Washington, D.C., and Chicago), operating-cost inflation, renovation disruption, reliance on hotel managers and brands, debt and interest-rate exposure, lease obligations, and geographic concentration. Twenty-one of 30 hotels were concentrated in California, New York, Illinois, Massachusetts and the greater Washington, D.C. area.
- A 100-basis-point change in variable rates was estimated to affect annual interest expense and cash flow by approximately $3.7 million before the Hilton San Diego Bayfront non-controlling-interest adjustment, or $3.2 million after it. The Times Square interest-rate cap was due to mature in October 2015.
- The filing reports customary environmental indemnities without a stated term or damage limit, $0.6 million of letters of credit for workers’ compensation obligations, and no pending legal proceedings. Management reported effective disclosure controls and no material change in internal control during the quarter.
Important facts for investors to verify
- How much of the reported revenue and earnings growth came from comparable hotel operations versus the Wailea acquisition and the accounting reclassification of service charges.
- Progress and expected costs of Boston Park Plaza renovations, the $75.7 million construction commitments, and any resulting room or revenue disruption.
- Funding plans and covenant capacity for the $115.8 million of stated next-12-month debt maturities, and the terms or use of the new credit facility.
- Actual Q3 recognition and cash proceeds from the Rochester asset sale, including the reported $16.0 million expected gain.
- Whether operating-cost inflation, market-specific new supply, and the expiring Times Square rate cap affect margins, occupancy or interest expense.