Sunstone Hotel Investors, Inc. — Q1 2014 Form 10-Q
Business context and reporting period
Quarter ended March 31, 2014. Sunstone is a self-managed hotel REIT that owns and asset-manages hotels leased to its taxable REIT subsidiary and operated by third-party managers. At quarter-end, it held interests in 29 hotels with 13,753 rooms. The portfolio is primarily upscale and upper-upscale urban, convention, business, and airport hotels.
Financial and operating performance
| Metric | Q1 2014 | Q1 2013 |
|---|---|---|
| Total revenue | $243.5 million | $194.9 million |
| Operating income | $14.3 million | $3.6 million |
| Operating margin | 5.9% | 1.8% |
| Net income (loss) | $(3.5) million | $28.9 million |
| Loss attributable to common stockholders | $(8.1) million; $(0.04) per share | Income of $17.5 million; $0.12 per share |
| Cash provided by operating activities | $39.3 million | $13.4 million |
| Capital expenditures on hotel renovations and additions | $33.3 million | $37.1 million |
- Revenue rose 24.9%, with room revenue up 26.8%, food and beverage up 20.7%, and other operating revenue up 21.9%. The three hotels acquired in 2013 contributed substantially to the increase.
- Comparable Portfolio RevPAR increased 8.8% to $135.91, as occupancy rose 400 basis points to 77.7% and ADR increased 3.2% to $174.91. Adjusted for Marriott’s reporting-calendar change, RevPAR growth was 8.6%.
- Adjusted EBITDA, a non-GAAP measure, was $49.4 million versus $38.4 million. Adjusted FFO was $27.6 million versus $14.0 million. These measures are supplemental and are not substitutes for GAAP results.
- At March 31, cash and cash equivalents were $94.8 million and restricted cash was $82.7 million. Combined cash balances were $177.5 million, but restricted amounts are not freely available. Cash and cash equivalents declined $9.6 million during the quarter.
- Notes payable totaled $1.398 billion; capital lease obligations were an additional $15.6 million long-term. Approximately 70.7% of debt was fixed-rate, the weighted-average debt maturity was about four years, and the weighted-average interest rate was 4.9%.
- Current assets were $230.4 million and current liabilities $126.3 million. Liquidity includes restricted cash and should not be assessed from the current ratio alone.
Material changes versus the prior comparable period
- Continuing-operations loss improved to $3.5 million from $19.5 million. The prior-year quarter included a $51.6 million gain on the sale of the Rochester portfolio, contributing to prior-year net income; no such gain occurred in Q1 2014.
- The three 2013 acquisitions added revenue and earnings, while renovations affected results in both periods. Renovations at four hotels in Q1 2013 had reduced room availability; three hotels were undergoing significant renovations in Q1 2014.
- Preferred-stock dividends and redemption charges fell to $2.3 million from $10.9 million, partly reflecting the 2013 redemptions of Series A and Series C preferred stock. Series D preferred stock remains outstanding, with $115 million liquidation preference.
- Operating cash flow increased year over year, while investing cash flow shifted to a $32.9 million use from $22.2 million provided, mainly because Q1 2013 included proceeds from the Rochester portfolio sale.
- Comparability is also affected by Marriott’s calendar change: its Q1 2013 results included three extra days, which management estimated added approximately $1.6 million in room revenue and $0.6 million in food and beverage revenue for Marriott-managed hotels.
Outlook, management commentary, risks, and unusual items
- Management described the lodging recovery as being in its middle phase and expected lodging demand to remain strong over the next several years if the U.S. economy and employment continue to improve. The filing provides no quantified earnings or RevPAR guidance.
- Management’s stated priorities are to improve portfolio quality and scale, pursue disciplined acquisitions, maintain low leverage and financial flexibility, and fund near-term acquisitions with a greater proportion of equity than debt. A February 2014 equity distribution program permits up to $150 million of common-stock sales; $1.2 million of net proceeds were raised in Q1.
- Management believed available cash, operating cash flow, capital-market access, and unencumbered properties would be sufficient for foreseeable needs and at least the next 12 months. This is management’s assessment, not a guarantee of future liquidity.
- Q1 results included approximately $2.9 million of prior-year property-tax credits. Excluding those credits, management reported comparable-portfolio operating flow-through of 55.0%.
- Renovation and construction commitments were $49.5 million at quarter-end; $45.5 million was held in FF&E reserve accounts. A subsequent-event agreement provides for an expected Q2 2014 purchase of approximately seven acres under the Fairmont Newport Beach for $11 million.
- Risks include lodging-cycle and local-market weakness, operating-cost inflation, renovation disruption, hotel-manager and brand requirements, concentration in major U.S. markets, ground/building/air leases at 10 hotels, debt and covenant obligations, and limited access to capital markets. A 100-basis-point change in variable rates was estimated to affect annual cash flows by approximately $4.1 million.
- The Company retained a potential liability of up to $14 million tied to the Rochester portfolio pension plan, contingent on specified events. It also disclosed customary environmental indemnities and $0.8 million of letters of credit for workers’ compensation obligations; no draws had been made.
- No hotel impairment indicators were identified in the quarter. Management reported effective disclosure controls and no material change in internal control over financial reporting. No legal proceedings were reported.
Most important facts for investors to verify
- How much of revenue and adjusted earnings growth reflects the 2013 acquisitions versus comparable-property demand and pricing, accounting-calendar effects, and renovation timing.
- The sustainability of the 8.8% comparable RevPAR increase and the effect of renovations, weather, market supply, and operating-cost inflation on margins.
- Availability and terms of unrestricted liquidity, debt maturities, covenants, and refinancing options; distinguish restricted cash and FF&E reserves from cash available for general purposes.
- Whether the $49.5 million renovation commitments, planned $11 million land purchase, lease obligations, and potential $14 million pension exposure affect capital flexibility.
- The assumptions behind management’s 12-month liquidity assessment and its qualitative lodging-demand outlook, which is subject to economic and capital-market risks.