Service Properties Trust quarterly report, Q3 FY2017

Business context and reporting period

Hospitality Properties Trust (the filing registrant, now known as Service Properties Trust) filed this unaudited Form 10-Q for the quarter and nine months ended September 30, 2017. It owned 323 hotels and 199 travel centers; properties were operated by third-party managers or tenants, with all travel centers leased to TravelCenters of America (TA). Amounts below are in millions of dollars unless stated otherwise.

Financial performance and position

• Q3 operating margin was about 21.2%, compared with 17.2% a year earlier; nine-month operating margin was about 18.8%, versus 18.3%. Hotel and travel-center rental revenue grew, while reported hotel operating results were affected by acquisitions and operating costs.
• For the nine months, operating cash flow was $387.1, up from $360.1. Investing used $683.5, principally reflecting $594.9 of real estate acquisitions; financing provided $300.0. Cash and cash equivalents were $14.5 at September 30; restricted FF&E cash of $73.1 is separately reported.
• At September 30, reported debt carrying amounts included $458.0 drawn on the $1.0 billion revolving facility, a $398.9 term loan and $3,163.9 of senior notes. Revolver availability was $542.0. Revolver and term-loan rates were 2.34% and 2.44%, respectively. Total assets were $7,144.5 and shareholders’ equity was $2,789.5.
• The regular common distribution was raised to $0.52 per share for the May 2017 quarter and remained $0.52 for the October declaration. The company redeemed all $290.0 liquidation preference of its 7.125% Series D preferred shares in February.

Material changes versus the prior comparable period

• Q3 revenue rose 6.3%; net income available to common shareholders increased 83.8%. The comparison benefited from lower general and administrative expense, including lower estimated RMR incentive fees, and a $9.3 gain on three hotel sales. Q3 comparable-hotel RevPAR declined 0.4%.
• Nine-month revenue increased 4.4% and net income available to common shareholders rose 19.3%; diluted EPS increased 11.7%. The $9.3 hotel-sale gain contributed, while the preferred-share redemption produced a $9.9 charge to common earnings.
• Growth in hotel and travel-center revenue reflected acquisitions, rent increases tied to funded improvements and, in part, higher hotel revenues at certain properties. However, nine-month comparable hotel occupancy fell 0.3 percentage points; ADR rose 0.6% and RevPAR rose 0.2%, below industry-wide trends cited by management.
• Real estate acquisitions and deposits were $594.9 for the first nine months, versus $206.7 in 2016. Acquisitions included 20 hotels and one travel center. The company also issued $600.0 of senior notes, redeemed its preferred shares and increased revolving borrowings.

Outlook, risks and unusual items

• Management said it expected available funding sources to cover operating and capital expenses, debt service and distributions for the next 12 months. This expectation depends on managers and tenants continuing to pay contractual returns and rents and on access to financing.
• Management expected approximately $32.5 of hotel renovations and other improvements for the remainder of 2017 and about $174.0 in 2018–2019; it also expected about $16.1 of TA travel-center improvements in the remainder of 2017. Costs or operating disruption could exceed expectations, and higher contractual returns or rents may not be matched by improved property performance.
• Four of nine hotel operating agreements, representing 19% of annual minimum returns and rents, had trailing 12-month coverage below 1.0x (0.75x–0.86x). Wyndham’s guarantee supporting its hotels’ minimum returns was depleted; management said it could not predict whether Wyndham would continue paying. Sonesta provides no guarantee or security deposit, and certain Sonesta portfolio shortfalls were not funded.
• The company was litigating with Morgans and SBE over The Clift Hotel lease. Morgans had paid rent through November 7, 2017, but the outcome was uncertain, legal expenses continued, and management anticipated possible future rent loss and substantial renovation needs. Marriott had said it would not renew the Kauai hotel lease at its December 2019 expiry.
• Debt and interest-rate exposure are material: the revolving facility matures in July 2018, with a conditional one-year extension; the term loan matures in April 2019. A 100-basis-point rate increase was estimated to raise annual floating-rate interest expense by about $8.6 at September 30 balances. Subsequent to quarter-end, the company issued $400.0 of 3.95% notes due 2028 and redeemed $350.0 of 6.70% notes due 2018.
• A business-email-compromise fraud caused a wire payment to be misdirected in June; RMR LLC reimbursed the company during Q2, leaving no effect on the financial statements. The filing also highlights related-party relationships with RMR, TA and Sonesta.

Important facts for investors to verify

• Whether property-level hotel performance and coverage improve, particularly at agreements below 1.0x and at hotels undergoing renovations.
• Whether Wyndham continues to pay minimum returns after depletion of its guarantee, and the status of available security deposits and other guarantees.
• TA’s capacity to pay current and deferred rent, including $150.0 of deferred rent due over 2024–2032, and the economics of rent increases tied to capital improvements.
• Progress and costs of planned renovations, the Morgans dispute and the transition plan for the Kauai hotel after 2019.
• Debt refinancing, revolver extension and covenant headroom, as well as the sustainability of the $0.52 quarterly common distribution against cash needs and operating performance.