Business context and reporting period
Service Properties Trust (SVC) is a REIT investing in hotels and service-focused retail net-lease properties. This unaudited Form 10-Q covers the three months ended March 31, 2023; comparisons are with Q1 2022. At quarter-end, SVC owned 220 hotels and 765 net-lease properties. Dollar amounts below are in millions unless noted.
Financial and operating results
- Revenue: $429.2, up 9.0% year over year. Hotel operating revenue rose 12.6% to $334.8; rental income fell 2.0% to $94.4.
- Profit: GAAP net income was $26.0, versus a $119.8 loss; reported diluted EPS was $0.16, versus a $0.73 loss. Results included a $41.9 gain on hotel sales and a $49.4 unrealized gain on SVC’s TA shares. Normalized FFO was $37.1, or $0.23 per share, versus a $3.4 loss, or $0.02 per share.
- Margins and hotel trends: Net income was about 6.0% of revenue, but materially reflects the gains noted above. Comparable-hotel RevPAR increased 22.0% to $80.05, with occupancy up 3.8 percentage points to 57.7% and ADR up 13.9% to $138.73. Hotel operating expenses rose 3.2% to $299.6.
- Cash flow and liquidity: Operating cash flow was $12.4, versus cash used of $12.0 in Q1 2022. Cash and restricted cash totaled $195.8 at quarter-end, up from $45.4 at year-end. Investing cash flow was $114.3, including real-estate sale proceeds of $144.4.
- Debt: Principal debt was $5.81 billion: $5.20 billion of senior notes and $610.0 million of net-lease mortgage notes. SVC issued the mortgage notes in February and used proceeds in part to redeem $500 million of 4.50% notes due 2023. The $800 million revolving facility had no borrowings but matures July 15, 2023. SVC reported compliance with debt covenants.
- Distributions: SVC paid $0.20 per share in Q1 and declared another $0.20 per share for payment in May 2023.
Material changes versus Q1 2022
- Hotel revenue increased on stronger occupancy and room rates, partly offset by hotel dispositions. Comparable-hotel RevPAR improved 22.0%.
- Total net-lease occupancy was 97.4%; portfolio coverage was 2.98x, compared with 2.67x a year earlier. Rental income declined, primarily due to higher reserves for uncollectible rents; reserves were $11.2 million at quarter-end versus $7.7 million at year-end.
- Higher hotel revenue, the hotel-sale gain, the TA-share fair-value gain, lower interest expense, and the absence of the prior-year impairment charge contributed to the swing to GAAP net income. Unrealized gains and sale gains are excluded from SVC’s FFO calculation.
- Cash flow from operations improved, while the financing mix changed with the new mortgage issuance and repayment of senior notes. SVC sold 18 hotels for $157.2 million in Q1.
Outlook, commentary, risks and unusual items
- Management said existing sources of funds are expected to cover operating costs, capital expenditures, debt service and distributions for the next 12 months, but cautioned that a recession or tenant and manager payment problems could reduce cash flows and distributions.
- The revolving facility’s July 2023 maturity and the transition away from LIBOR create near-term refinancing and interest-rate risks. SVC expected to arrange a new facility or alternative financing but gave no assurance it would succeed.
- SVC expected to fund approximately $200 million of hotel capital improvements during the remaining nine months of 2023, using cash on hand. It funded $20.0 million of hotel capital improvements beyond available FF&E reserves in Q1.
- TA’s proposed acquisition by BP was pending at filing. Subject to closing, SVC agreed to amend leases covering 176 travel centers: aggregate minimum rent would be $254 million annually, with 2% annual increases; TA would prepay $188 million of rent and receive $25 million in annual rent credits over the initial ten-year term. BP’s lease guarantees would have an initial aggregate cap of approximately $3.04 billion. The merger was then expected in Q2 2023, subject to customary conditions.
- Risks highlighted include inflation, elevated interest rates, recession, hotel demand and labor costs, tenant and manager performance, debt refinancing, and related-party conflicts. SVC has significant concentration with TA and Sonesta; TA leased 177 properties, representing 66.6% of net-lease annualized minimum rent.
Investor facts to verify
- Whether the BP-TA merger closed and whether the amended TA leases and guarantees took effect as described.
- Whether SVC refinanced or replaced the revolving credit facility before its July 15, 2023 maturity, and the resulting cost and terms.
- Subsequent hotel and other property-sale proceeds, uses of proceeds, and the pace of planned hotel capital spending.
- Whether hotel operating improvements and net-lease coverage continued, and whether rent collection or uncollectible-rent reserves worsened.
- Whether the $0.20 quarterly distribution remained supported by recurring cash flow and normalized FFO, rather than asset-sale or investment fair-value gains.