Service Properties Trust (then Hospitality Properties Trust) — Q1 2018 Form 10-Q
Reporting period: Three months ended March 31, 2018; unaudited. The filing reports the company under its then-current name, Hospitality Properties Trust. Unless stated otherwise, financial amounts below are in U.S. dollars.
Business context
The REIT owned 323 hotels and 199 travel centers. It did not operate the properties directly: hotels were managed or leased under agreements with hotel operators, and the travel centers were leased to TravelCenters of America (TA). Hotel operations and travel-center rent are the principal business sources reflected in reported results.
Financial performance and liquidity
| Metric | Q1 2018 | Q1 2017 | Change / context |
|---|---|---|---|
| Total revenue | $528.6 million | $488.6 million | Up 8.2% |
| Operating income | $102.3 million | $80.1 million | Up 27.7%; operating margin 19.4%, versus 16.4% |
| Net income | $80.2 million | $37.2 million | Up 115.8%; includes $25.0 million unrealized investment gains in 2018 |
| Net income per common share | $0.49 | $0.16 | 2017 included preferred distributions and a preferred-share redemption charge |
| FFO per share | $1.10 | $0.73 | Company-defined supplemental measure |
| Normalized FFO per share | $0.94 | $0.91 | Excludes 2018 unrealized equity gains; 2017 adjustments include incentive fees and preferred-share redemption charge |
| Operating cash flow | $34.8 million | $57.9 million | Down $23.1 million |
| Cash and cash equivalents | $16.8 million | $24.1 million at Dec. 31, 2017 | Restricted cash was an additional $59.5 million |
Hotel operating revenue rose 9.1%, while hotel operating expenses rose 11.4%. Rental income increased 3.6%, including a 3.7% increase from travel centers. The company reported $26.5 million of investing cash outflow, primarily property improvements, and paid $85.5 million in common distributions. Cash distributions therefore exceeded quarterly operating cash flow.
At March 31, total liabilities were $4.37 billion. Debt principal comprised $3.65 billion of senior notes, a $400 million term loan and $86 million drawn on a $1.0 billion revolving facility. The company had $914 million available on the revolver at quarter-end; by May 8, it reported no revolver borrowings. The term loan matures in April 2019 and the revolver in July 2018, with a conditional one-year extension option. The company said it was in compliance with debt covenants.
Material changes versus the prior period
- Revenue growth reflected acquisitions, higher revenue at certain hotels, contractual rent increases and property improvements. Comparable hotels’ RevPAR increased 2.0%, but companywide hotel RevPAR increased only 0.6%.
- Net income benefited from a new accounting requirement to recognize fair-value changes in equity securities through earnings: the quarter included a net $25.0 million unrealized gain, primarily on RMR Inc. shares. Normalized FFO, which excludes this item, rose to $154.9 million from $148.8 million.
- General and administrative expense declined to $11.7 million from $32.3 million, primarily because no 2018 business-management incentive fee was accrued; 2017 included estimated incentive fees. The company paid RMR LLC a $74.6 million incentive fee in January 2018 for 2017.
- Interest expense increased 9.1% to $47.5 million, mainly due to higher average borrowings. In February, the company issued $400 million of 4.375% senior notes due 2030; net proceeds were used to repay revolver borrowings and for general purposes.
- The common distribution paid for the quarter was $0.52 per share. After quarter-end, the company declared $0.53 per share for the next quarter.
Outlook, risks and unusual items
- Management said available operating receipts, cash and borrowing capacity should fund operating and capital costs, debt service and distributions for the next 12 months and foreseeable future. It cautioned that weaker property results or managers’ and tenants’ failure to pay could reduce cash flows and distributions.
- Planned capital spending was substantial: approximately $189.7 million for hotel renovations and improvements in the last nine months of 2018 and $122.1 million in 2019; approximately $38.3 million was expected for travel-center improvements in the balance of 2018. Funding generally increases contractual minimum returns or rents, but improved property performance is not assured.
- Hotel coverage was pressured: four of nine hotel operating agreements, representing 19% of annual minimum returns and rents, had trailing-twelve-month coverage below 1.0x. Overall hotel coverage was 1.04x for the trailing year and 0.82x for the quarter; travel-center lease coverage was 1.59x for the trailing year.
- Some hotel minimum returns were not supported by guarantees or deposits. The Wyndham guarantee was depleted in 2017; Wyndham paid 85% of contractual minimum returns in Q1 2018, $1.0 million below the full minimum. The company warned it cannot assure continued payment. Marriott No. 1 and Sonesta also had no guarantees or security deposits for their minimum returns.
- For managed hotel portfolios, property operating results were $27.6 million below minimum returns in Q1; guarantees and deposit applications covered $10.9 million, leaving $17.8 million in unfunded shortfalls. Applying security deposits can produce accounting income but does not provide additional cash.
- After quarter-end, a settlement terminated the Morgans lease for The Clift Hotel on May 8, 2018; Morgans surrendered the property, which was rebranded Royal Sonesta and added to the Sonesta management agreement.
- Key risks include hotel and travel-center demand, competition and renovation disruption, the ability of TA and hotel operators to meet payment obligations, rising interest rates and refinancing access, and related-party conflicts involving RMR, TA and Sonesta. The company disclosed no material changes to the risk factors in its 2017 annual report.
Important facts for investors to verify
- Whether hotel renovations improve occupancy, rates and coverage enough to support increased minimum returns and the planned capital spending.
- Whether Wyndham and other operators meet payment obligations as guarantees and security deposits are depleted or expire.
- Whether TA continues paying current and deferred rent and can support additional rent from planned travel-center improvements.
- How the company will address the July 2018 revolver maturity and April 2019 term-loan maturity, and the cost and availability of refinancing.
- Whether recurring operating cash flow can support capital needs and distributions; distinguish reported net income and FFO from cash generation and note that restricted cash is not equivalent to unrestricted liquidity.
- The effect of related-party arrangements and RMR incentive fees, and the significance of fair-value movements in the company’s equity investments.