Business context and reporting period
The supplied filing is Hospitality Properties Trust (HPT), not Service Properties Trust, and covers the unaudited quarter and nine months ended September 30, 2016. HPT was a REIT with 305 hotels and 198 travel centers. Its two segments were hotel investments and travel center investments; the travel centers were leased to related-party tenant TravelCenters of America (TA).
Financial performance and position
| Metric | Q3 2016 | Q3 2015 | Nine months 2016 | Nine months 2015 |
|---|---|---|---|---|
| Total revenue | $543.5 million | $511.9 million | $1,567.9 million | $1,454.5 million |
| Operating income | $93.5 million | $98.3 million | $286.5 million | $284.2 million |
| Net income | $51.8 million | $61.2 million | $159.9 million | $185.9 million |
| Net income available to common shareholders | $46.6 million | $56.0 million | $144.4 million | $170.4 million |
| Basic and diluted earnings per common share | $0.30 | $0.37 | $0.94 | $1.13 |
- Operating margin was approximately 17.2% in Q3, versus 19.2% a year earlier; for the nine months it was approximately 18.3%, versus 19.5%.
- For the nine months, operating cash flow was $360.1 million, down from $374.9 million. Investing used $331.2 million, versus $575.3 million; financing used $33.0 million, versus providing $195.9 million. Cash and cash equivalents were $9.5 million at quarter-end.
- At September 30, HPT had $150 million outstanding on its $1 billion revolver, leaving $850 million available, and a $400 million term loan. Principal debt was approximately $3.16 billion, including $2.6 billion of senior notes and $8.5 million of convertible notes. The filing reports $3.12 billion of debt carrying value, net of discounts and issuance costs. HPT reported compliance with debt covenants.
- Total assets were $6.59 billion and shareholders’ equity was $3.15 billion. HPT paid common distributions of $0.50 per share in Q1 and $0.51 in each of Q2 and Q3; it declared a further $0.51 distribution for Q4.
- FFO per diluted share was $0.87 in Q3 and $2.68 for the nine months. Normalized FFO per diluted share was $1.03 and $3.05, respectively. These are non-GAAP measures; normalized FFO excludes certain items and defers recognition of management incentive fees to Q4.
Material changes versus comparable periods
- Q3 revenue rose 6.2%, but operating income fell 5.0%, net income fell 15.3%, and common earnings per share fell 18.9%. Hotel operating revenue increased, as did TA rent, but expenses, depreciation, general and administrative expense, and interest expense also increased.
- Nine-month revenue increased 7.8% and operating income increased 0.8%, while net income declined 14.0% and common earnings per share declined 16.8%. The prior-year period included an $11.0 million gain on sale of real estate; 2016 interest expense and estimated management incentive fees were higher.
- General and administrative expense rose 90.3% in Q3 and 69.3% for the nine months, primarily due to increased estimated incentive fees payable to RMR LLC, HPT’s related-party manager. Estimated 2016 incentive fees were $25.0 million for Q3 and $56.3 million year to date; final fees depend on HPT’s full-year share total return.
- HPT issued 12.65 million common shares in August, generating approximately $372.0 million net proceeds, and issued $750 million principal amount of notes in February. It redeemed $275 million of 2016 notes and $300 million of 2017 notes during the year.
- Comparable hotel RevPAR increased 3.8% in Q3 and 4.5% for the nine months. Across all hotels, Q3 ADR rose 3.0%, occupancy increased 0.4 percentage points to 80.0%, and RevPAR rose 3.5%.
Outlook, commentary and risks
- Management said operating cash flows, available revolver capacity and other funding sources should cover operating and capital expenses, debt service and distributions for the next 12 months and foreseeable future. This depends on managers and tenants continuing to meet payment obligations.
- HPT expected approximately $53.1 million of hotel renovations and capital improvements in Q4 2016, plus approximately $30 million of travel-center improvements. These expenditures are generally intended to increase contractual minimum returns or rent, but property results may not rise enough to cover the increased payments.
- HPT expected to acquire a Milpitas hotel for $46 million in Q4 2016, and hotels in Addison and Chicago in Q1 2017, subject to closing conditions. It also expected to purchase one more TA-developed travel center in Q1 2017 for development cost, capped at $29 million. These transactions were not assured.
- TA was HPT’s largest tenant and leased all 198 travel centers. TA leases generated $207.0 million of rental income in the first nine months; $150 million of deferred rent was outstanding, generally due at lease expirations or, for one lease, in 2024. HPT also owned approximately 8.8% of TA.
- Hotel minimum-return coverage for the trailing 12 months was below 1.0x for three of nine hotel agreements; Sonesta’s was 0.73x. HPT disclosed unfunded minimum-return shortfalls, including amounts attributable to Sonesta, which had no guarantee or security deposit. Guarantees and deposits can be limited or depleted and applying deposits does not generate new cash.
- Marriott notified HPT it would not exercise its renewal option on the Kauai hotel lease expiring December 31, 2019. Future operator, terms and cash flow were uncertain. Other risks include hotel and trucking downturns, tenant or guarantor payment failures, renovation disruption, related-party conflicts, REIT qualification, and refinancing or interest-rate exposure. A 100-basis-point increase in rates was estimated to add approximately $5.5 million to annual interest expense on then-outstanding floating-rate debt.
Important facts for investors to verify
- Confirm the issuer identity: the filing names Hospitality Properties Trust, while the request metadata names Service Properties Trust.
- Track cash available after distributions and planned capital spending, and whether hotel and travel-center operators meet minimum payments without relying on expiring or depleted security features.
- Assess the size, final determination and cash payment timing of RMR LLC incentive fees, and the governance implications of HPT’s related-party arrangements with RMR, TA and Sonesta.
- Review TA’s capacity to pay current and deferred rent, its lease coverage and HPT’s exposure to this concentrated tenant relationship.
- Monitor hotel coverage—especially Sonesta and the Kauai lease transition—as well as completion, cost and operating performance of planned acquisitions and renovations.
- Reconcile reported GAAP earnings with FFO and normalized FFO, including the treatment of incentive fees, and review debt maturities, floating-rate exposure and revolver availability.