Service Properties Trust (filed as Hospitality Properties Trust): Q2 2015 Form 10-Q
Business context and period. Unaudited results cover the three and six months ended June 30, 2015; comparisons are with 2014. At quarter-end, the company owned 293 hotels and 191 travel centers. Hotel operations are reported as operating revenue; travel centers are primarily leased to TravelCenters of America (TA). Dollar amounts below are in millions unless stated otherwise.
Financial performance and liquidity
| Metric | Q2 2015 | Q2 2014 | Six months 2015 | Six months 2014 |
|---|---|---|---|---|
| Total revenue | $507.1 | $451.9 | $942.6 | $846.2 |
| Operating income | $108.6 | $89.0 | $185.8 | $162.9 |
| Net income | $83.1 | $53.9 | $124.7 | $91.5 |
| Net income available to common shareholders | $78.0 | $48.7 | $114.4 | $81.1 |
| Common earnings per share, basic and diluted | $0.52 | $0.33 | $0.76 | $0.54 |
| FFO per common share | $0.98 | $0.85 | $1.75 | $1.59 |
| Normalized FFO per common share | $0.98 | $0.87 | $1.82 basic / $1.81 diluted | $1.62 |
- Q2 revenue rose 12.2%; operating income rose 22.0%; common net income rose 60.0%. The $11.0 million gain from selling five travel centers contributed to reported earnings; it is excluded from FFO.
- Hotel operating revenue increased 12.8% in Q2, while hotel operating expenses increased 12.4%. Management cited improved hotel rates and occupancy, acquisitions, higher labor and marketing costs, operator fees, and security-deposit and guarantee replenishments.
- For comparable hotels, Q2 ADR rose 8.1% to $122.82, occupancy increased 1.9 percentage points to 80.1%, and RevPAR rose 10.7% to $98.38. Renovations weighed on occupancy and RevPAR at some properties.
- Six-month operating cash flow was $252.1 million, versus $217.1 million. Investing used $387.7 million, versus $149.0 million; financing provided $142.2 million, versus $75.1 million used. Cash increased $6.6 million to $18.4 million.
- At June 30, total assets were $6.40 billion and shareholders’ equity was $3.01 billion. Debt principal comprised $319 million on the revolver, $400 million of term loans, $2.425 billion of senior notes, and $8.5 million of convertible notes. The revolver had $431 million available; cash plus reported undrawn capacity was approximately $449 million.
- Revolver and term-loan rates were 1.29% and 1.38%, respectively. The company reported covenant compliance. Common distributions declared were $0.50 per share in Q2; the six-month declared total was $0.99 per share.
Material changes, outlook and risks
- TA transactions: In June, the company reorganized its TA leases into four agreements and purchased 12 travel centers and certain assets for $227.9 million, increasing annual minimum rent by $19.6 million. It sold five travel centers to TA for $45.0 million and recorded an $11.0 million gain. Further purchases included two travel centers and assets for $51.5 million, expected by year-end 2015, and five TA development properties estimated at up to $118 million, expected by June 2017. The new leases extend initial terms through 2026–2030.
- Other investment and acquisitions: The company bought hotels in Rosemont and Denver for $35.5 million and $77.3 million, respectively. In June, it acquired a 33.5% interest in RMR Inc., indirectly representing a 16.2% economic interest in its manager RMR LLC; it agreed to distribute about half the RMR Inc. shares to shareholders after SEC registration and exchange-listing processes. In July, it acquired nine extended-stay hotels for $85 million and expected to invest approximately $45 million in renovations.
- Management outlook: Management expected operating cash flow to cover operating expenses, interest and distributions for the next 12 months and foreseeable future, while cautioning that weaker tenant or manager payments could require distribution reductions. No specific earnings guidance was provided. Planned hotel capital improvements and renovations totaled approximately $97.7 million for the remainder of 2015 and 2016; projects may cost more or fail to improve operating results as expected.
- Operating and liquidity risks: Three of nine hotel operating agreements, representing 15% of annual minimum returns and rents, had trailing-twelve-month coverage below 1.0x (0.50x–0.85x). Some hotel shortfalls are not guaranteed; security deposits and guarantees are limited, may expire or be exhausted, and applying deposits does not generate new cash. TA payment capacity is also exposed to economic, trucking, fuel-price and competitive conditions.
- Financing and governance: Floating-rate debt exposes earnings to LIBOR increases; a 100-basis-point rise was estimated to add $7.2 million annually on quarter-end floating borrowings. Related-party dealings with TA and RMR entities are significant. Amended RMR management agreements run to 2035 with automatic extensions and potential termination fees. The filing reports no material change in internal controls.
Most important facts for investors to verify
- Whether hotel operating performance and lease coverage continue improving, particularly for portfolios with coverage below 1.0x and properties under renovation.
- Whether managers and tenants meet minimum return and rent obligations, and the remaining availability and expiry terms of their guarantees and security deposits.
- Completion, cost and rent economics of pending TA purchases and development properties, and whether TA can sustain its obligations.
- Execution and cost of the announced hotel renovation program, including expected returns on capital and the post-quarter Sonesta hotel investment.
- Actual liquidity after distributions, acquisitions and capital spending; debt maturities begin with $275 million due in 2016, and variable-rate exposure could increase financing costs.
- Terms, valuation and timing of the RMR Inc. share distribution and continuing related-party arrangements; assess the effect of termination provisions and potential conflicts.