Service Properties Trust (then Hospitality Properties Trust) — Q2 2013 Form 10-Q
Reporting period: Three and six months ended June 30, 2013; unaudited. The filing was submitted under the name Hospitality Properties Trust. At quarter-end, the REIT owned 290 hotels and 185 travel centers, operated under 11 management or lease agreements.
Financial performance and position
| Metric | Q2 2013 | Q2 2012 | First six months 2013 | First six months 2012 |
|---|---|---|---|---|
| Total revenue | $412.3 million | $343.2 million | $766.8 million | $644.6 million |
| Operating income | $74.3 million | $73.7 million | $137.4 million | $151.3 million |
| Net income | $45.4 million | $37.7 million | $72.9 million | $80.6 million |
| Net income available to common shareholders | $37.3 million | $27.0 million | $56.7 million | $55.8 million |
| Basic and diluted earnings per common share | $0.27 | $0.22 | $0.43 | $0.45 |
| Normalized FFO per share | $0.78 | $0.75 | $1.52 | $1.53 |
- Revenue mix and hotel trends: Q2 hotel operating revenue was $349.9 million, up 32.0%; rental income was $61.9 million, down 16.1%. For comparable hotels, Q2 ADR rose 1.8%, occupancy increased 3.8 percentage points to 76.9%, and RevPAR rose 7.1%. Reported hotel revenue growth was substantially affected by converting 53 hotels from leased to managed in January 2013.
- Cash flow: First-half operating cash flow was $171.9 million, versus $180.4 million; investing cash outflow was $311.8 million, versus $301.8 million; financing cash inflow was $320.6 million, versus $137.8 million. Cash and equivalents ended June at $200.7 million, up from $20.0 million at year-end 2012.
- Debt and liquidity: At June 30, revolving-credit borrowings were $90 million, the term loan was $400 million, and senior and convertible notes had carrying values of approximately $2.303 billion combined. The $750 million revolver had $660 million available; borrowings were $120 million and availability $630 million on August 6. The company reported covenant compliance.
- Distributions: Common shareholders received $0.47 per share in February and May; a further $0.47 distribution was declared in July. Preferred distributions were also paid during the period.
Material changes versus the prior period
- Q2 revenue growth primarily reflected the 53-hotel lease-to-management conversion, better hotel revenues and acquisitions. The conversion also shifted amounts from rental revenue to hotel revenue and added hotel operating costs; therefore, reported revenue growth does not by itself represent comparable-property growth.
- Q2 operating income was nearly flat, while first-half operating income fell 9.2%. Higher depreciation, hotel expenses and interest expense contributed to the first-half decline.
- Q2 net income included a $6.868 million tax benefit from restructuring certain taxable REIT subsidiaries. Excluding this item, reported net income growth would have been lower. First-half common earnings per share declined despite slightly higher common earnings, partly reflecting the March common-share issuance.
- First-half hotel performance improved overall, but results varied: Sonesta and Wyndham comparable portfolio RevPAR declined 10.1% and 13.3%, respectively, while other major portfolios generally improved.
Outlook, risks and unusual items
- Management expected hotel renovation activity to remain high through year-end 2013 and believed operating cash flow would cover operating costs, interest and declared distributions over the next 12 months. This was not a quantified earnings or FFO forecast.
- Planned capital spending remained substantial: the filing described further 2013 funding for hotel renovations and rebranding, including approximately $19.2 million for Marriott No. 234, $63 million for InterContinental, approximately $79 million for Sonesta, and $75.6 million for Wyndham; it also expected about $35 million for travel-center improvements. Actual costs and operating returns were uncertain.
- Hotel minimum-return shortfalls were significant: certain managed portfolios were $8.0 million below minimum returns in Q2 and $30.4 million below in the first half. Of these, $6.8 million and $21.6 million, respectively, were not funded by managers under the agreements. Guarantees and security deposits are limited, can be exhausted, and deposit applications do not provide new cash.
- Eight of nine hotel operating agreements had trailing-12-month coverage below 1.0x; the hotel total was 0.82x. Travel-center lease coverage was 1.60x. The company cautioned that property-level coverage is not a complete measure of tenant or manager ability to pay.
- TA, the largest tenant, had $150 million of deferred rent due in 2022 and 2024 that HPT had not recognized because collection was uncertain. TA also accounted for 37% of HPT’s real estate properties at cost.
- HPT issued $300 million of 4.5% senior notes due 2023 and raised $393.5 million net from a common-share offering. It redeemed all 6.7 million Series C preferred shares on July 1 for $167.5 million plus accrued distributions and expected a $5.627 million third-quarter charge.
- Acquisitions included a Duluth hotel for $29.7 million and the New Orleans hotel for $120.5 million. Subsequent to quarter-end, HPT acquired travel-center land for $6.3 million and a Florham Park hotel for $52.75 million. A proposed approximately $375 million NH Hoteles investment was abandoned after financing approvals were unavailable.
- Key risks include tenant and manager payment shortfalls, hotel and travel-center industry weakness, renovation execution and returns, refinancing and interest-rate exposure, REIT qualification, and conflicts of interest involving RMR and related parties. The company has no employees and receives management services from RMR; the filing also describes related-party relationships with TA, Sonesta and AIC.
Important facts for investors to verify
- How much of revenue and earnings growth reflects the accounting and operating-model change for the 53 converted hotels versus underlying comparable performance.
- Whether hotel operating cash flows, coverage and guarantee availability improve, particularly for portfolios with unreimbursed minimum-return shortfalls.
- TA’s ability to pay current and deferred rent, and the collectability and timing of the deferred amounts.
- Actual renovation and acquisition spending, funding sources, and whether resulting property performance supports increased contractual minimum returns.
- Liquidity after distributions, preferred-share redemption and planned capital spending, including future revolver usage and debt maturities.
- The recurring earnings impact apart from the one-time tax benefit and impairment charge; also note that FFO and Normalized FFO are non-GAAP measures and are not substitutes for operating cash flow.