Business context and reporting period
Hospitality Properties Trust (HPT) filed this unaudited Form 10-Q for the quarter and nine months ended September 30, 2010. HPT owned 289 hotels and 185 travel centers, operated under 13 management agreements or leases. The trust elected REIT status. Unless stated otherwise, amounts below are in millions of dollars.
Financial performance and position
| Metric | Q3 2010 | Q3 2009 | Nine months 2010 | Nine months 2009 |
|---|---|---|---|---|
| Total revenue | $281.2 | $264.4 | $817.7 | $785.8 |
| Operating income | $84.5 | $72.4 | $245.0 | $216.9 |
| Net income | $50.2 | $48.3 | $114.3 | $160.4 |
| Net income available to common shareholders | $42.8 | $40.8 | $91.9 | $138.0 |
| Basic and diluted earnings per common share | $0.35 | $0.34 | $0.74 | $1.34 |
- Revenue rose 6.4% in Q3 and 4.1% year to date. Q3 hotel operating revenue increased 4.9%; rental income increased 8.7%, including contractual travel-center rent increases and $3.8 million of interest on deferred TA rent.
- Operating margin was approximately 30.1% in Q3 versus 27.4% a year earlier, and 30.0% for the nine-month period versus 27.6%. Q3 net income increased 4.1%; nine-month net income fell 28.7%, reflecting prior-year debt-extinguishment gains and current-year impairment and debt-extinguishment losses.
- Operating cash flow for the first nine months was $239.3 million, compared with $228.1 million. Investing activities used $62.1 million, versus $72.2 million; financing activities used $302.7 million, versus $126.4 million. Cash declined by $125.5 million to $4.9 million.
- At September 30, total debt carrying amounts were approximately $2.09 billion, including $123 million drawn on the revolver; shareholders’ equity was $3.02 billion. The $750 million unsecured revolving facility had $627 million available and a 0.81% rate on borrowings. Its maturity was extended to October 24, 2011. HPT reported compliance with debt covenants.
- Restricted cash for hotel FF&E reserves was $66.8 million. HPT funded $62.0 million of property improvements in the first nine months; these improvements increased annual minimum returns and rents by $5.5 million.
Material changes and management commentary
- Hotel occupancy improved: Q3 average occupancy rose 6.2 percentage points to 74.4%, while average daily rate fell 2.2% to $89.43. Q3 RevPAR increased 6.7% to $66.54. For the nine months, occupancy rose 5.7 points, ADR declined 6.1%, and RevPAR increased 2.2%.
- HPT repurchased $185.7 million face value of convertible notes for $185.6 million and recorded a $6.7 million loss on extinguishment. It also redeemed $50 million of 9.125% senior notes. In the comparable 2009 nine-month period, HPT recorded a $51.1 million gain on debt extinguishment.
- HPT recorded a $16.4 million impairment charge after deciding to pursue sales of three hotels; a fourth hotel was also being offered for sale. HPT cautioned that actual sale proceeds could be below carrying values.
- Management expected operating cash flow to cover operating expenses, interest, and some distributions for the foreseeable future. It expected up to approximately $42.7 million in additional property improvements during the remainder of 2010, potentially funded from cash or revolver borrowings. No earnings or distribution guidance was provided.
Outlook, risks, contingencies, and unusual items
- TA rent deferral and concentration: TA leased HPT’s 185 travel centers and represented 39% of HPT’s real estate investments at cost. TA had deferred $135 million of rent by September 30 and deferred a further $5 million in October; the balance could reach $150 million by year-end. The agreement required payment by July 1, 2011, but TA and HPT expected to discuss possible lease modifications or alternatives. HPT had not recognized the deferred rent as income or receivable because collection was uncertain.
- Hotel payment shortfalls: Marriott’s 34-hotel agreement and Crestline’s 19-hotel lease fell short of minimum payments by $11.3 million and $8.5 million, respectively, during the first nine months. HPT applied security deposits, leaving balances of $15.0 million and $11.2 million, respectively, as of November 7. Applying deposits reduced liabilities but did not generate cash. All 11 hotel operating agreements had coverage below 1.0x for the 12 months ended September 30; reported coverage ranged from 0.11x to 0.84x. TA’s two travel-center leases had coverage of 1.22x and 1.07x, calculated without adjusting for rent deferrals.
- HPT planned to return Host security deposits of $17.2 million when the Marriott No. 2 lease expired on December 31, 2010, and potentially $50.5 million upon expiration of the Marriott No. 1 lease in 2012 if Host did not renew. HPT expected to fund these returns with cash or revolver borrowings.
- A credit rating agency downgraded HPT’s corporate credit and senior unsecured debt rating on October 22, 2010. Management warned that tighter credit access or higher borrowing costs could affect refinancing and results; HPT could not assure renewal of the revolver on its current size or terms. Significant debt maturities begin in 2012, and convertible-note holders could require repurchase in March 2012.
- Common distributions of $0.45 per share were paid in February, May, and August, and another $0.45 distribution was declared in October. Preferred distributions were also declared or paid. Management cautioned that future distributions could be reduced or suspended.
- Other noted risks include the recession’s effect on hotel and travel-center operators, exhaustion of guarantees or security deposits, variable-rate exposure on revolver borrowings, related-party relationships with RMR and TA, and uncertainty over hotel sales. HPT reported effective disclosure controls and no material change in internal control over financial reporting.
Important facts for investors to verify
- Whether TA pays, restructures, or otherwise resolves the $135–$150 million deferred-rent balance by the contractual July 1, 2011 deadline, and whether full ongoing rent is paid.
- Whether Marriott and Crestline resume full contractual payments and how quickly their remaining security deposits are consumed or replenished.
- Liquidity and refinancing plans for the October 2011 revolver maturity, the 2012 note put option, and subsequent debt maturities, particularly following the rating downgrade.
- Whether hotel operating recovery and improved occupancy translate into stronger ADR, property coverage, and cash payments to HPT.
- Sale outcomes for the four hotels being marketed, including realized proceeds versus impaired carrying values, and the timing and funding of Host deposit returns.