Business Context and Reporting Period
Company: Sunstone Hotel Investors, Inc. (Sunstone)
Filing Type: Form 10-K (Annual Report)
Reporting Period: Fiscal year ended December 31, 2007
Business Overview: Sunstone is a Maryland corporation operating as a Real Estate Investment Trust (REIT). Its primary business is acquiring, owning, asset managing, renovating, and selling luxury, upper upscale, and upscale full-service hotels in the United States. As of December 31, 2007, the portfolio consisted of 45 hotels with 15,625 rooms located in 14 states and Washington, D.C. The company also holds a 38% equity interest in a joint venture owning the Doubletree Times Square in New York City.
Key Financial Metrics
| Metric | 2007 | 2006 |
|---|---|---|
| Total Revenues | $1,056.7 million | $855.3 million |
| Operating Income | $155.4 million | $124.3 million |
| Net Income | $125.7 million | $53.2 million |
| Income Available to Common Stockholders | $103.3 million | $33.6 million |
| Diluted EPS (Common) | $1.75 | $0.59 |
| Cash Flow from Operating Activities | $214.0 million | $163.1 million |
| Total Debt | $1,722.2 million | $1,499.8 million |
| Weighted Average Interest Rate | 5.5% | 5.8% |
| Hotel Operating Margin | 28.8% | 26.2% |
| RevPAR (Total Portfolio) | $122.76 | $111.56 |
Material Changes vs. Prior Period
- Revenue Growth: Total revenues increased 23.6% to $1.057 billion, driven by a 25.3% increase in room revenue and a 26.9% increase in food and beverage revenue. This growth was attributed to acquisitions and organic growth in occupancy and Average Daily Rate (ADR).
- Profitability: Net income surged 136.0% to $125.7 million. A significant contributor was income from discontinued operations, which rose to $63.5 million (from $15.6 million in 2006) due to the sale of seven hotels in 2007.
- Portfolio Activity:
- Acquisitions: Acquired three hotels in 2007 (LAX Renaissance, Marriott Long Wharf, Marriott Boston Quincy) for approximately $410.7 million.
- Dispositions: Sold seven hotels in 2007 for net proceeds of $179.3 million, recognizing a net gain of $59.9 million.
- Capital Expenditures: Spent $135.2 million on capital investments and renovations in 2007.
- Debt Structure: Issued $250 million in 4.60% exchangeable senior notes in June 2007. Repaid a $175 million mortgage loan and fully repaid the $200 million credit facility by year-end.
Guidance, Outlook, Risks, and Unusual Items
- Management Commentary: Management highlighted a "conservative and flexible capital structure" with fixed-rate debt averaging 5.5% and a nine-year average term to maturity. The company expects to continue redeploying capital from slower-growth to higher-growth hotels.
- Dividends: The Board authorized a quarterly common dividend of $0.35 per share in November 2007 (paid in January 2008), an increase from the $0.32 per share paid in 2007.
- Unusual Items:
- Performance Guaranty: Fully utilized a $27.0 million performance guaranty from Hyatt Corporation regarding the Hyatt Regency Century Plaza. $2.8 million was recognized in 2007 revenue.
- Executive Costs: Corporate overhead increased 48.5% due to one-time executive officer severance costs ($3.5 million) and CEO succession costs ($1.5 million).
- Joint Venture: Sold a 50% interest in BuyEfficient, LLC, recognizing a $6.1 million gain.
- Risks:
- Debt Refinancing: Significant reliance on refinancing debt maturing in the future; inability to refinance on favorable terms could force asset sales.
- Geographic Concentration: Approximately 38% of 2007 revenues were generated from hotels in California, exposing the company to regional economic downturns or natural disasters.
- Third-Party Management: Operations depend entirely on third-party managers (e.g., Interstate SHP, Marriott); termination of these agreements could disrupt operations.
- REIT Status: Failure to maintain REIT qualification would subject the company to corporate income tax.
Investor Verification Checklist
- Debt Maturities: Verify the schedule of debt maturities, noting that while the weighted average term is nine years, specific tranches may require refinancing sooner.
- Discontinued Operations: Assess the sustainability of earnings by excluding the $63.5 million gain from discontinued operations, which significantly boosted 2007 net income.
- California Exposure: Review the specific performance of the 18 hotels in California, which represent the largest single geographic concentration of revenue.
- Management Agreements: Confirm the terms and renewal dates of management agreements with Interstate SHP (managing 26 hotels) and Marriott (managing 13 hotels).
- Capital Expenditure Requirements: Evaluate the $22.3 million in contractual construction commitments for 2008 and the adequacy of the $30.7 million in restricted cash reserves.