Sunstone Hotel Investors, Inc. annual report, FY2014

Business context and reporting period

Sunstone Hotel Investors, Inc. is a U.S. hotel REIT reporting for the year ended December 31, 2014; the filing is an annual 10-K, not a standalone fourth-quarter filing. At year-end, the company held interests in 30 hotels with 14,303 rooms across 13 states and Washington, D.C. Its hotels are primarily upper-upscale, third-party managed properties. The filing also provides unaudited fourth-quarter results.

Financial and operating performance

Operating margin was approximately 13.7% in 2014 versus 10.7% in 2013, based on reported operating income and revenue. Comparable Portfolio RevPAR rose 6.9% to $160.11, with occupancy up 190 basis points to 82.4% and ADR up 4.4% to $194.31. Adjusted EBITDA, a non-GAAP measure, was $312.7 million versus $240.8 million; Adjusted FFO available to common stockholders was $225.4 million versus $151.2 million.

Fourth-quarter 2014 revenue was $289.9 million, operating income was $35.7 million, net income was $14.3 million, and earnings per common share were $0.05. The comparable fourth-quarter 2013 amounts were $243.9 million, $24.6 million, $5.2 million, and $0.01, respectively.

Material changes versus the prior comparable period

• Annual revenue increased 23.6%; operating income increased 58.0%, while operating expenses rose 19.5%.
• Growth reflects acquisitions, including Marriott Wailea, as well as improved hotel demand and operating performance. The company said acquired hotels contributed $113.8 million of room revenue in 2014; renovations at several properties partially offset gains.
• Net income includes $4.8 million from discontinued operations in 2014, compared with $48.4 million in 2013, when substantial gains on property sales were recorded. Continuing-operations income increased to $83.1 million from $21.6 million.
• Operating cash flow increased by $107.5 million. Investing used $406.7 million, primarily for acquisitions and $126.0 million of hotel renovations; financing provided $245.9 million, including common-stock proceeds.
• Debt increased modestly overall, but refinancing extended maturities and reduced rates on the JW Marriott New Orleans, Embassy Suites La Jolla, and Hilton San Diego Bayfront loans. A $4.6 million debt-extinguishment loss was recorded, principally from the La Jolla refinancing.

Liquidity, debt and capital allocation

Unrestricted cash was $222.1 million and restricted cash was $82.1 million at year-end. Management said cash, operating cash flow, capital-market access, and unencumbered properties were expected to cover operating and other needs for at least the next 12 months. Debt had an approximately four-year weighted-average term; 71.6% was fixed-rate, at a 5.2% weighted-average rate. The weighted-average rate including variable-rate debt was 4.5%. The company had $150 million available under its revolving credit facility and $0.7 million of outstanding letters of credit.

Scheduled debt principal and amortization were $121.3 million in 2015, $205.8 million in 2016, $257.4 million in 2017, $290.9 million in 2018, and $223.9 million in 2019. The company reported $56.5 million of construction commitments and $50.3 million in hotel FF&E reserve accounts. Capital improvements were $126.0 million in 2014.

Outlook, management commentary, risks and unusual items

• Management characterized the lodging cycle as in its middle phase of recovery, anticipated continued demand improvement if the U.S. economy strengthens, and planned selective acquisitions and dispositions while prioritizing liquidity and low leverage. No numeric 2015 earnings or operating guidance is provided.
• The company expected to continue a regular common dividend of $0.05 per share quarterly in 2015; any additional “catch-up” distribution could be paid in cash, stock, or both. The $0.36-per-share common dividend declared in fourth-quarter 2014 was paid in January 2015 in cash and/or shares based on stockholder elections.
• Key risks include economic and travel downturns, hotel supply and competition, geographic concentration, rising labor and operating costs, renovation disruption and cost overruns, reliance on third-party managers and brands, refinancing and interest-rate exposure, and the ability to maintain REIT qualification.
• Two variable-rate mortgages were subject to interest-rate caps that expire in 2015. Management estimated a 100-basis-point rate change would alter annual interest expense by approximately $3.7 million before the noncontrolling-interest effect.
• Contingencies include a remaining $7.0 million potential Rochester portfolio pension liability and a $0.8 million accrued estimate for post-sale capital expenditures. Environmental indemnities to certain lenders have no stated term or damage limit. Management did not expect pending ordinary-course legal matters to materially harm financial position or results.
• Former CEO Kenneth E. Cruse left in January 2015; President John V. Arabia became CEO. The auditor issued unqualified opinions on the financial statements and internal control over financial reporting.

Important facts for investors to verify

• How much of revenue and Adjusted EBITDA growth came from same-hotel performance versus acquired properties, and how renovation-related disruption will evolve.
• The amount and timing of 2015 debt maturities, refinancing plans, and the status or renewal of the interest-rate caps expiring in 2015.
• Cash available for dividends after required capital spending, debt service, and the company’s planned acquisition and balance-sheet priorities.
• Terms, expected recovery, and remaining exposure associated with the Rochester preferred equity investment, pension liability, and capital-expenditure contingency.
• Whether non-GAAP Adjusted EBITDA and Adjusted FFO trends reconcile to cash generation and remain comparable across periods, particularly given acquisitions, asset-sale gains, and financing items.