Business context and reporting period
Sunstone Hotel Investors, Inc. is a lodging REIT that owns, asset-manages and renovates hotels leased to its taxable REIT subsidiary and operated by third-party managers. This unaudited Form 10-Q covers the quarter and six months ended June 30, 2013. The company held interests in 27 hotels with 11,886 rooms at quarter-end.
Comparisons are affected by Marriott’s switch to a calendar-year reporting period in 2013. Marriott-managed hotels contributed seven additional reporting days in Q2 and 16 additional days in the first half versus 2012.
Financial and operating performance
| Metric | Q2 2013 | Q2 2012 | Six months 2013 | Six months 2012 |
|---|---|---|---|---|
| Revenue | $234.6 million | $212.8 million | $429.6 million | $391.1 million |
| Operating income | $36.6 million | $28.6 million | $40.2 million | $33.8 million |
| Net income (loss) | $20.0 million | $11.9 million | $48.9 million | $(1.1) million |
| Income available to common stockholders | $15.1 million | $4.1 million | $32.7 million | $(16.9) million |
| Basic and diluted EPS | $0.09 | $0.03 | $0.21 | $(0.14) |
- Q2 revenue rose 10.2%; operating income rose 28.0%. Operating margin was approximately 15.6%, compared with 13.4% a year earlier. For the first half, revenue rose 9.8% and operating income rose 19.0%; operating margin was approximately 9.4% versus 8.6%.
- Comparable-portfolio RevPAR increased 2.2% in Q2 and 2.1% year to date. Q2 occupancy fell 80 basis points to 83.0%, while ADR rose 3.2% to $188.89. For the first half, occupancy fell 110 basis points to 78.7%, while ADR rose 3.6% to $179.22.
- Management-reported Adjusted EBITDA was $70.3 million in Q2, down from $71.1 million, and $108.7 million for the first half, down from $114.3 million. Adjusted FFO was $48.7 million in Q2 versus $42.1 million, and $62.7 million for the first half versus $55.8 million. These are non-GAAP measures and should be considered alongside GAAP results.
- Cash provided by operations was $74.5 million in the first half, versus $79.9 million. Investing activities used $13.9 million versus $86.3 million; financing activities used $94.6 million versus providing $59.8 million. Period-end cash and cash equivalents were $123.2 million, down from $157.2 million at year-end 2012.
- At June 30, total assets were $3.12 billion, total liabilities $1.43 billion, and total equity $1.68 billion. Notes payable were $1.30 billion; capital lease obligations were $15.6 million. Including restricted cash, cash and cash equivalents totaled approximately $199.9 million. A further $72.3 million was held by an accommodator for tax-deferred exchanges.
- Management reported a 4.9% weighted-average interest rate on debt, a roughly four-year weighted-average debt maturity and 68.1% fixed-rate debt. A 100-basis-point change in variable rates was estimated to change annual cash flows by approximately $4.4 million.
Material changes versus prior periods
- Revenue growth reflects acquisitions, Marriott’s added reporting days and underlying rate improvement; it is not solely same-property growth. Renovations also reduced available room inventory and weighed on occupancy and earnings.
- The January sale of the Rochester portfolio generated $195.6 million in net proceeds and a $51.6 million gain. The gain substantially contributed to first-half net income; Q2 2013 had no discontinued-operations income, versus $2.6 million in Q2 2012.
- In February, Sunstone issued 25.3 million common shares for approximately $294.9 million net proceeds. It used proceeds to redeem all Series A preferred stock in March and all Series C preferred stock in May, paying approximately $276.3 million in aggregate, including accrued dividends. Common shares outstanding rose to 160.9 million at June 30 from 135.2 million at year-end.
- Sunstone repurchased or redeemed its remaining $58.0 million of senior notes in January. Interest expense declined 11.1% in Q2 and 10.6% for the first half, in part because of reduced debt balances and favorable derivative valuation changes.
- In May, the company acquired the 250-room Hilton New Orleans St. Charles for a net purchase price of $59.1 million. On July 2, after quarter-end, it acquired the 1,053-room Boston Park Plaza for $250.0 million gross, funded with cash, exchange proceeds and assumption of a $119.2 million non-recourse loan.
Outlook, risks and unusual items
- No numerical earnings or operating guidance is provided. Management expected lodging demand to continue improving over the next several quarters if the U.S. economy and employment strengthened, and described the industry as in the middle phase of a cyclical recovery. Its stated priorities were portfolio improvement, disciplined acquisitions and gradual deleveraging; near-term acquisitions were expected to rely more on equity than debt.
- Management said available cash, operating cash flow, capital-market access and unencumbered properties were expected to cover operating and other business needs for at least the next 12 months. This outlook depends partly on market access and operating performance.
- The Rochester sale left a potential $14.0 million pension-plan liability, which could be triggered in certain circumstances. The company also retained a $25.0 million preferred-equity investment yielding 11% and a $3.7 million working-capital advance; related gains are deferred until repayment or release from obligations.
- The first-half tax provision was $6.3 million, including a $4.7 million accrual related to an IRS matter for tax years 2008–2010 and a further $1.5 million adjustment to uncertain tax positions. Management stated it believed its leases complied with applicable tax requirements but chose not to contest the IRS position.
- Renovation and construction commitments totaled $26.3 million; the company invested $69.1 million in hotel properties during the first half. Other risks include hotel-cycle sensitivity, operating-cost and property-tax increases, renovations, competition, manager and brand relationships, leverage and interest rates, and concentration in markets including California, New York and Illinois.
- The filing reported no legal proceedings, defaults upon senior securities or new risk-factor disclosures. Management concluded disclosure controls were effective and reported no material change in internal control over financial reporting.
Important facts for investors to verify
- Separate underlying hotel performance from Marriott’s extra reporting days, acquisitions and renovation-related room outages; review the comparable RevPAR and Adjusted EBITDA reconciliations.
- Assess how much first-half earnings depended on the Rochester sale gain and how recurring operating results compare with non-GAAP Adjusted EBITDA and Adjusted FFO.
- Review the impact of the common-stock issuance and preferred-stock redemptions on per-share results, future preferred distributions and leverage.
- Confirm post-quarter Boston Park Plaza funding, assumed debt terms and remaining liquidity after closing.
- Monitor the Rochester pension exposure, deferred sale gains, IRS-related tax matters, renovation commitments and variable-rate debt exposure.