Business context and reporting period
Sunstone Hotel Investors, Inc. is a self-managed hotel REIT. This unaudited Form 10-Q covers the quarter and six months ended June 30, 2011. At quarter-end, the company had interests in 33 hotels: 32 held for investment and the Valley River Inn classified as held for sale. The portfolio held for investment included 13,206 rooms.
Financial performance and position
Amounts below are in millions of dollars except per-share data, percentages and hotel statistics.
| Metric | Q2 2011 | Q2 2010 | First half 2011 | First half 2010 |
|---|---|---|---|---|
| Revenue | $218.3 | $157.4 | $377.3 | $295.2 |
| Operating income | $28.0 | $12.9 | $26.4 | $15.5 |
| Income (loss) from continuing operations | $8.1 | $(3.7) | $58.2 | $(20.7) |
| Income (loss) from discontinued operations | $30.8 | $4.0 | $32.1 | $(0.1) |
| Net income (loss) | $38.9 | $0.3 | $90.3 | $(20.8) |
| Income (loss) available to common stockholders | $31.1 | $(4.9) | $76.8 | $(31.2) |
| Basic earnings (loss) per share | $0.27 | $(0.05) | $0.66 | $(0.32) |
| Adjusted EBITDA | $63.0 | $43.2 | $95.2 | $74.2 |
| Adjusted FFO | $34.6 | $17.8 | $43.0 | $21.7 |
Operating margin was approximately 12.8% in Q2 2011 versus 8.2% a year earlier, and 7.0% for the first half versus 5.3%. These reported results include acquired hotels and, for net income, significant gains and discontinued operations; non-GAAP measures are company-defined and are not substitutes for GAAP results.
- Hotel trends: Portfolio RevPAR increased 7.2% in Q2 and 7.3% in the first half year over year. Q2 occupancy was 77.7% (up 230 basis points) and ADR was $169.74 (up 4.1%); first-half occupancy was 73.6% (up 160 basis points) and ADR was $165.12 (up 5.0%). Comparable statistics include prior ownership results for acquired hotels.
- Cash flow: Operating cash flow was $74.3 million in the first half, versus cash use of $2.0 million in 2010. Investing used $294.7 million, including $263.3 million for acquisitions and $64.7 million for renovations and additions. Financing provided $89.1 million. Cash and cash equivalents ended at $144.7 million; restricted cash was $61.1 million.
- Debt and liquidity: Notes payable were $1.672 billion, including $292.2 million classified as current; management reported total debt of about $1.7 billion including debt on the held-for-sale hotel. Debt weighted-average maturity was 5.2 years; 69.6% was fixed rate, at a weighted-average rate of 5.5%. Total cash, including restricted cash, was $205.9 million. The company stated it expects adequate liquidity for at least the next 12 months.
- Capital and obligations: April’s Series D preferred offering raised $110.9 million net. Preferred dividends and accretion were $12.4 million in the first half. Contractual obligations totaled $2.547 billion, including $435.3 million of operating leases and $26.7 million of construction commitments.
Material changes versus prior comparable periods
- Revenue rose 38.7% in Q2 and 27.8% in the first half. The increases were substantially affected by portfolio expansion: three hotel acquisitions in 2011 and the 2010 reacquisition of Renaissance Westchester. Management attributed the remaining existing-portfolio room revenue growth to higher occupancy and ADR.
- Operating income increased 116.3% in Q2 and 70.2% in the first half. Hotel operating costs also rose, while corporate overhead increased 23.1% in Q2 and 43.9% in the first half, principally due to acquisition and due-diligence expenses.
- First-half continuing income included a $69.2 million non-cash gain from remeasuring prior interests in Doubletree Guest Suites Times Square and BuyEfficient upon acquiring the remaining ownership interests.
- Discontinued-operations income included a $14.0 million gain on the Royal Palm Miami Beach sale and an $18.1 million gain from resolution of Mass Mutual franchise-fee contingencies. A $1.5 million impairment was recorded for the Salt Lake City laundry facility sold in July.
Outlook, commentary and risks
- Management described the lodging market as in an early recovery phase, expected demand to strengthen through the remainder of 2011, and cited constrained hotel development as a potential support for existing properties. These are expectations, not guidance with quantified financial targets.
- The company expected to refinance the $270 million Doubletree Times Square mortgage and mezzanine debt, due January 2012, during 2011, using existing cash for any refinancing shortfall. This is a significant refinancing and liquidity risk.
- Management planned selective acquisitions and capital investment, with near-term acquisitions expected to use a greater proportion of equity than debt. The company also noted that capital markets may not be available on favorable terms or at all.
- Variable-rate exposure remains: management estimated a 100-basis-point rate change would alter 2011 interest expense and cash flows by approximately $1.8 million. Derivatives were not designated for hedge accounting; a $1.0 million net derivative loss was recorded in the first half.
- Risks cited include economic and lodging-demand weakness, rising labor, benefits and utility costs, hotel-manager and franchisor performance, renovation needs, ground or air leases at nine investment hotels, geographic concentration in California and New York, leverage and covenants, and asset valuation and impairment estimates. Renovation and franchise standards may require further capital spending.
- The filing reported no legal proceedings, no defaults upon senior securities, and no material change in internal control over financial reporting. Management stated disclosure controls were effective.
Important facts for investors to verify
- Progress and final terms of the planned refinancing of the $270 million Doubletree Times Square debt, including any cash shortfall and updated maturity schedule.
- How much of reported revenue and earnings growth reflects acquired properties versus same-property performance; review comparable RevPAR and hotel-level operating results.
- The sustainability of earnings excluding the $69.2 million remeasurement gain and the gains and other items in discontinued operations.
- Availability of unrestricted liquidity, given $61.1 million of restricted cash, near-term debt classification and $26.7 million of renovation commitments.
- Debt-rate exposure, preferred dividend obligations, covenant compliance and the potential effect of higher operating costs or weaker lodging demand.