Business context and reporting period
DiamondRock Hospitality Company’s Form 10-K covers the fiscal year ended December 31, 2012; it is an annual filing, not a standalone fourth-quarter report. The company is a lodging REIT and hotel owner, with third-party managers operating its properties. At year-end it owned 27 premium hotels and resorts with 11,590 rooms, held a senior mortgage loan secured by Chicago’s Allerton Hotel, and had a contract to acquire a Times Square hotel after development.
During 2012, DiamondRock acquired five hotels and sold four non-core hotels. Its portfolio is concentrated in major urban markets and destination resorts, including New York, Chicago, Boston, Los Angeles, and the U.S. Virgin Islands.
Financial and operating performance
| Metric | FY 2012 | FY 2011 |
|---|---|---|
| Total revenue | $749.6 million | $622.2 million |
| Operating income | $31.1 million | $40.1 million |
| Net loss | $16.6 million | $7.7 million |
| Basic and diluted loss per share | $0.09 | $0.05 |
| Operating cash flow | $93.1 million | $104.2 million |
| Capital expenditures | $49.3 million | $54.8 million |
| FFO / Adjusted FFO | $121.0 million / $140.2 million | $91.5 million / $103.6 million |
| EBITDA / Adjusted EBITDA | $134.9 million / $189.7 million | $149.7 million / $162.1 million |
Revenue rose 20.5%, while operating income fell; the filing attributes much of the revenue increase to acquisitions and improved comparable-hotel performance. Operating margin was approximately 4.2%, versus 6.4% in 2011, based on reported revenue and operating income. Net loss included $30.8 million of impairment losses in continuing operations, principally a $30.4 million write-down related to Oak Brook Hills Marriott Resort; a separate $14.7 million impairment related to the Atlanta Westin North was reported in discontinued operations.
On a pro forma comparable-ownership basis, occupancy increased to 76.7% from 75.7%, ADR rose 3.9% to $175.01, and RevPAR increased 5.2% to $134.16. The company declared dividends of $0.32 per common share for 2012. Fourth-quarter reported revenue was $266.4 million and net income was $16.6 million; quarterly results include acquisition, disposition, and impairment effects and should not be treated as a comparable-property trend.
Liquidity, debt, and capital allocation
- Year-end total debt was $988.7 million, with a weighted-average interest rate of 5.31% and weighted-average maturity of approximately 4.1 years. Fifteen of 27 hotels were unencumbered by mortgage debt.
- Cash and cash equivalents were $9.6 million; restricted cash was $76.1 million. The $200 million unsecured credit facility had $20 million drawn at year-end, leaving $180 million of stated borrowing capacity. An additional $15 million was drawn after year-end.
- Approximately $190.4 million of debt was variable-rate. Management estimated that a 25-basis-point rate change would affect annual interest expense and cash flow by approximately $0.5 million.
- Operating cash flow was $93.1 million. Investing cash use was $369.1 million, including $444.7 million for hotel acquisitions and $49.3 million of capital expenditures, partly offset by $131.1 million of net property-sale proceeds. Financing cash provided was $259.3 million, including $199.8 million net proceeds from an equity offering.
- Debt maturities are concentrated in 2015 and 2016: $436.4 million and $309.3 million, respectively. The company reported compliance with mortgage and credit-facility financial covenants at year-end; the credit facility’s actual leverage ratio was 42.0% against a 60% maximum, and fixed-charge coverage was 2.47x against a 1.50x minimum.
Material changes, outlook, and risks
The 2012 portfolio expansion included a four-hotel acquisition for a contractual $495 million and Hotel Rex for approximately $29.5 million. The company sold a three-hotel portfolio for a contractual $262.5 million and the Atlanta Westin North for $39.6 million. It raised approximately $199.8 million in a public stock offering and issued 7.2 million shares to a seller in connection with the four-hotel acquisition. Management reported that comparable RevPAR growth reflected stronger room rates and, to a lesser extent, occupancy; wages, benefits, sales and marketing, repairs, and property taxes contributed to higher hotel expenses.
Management described the lodging industry as being in a multi-year recovery and expected 2013 RevPAR gains to be driven more by room-rate increases than occupancy growth. It cautioned that federal fiscal-policy developments could affect growth and that group demand could be volatile. The company expected approximately $140 million of capital improvements in 2013 and early 2014, about $100 million funded from corporate cash, including major renovations and repositioning projects at several hotels.
- Key execution risks include renovation costs, disruption, and the expected performance of the Lexington Hotel’s Autograph Collection rebranding and other property-improvement projects.
- Three hotels failed management-agreement performance tests at year-end: Oak Brook Hills Marriott Resort, Orlando Airport Marriott, and Hilton Garden Inn Chelsea/New York City. The company was evaluating whether to exercise termination rights.
- Hotel earnings are cyclical and sensitive to economic conditions, competition, new supply, labor and operating costs, and concentrated exposure to a limited number of markets. The filing cited expected additions of more than 6,000 Manhattan rooms and more than 1,600 downtown Chicago rooms by the end of 2014.
- Natural-disaster exposure, including hurricane risk at Frenchman’s Reef, is material; that property has a $5 million named-windstorm deductible. Its U.S. Virgin Islands tax agreement expires in February 2015, after which the applicable tax rate could increase if not extended.
- Management identified refinancing risk around 2015–2016 maturities, possible cash-trap restrictions, and the need for capital-market access. REIT qualification and the ability to maintain distributions also depend on statutory requirements, cash flows, debt terms, and board decisions.
Unusual and subsequent events include the January 2013 Allerton loan restructuring: the borrower paid $5 million of principal and entered into a $66 million, four-year fixed-rate loan at 5.5%, with a one-year extension option. The filing also disclosed a $2.8 million expected first-quarter 2013 charge related to the announced retirement of the president and chief operating officer. The Los Angeles Airport Marriott employee-litigation settlement was funded into escrow in 2012 and received court approval in January 2013, subject to appeals.
KPMG issued an unqualified opinion on the financial statements and internal controls; management also concluded disclosure controls and internal control over financial reporting were effective as of year-end.
Important facts for investors to verify
- Whether operating and RevPAR growth persists after separating comparable-hotel results from acquisitions, dispositions, and the Frenchman’s Reef renovation recovery.
- The assumptions and valuation evidence behind the Oak Brook Hills impairment and the property’s subsequent operating performance.
- Whether the planned $140 million capital program is completed on time and budget, and how renovations affect hotel cash flows.
- The refinancing plan and covenant headroom for the substantial 2015–2016 debt maturities, including exposure to floating interest rates and cash-trap provisions.
- Collections and performance under the restructured Allerton loan, and whether the Frenchman’s Reef tax agreement is extended before February 2015.
- The potential effect of resale of the 7.2 million acquisition-related shares, further equity issuance, and the company’s capacity to sustain dividends while funding capital needs.