Business context and reporting period
Hospitality Properties Trust (now Service Properties Trust) filed this unaudited Form 10-Q for the quarter ended March 31, 2017. The REIT owned 308 hotels and 198 travel centers; third-party operators managed or leased all properties. Results are compared with the three months ended March 31, 2016. Dollar figures below are in millions unless noted.
Financial performance and position
| Metric | Q1 2017 | Q1 2016 | Change |
|---|---|---|---|
| Total revenue | $488.6 | $474.1 | +3.1% |
| Operating income | $80.1 | $93.9 | -14.7% |
| Operating margin | 16.4% | 19.8% | -3.4 percentage points |
| Net income | $37.2 | $52.1 | -28.6% |
| Net income available to common shareholders | $25.8 | $46.9 | -44.9% |
| Basic and diluted earnings per share | $0.16 | $0.31 | -48.4% |
| Operating cash flow | $57.9 | $38.4 | +$19.5 |
| Cash and cash equivalents at quarter-end | $23.8 | $10.9 at Dec. 31, 2016 | +$12.9 |
Hotel operating revenue rose 2.8% to $407.6 million and rental income rose 4.6% to $79.8 million. Hotel operating expenses increased 2.3%; depreciation and amortization increased 7.1%. General and administrative expense more than doubled to $32.3 million, primarily reflecting higher estimated business management and incentive fees, including a $19.6 million estimated 2017 incentive fee to RMR LLC. Interest expense increased 4.8% to $43.6 million.
FFO available to common shareholders, a non-GAAP measure, was $119.3 million ($0.73 per share), versus $134.2 million ($0.89 per share). Normalized FFO was $148.8 million ($0.91 per share), versus $140.2 million ($0.93 per share). Normalized FFO excludes or adjusts for items including estimated incentive fees and the preferred-share redemption charge; it is not a measure of cash generated.
Cash used in investing was $188.5 million, including $153.7 million for real estate acquisitions and $32.7 million for improvements. Financing provided $143.5 million. The $56.7 million of restricted FF&E reserve cash is separate from reported cash and cash equivalents.
At March 31, total debt principal was approximately $3.73 billion: $130 million drawn on the revolving facility, a $400 million term loan and approximately $3.20 billion of senior and convertible notes. The balance sheet reported $3.69 billion of debt carrying value. The company had $870 million available on its $1.0 billion revolving facility at quarter-end, and reported compliance with debt covenants. Total assets were $6.79 billion and total liabilities were $3.98 billion.
Material changes versus the prior comparable period
- Revenue grew, but operating income and net income declined, principally because of higher G&A and depreciation, increased operating costs, and interest expense.
- Common-share results were additionally affected by the $9.9 million excess of the redeemed preferred shares’ liquidation preference over their carrying value, and by an 8.4% increase in weighted-average common shares.
- Operating cash flow improved, while acquisition and improvement spending increased.
- The company issued $600 million of senior notes in January, including $200 million of 4.50% notes due 2023 and $400 million of 4.95% notes due 2027. It used proceeds in part to redeem all Series D preferred shares for approximately $291.4 million. It also repurchased nearly all remaining convertible notes.
- Two hotels were acquired for approximately $157.9 million: Hotel Allegro in Chicago and Hotel Alexis in Seattle.
Outlook, commentary, risks and unusual items
- Management said available funding sources were expected to cover operating and capital expenses, debt service and shareholder distributions for at least the next 12 months. This outlook depends on tenants’ and managers’ ability and willingness to pay rents and minimum returns and on access to financing.
- Management reported U.S. hotel industry growth in occupancy, ADR and RevPAR, but said its comparable hotels underperformed the industry. For 302 comparable hotels, ADR rose 0.9% to $125.03, occupancy increased 0.1 percentage point to 71.5%, and RevPAR rose 1.0% to $89.40. Renovations, new room supply and weaker local business activity were cited as factors.
- Hotel coverage was uneven: three of nine hotel operating agreements, representing 16% of annual minimum returns and rents, had trailing 12-month coverage below 1.0x (0.70x–0.88x). The Wyndham guarantee was depleted during the quarter; future payment support was uncertain. Sonesta had no guarantee or security deposit, and some shortfalls were not funded by operators.
- TA leased all 198 travel centers and represented 36% of gross real estate carrying value. Travel-center lease coverage was 1.53x for the trailing 12 months. The company expected to fund up to $53.8 million of TA capital improvements during the rest of 2017, which would increase contractual rent but might not produce sufficient operating gains at TA.
- The company expected approximately $32.5 million of hotel renovations and improvements for the remainder of 2017 and $18.7 million in 2018, excluding potential additional acquisition-related work. Renovations may disrupt operations, cost more than planned or fail to yield returns matching increased minimum payments.
- The company was litigating with Morgans and SBE over The Clift Hotel lease after alleging an unauthorized merger breached the lease. Morgans had paid rent through May 9, 2017, but HPT warned of possible future rent loss, legal costs and substantial renovation needs. Marriott had also notified HPT it would not renew its Kauai hotel lease when it expires in 2019.
- HPT expected to complete its announced $87.75 million Chase Park Plaza hotel acquisition in Q2 2017, subject to conditions. It acquired a Columbia, South Carolina travel center after quarter-end for $27.6 million. The common distribution was increased from $0.51 to $0.52 per share for the distribution declared in April.
- Related-party relationships are significant: RMR LLC manages HPT; Sonesta is owned by HPT’s Managing Trustees; and HPT has substantial tenant and investment relationships with TA. The filing identifies potential conflicts of interest. Management reported effective disclosure controls and no material change in internal control over financial reporting.
Important facts for investors to verify
- Whether hotel and travel-center operators sustain required rent and minimum-return payments, particularly given weak hotel coverage and the depleted Wyndham guarantee.
- Whether cash flows and normalized FFO support the common distribution after capital spending, debt service and the increased distribution rate.
- The impact and final amount of RMR LLC incentive fees; the $19.6 million Q1 estimate was not the final 2017 fee, which depended on full-year performance.
- TA’s capacity to meet current and deferred rent obligations, and the operating returns on HPT-funded travel-center improvements.
- Progress and financial consequences of the Morgans/SBE dispute, the Kauai lease expiration, hotel renovations and announced acquisitions.
- Debt refinancing needs, interest-rate sensitivity and continued covenant compliance. The filing estimated a $5.3 million annual interest-cost increase from a 100-basis-point rise on then-outstanding floating-rate debt.