Sunstone Hotel Investors, Inc. — Q2 2014 Form 10-Q
Reporting period: Three and six months ended June 30, 2014. Sunstone is a REIT that owns and asset-manages hotels operated by third-party managers. At quarter-end it held interests in 29 hotels with 13,760 rooms; the July 2014 Wailea resort acquisition occurred after the reporting date. Unless noted otherwise, dollar amounts below are in millions.
Financial performance and liquidity
- Second-quarter revenue: $300.9, up 28.2% year over year; operating income was $55.9 versus $36.6, and net income was $43.5 versus $20.0. Income available to common stockholders was $39.3, or $0.22 per diluted share, compared with $15.1, or $0.09.
- First-half revenue: $544.3, up 26.7%; operating income was $70.2 versus $40.2. Net income was $40.0 versus $48.9, while income available to common stockholders was $31.3 versus $32.7, or $0.17 versus $0.21 per diluted share. The prior-year period included a $51.6 gain on the Rochester portfolio sale; 2014 included a $5.2 discontinued-operations gain.
- Margins: Operating margin was approximately 18.6% in Q2 versus 15.6% a year earlier, and 12.9% for the first half versus 9.4%. Adjusted EBITDA was $94.5 in Q2 and $143.8 for the first half, up from $70.3 and $108.7; respective adjusted EBITDA margins were approximately 31.4% and 26.4%, versus 30.0% and 25.3%.
- Comparable hotel trends: Q2 RevPAR rose 6.2% (occupancy +220 basis points; ADR +3.5%). First-half RevPAR increased 7.4%, or 7.2% adjusted for Marriott’s reporting-calendar change. Results were also affected by acquisitions and renovations, so reported revenue growth is not solely same-property growth.
- Cash flow: First-half operating cash flow was $117.8, versus $74.5. Investing cash outflow was $88.4, including $65.8 of hotel renovations and additions and an $11.0 land purchase. Financing provided $226.9, primarily from common-stock issuance. Cash and cash equivalents ended at $360.7; restricted cash was $88.0.
- Debt and liquidity: Notes payable totaled $1.392 billion; total liabilities were $1.549 billion. Approximately 70.7% of debt was fixed-rate, with a 4.9% weighted-average rate and about three years’ weighted-average maturity. The filing reports $122.8 of notes payable due within one year. Management said liquidity was expected to cover needs for at least 12 months. After the July Wailea acquisition, pro forma unrestricted cash was approximately $90.7.
- Capital and distributions: The June common-stock offering generated approximately $262.5 net proceeds from 18 million shares. Common dividends declared were $0.05 per share for Q2 and $0.10 year to date. The company had 199.4 million common shares outstanding at June 30.
Material changes and unusual items
- Revenue growth reflected three hotels acquired in 2013, as well as improved existing-hotel performance; the acquired hotels contributed $35.8 of Q2 room revenue and $60.6 for the first half.
- Three hotels had major room renovations during some or all of the first half of 2014. Management estimated renovation-related revenue disruption of $2.6 for the first half, compared with $7.7 in the 2013 period, when four hotels underwent major renovations.
- In June, Sunstone acquired the land beneath the Fairmont Newport Beach for $11.0. On July 17, it completed the $325.5 net purchase of the 544-room Marriott Wailea, funded with offering proceeds, $60.0 of stock issued to the seller, and cash.
- Sunstone recognized $5.2 of discontinued-operations income in Q2, including release of $7.0 of a Rochester pension-plan liability, partly offset by a new $1.8 accrual for potential capital expenditures. The company retained a further $7.0 pension-related exposure; the timing or likelihood of release is uncertain.
- In July, the Hilton San Diego Bayfront partnership agreed to amend its $229.7 mortgage: the proposed terms extend maturity from 2016 to 2019 and reduce the spread from 325 to 225 basis points. The amendment was expected to close in Q3 and carried anticipated fees of about $1.3.
Outlook, risks, and contingencies
- Management described lodging demand as improving and anticipated continued strength if the U.S. economy and employment continued to grow. It emphasized portfolio quality, disciplined acquisitions, low leverage, and financial flexibility. The filing provides no specific earnings or RevPAR guidance.
- Key risks include economic and lodging-demand volatility, hotel operating-cost inflation, renovation disruption and capital needs, brand and manager relationships, hotel competition and local supply growth, refinancing and interest-rate exposure, REIT compliance, and geographic concentration. Nine of the 29 hotels were subject to ground, building, or air leases.
- First-mortgage and management/franchise agreements require FF&E reserves; $42.6 was held in such reserves at June 30. Outstanding renovation and construction commitments were $49.2. Total contractual obligations were $2.296 billion, including debt, interest and lease obligations.
- A 100-basis-point change in variable rates was estimated to affect annual cash flows by approximately $4.1 and earnings by $3.5 after non-controlling interests. The two variable-rate mortgages were subject to interest-rate caps; the San Diego cap matures in April 2015 and the Times Square cap in October 2015.
- Other exposures include environmental indemnities and $0.8 of letters of credit for workers’ compensation obligations; no draws had been made. Management reported no legal proceedings, no material control changes, and effective disclosure controls.
Important facts for investors to verify
- How much of revenue and adjusted EBITDA growth came from same-property performance versus acquisitions, and how renovation activity affected comparable results.
- The final cost, funding mix, and operating contribution of the Wailea acquisition, including the impact of the common-stock issuance and reduced post-acquisition cash balance.
- Whether the Hilton San Diego Bayfront loan amendment closed on the stated terms and how upcoming debt maturities will be refinanced or repaid.
- The resolution and cash impact of the remaining Rochester pension liability and the $2.1 accrued capital-expenditure contingency.
- Whether operating cash generation can sustain renovation spending, contractual commitments, debt service, and dividends while preserving management’s stated liquidity and leverage objectives.