Sunstone Hotel Investors, Inc. — Q3 2012 Form 10-Q
Reporting period: Quarter and nine months ended September 30, 2012. Sunstone is a self-managed REIT that owns and asset-manages hotels, which are leased to its taxable REIT subsidiary and operated by third-party managers. It held interests in 30 hotels at quarter-end.
Financial performance and position
| Metric | Q3 2012 | Q3 2011 | Nine months 2012 | Nine months 2011 |
|---|---|---|---|---|
| Total revenue | $221.1m | $197.5m | $642.8m | $551.1m |
| Operating income | $19.3m | $1.1m | $58.7m | $26.3m |
| Operating margin | 8.7% | 0.6% | 9.1% | 4.8% |
| Net income (loss) | $39.6m | $(16.6)m | $38.4m | $73.7m |
| Income available to common stockholders | $30.9m | $(24.0)m | $14.3m | $53.0m |
| Adjusted EBITDA | $60.1m | $52.4m | $174.3m | $148.5m |
| Adjusted FFO | $31.6m | $23.7m | $87.4m | $67.6m |
Operating margins are calculated as operating income divided by revenue. Q3 comparable-portfolio RevPAR rose 5.1% year over year, with occupancy up 230 basis points to 80.7% and ADR up 2.1% to $171.02. For the first nine months, RevPAR increased 6.2%, occupancy rose 330 basis points to 78.9%, and ADR increased 1.8% to $170.29. Management reported year-to-date comparable-portfolio operating flow-through of approximately 45.7%.
- Cash flow: Nine-month operating cash flow was $129.3m, versus $119.0m. Investing activities used $159.2m, versus $311.3m; financing activities provided $44.6m, versus $75.6m. Cash and cash equivalents were $164.5m at quarter-end.
- Liquidity: Cash plus restricted cash totaled $241.3m. The $150m revolving credit facility had no borrowings, with $3.8m of letters of credit outstanding. Management said available cash, operating cash flow, capital-market access and unencumbered properties should cover foreseeable needs, including at least the next 12 months.
- Debt: Notes payable totaled approximately $1.396bn, including $77.6m current; total liabilities were $1.528bn. Debt had a 5.3-year weighted-average maturity, a 5.0% weighted-average rate, and was 70.2% fixed-rate at a weighted-average 5.5% rate. A 100-basis-point change in variable rates was estimated to affect annual interest expense and cash flows by approximately $4.3m.
- Capital allocation: Nine-month hotel acquisitions used $120.0m and renovations/additions used $76.6m. The company raised approximately $126.2m net in a common-stock offering and issued 5.45m shares as part of the Hyatt Chicago acquisition. Preferred dividends were $22.3m for the nine months.
Material changes versus comparable periods
- Revenue grew 11.9% in Q3 and 16.6% for the first nine months. Growth reflected stronger comparable-hotel performance and acquisitions, including the Hyatt Chicago Magnificent Mile and Hilton Garden Inn Chicago Downtown/Magnificent Mile; reported results also reflect changes in the portfolio.
- Q3 net income included $38.1m of gains on hotel and property sales in discontinued operations. The nine-month 2012 result also included $38.3m of sale gains. By contrast, 2011 nine-month results included a $69.2m gain on remeasurement of equity interests and an $18.1m discontinued-operations gain on extinguishment of debt. These items make GAAP net income comparisons less indicative of underlying hotel operations.
- Nine-month common-stockholder income fell to $14.3m from $53.0m, despite higher revenue and Adjusted EBITDA, primarily reflecting the absence of the 2011 remeasurement gain, higher interest expense and increased preferred dividends.
- In August and September, Sunstone sold the Marriott Del Mar and a portfolio of three hotels and an adjacent office building. Buyers assumed $122.6m of mortgages in total; reported net proceeds were $17.7m and $28.6m, respectively.
- In September, Sunstone amended its $150m revolver: maturity extended to November 2015, with an option through November 2016; pricing fell to 175–350 basis points over LIBOR from 325–425 basis points, and the 1% LIBOR floor was removed. An accordion feature permits requests to increase commitments to $350m.
Outlook, risks and unusual items
- Management characterized the lodging market as being in a recovery phase, citing improving demand and constrained new supply, and expected demand to remain strong over the next several quarters as the economy strengthens. The filing gives no formal earnings or RevPAR guidance.
- Management expects near-term acquisitions to be funded with a greater proportion of equity than debt, consistent with its goals of improving credit ratios and gradually reducing leverage. It expected to repay the remaining $58m Senior Notes balance at the January 2013 first put date using existing cash.
- The Hyatt Chicago acquisition includes a planned $25m renovation, partly funded by Hyatt. Renovation contracts outstanding totaled $31.8m; required FF&E reserves were $45.3m. Renovations can disrupt operations and revenue.
- After the hotel sales, $8.1m of cash remained in lender-controlled cash-management accounts under cash-trap provisions; release to buyers and return to Sunstone was expected in the near term, but had not occurred by quarter-end.
- Risks include lodging-cycle and economic weakness, rising operating costs, competition, dependence on hotel managers and brands, capital needs, debt and refinancing, and geographic concentration. California generated 31% of Q3 revenue; California, New York and Chicago together represented 57%.
- Contingencies include environmental indemnities without stated term or damage limits, $3.8m of letters of credit, and employee litigation settlements. Sunstone expected a maximum of $0.7m in costs for one unresolved claim and accrued $0.3m for a separate settlement. The filing reported no legal proceedings in Part II, no defaults on senior securities, and no newly listed risk factors.
Most important facts for investors to verify
- How much of revenue and Adjusted EBITDA growth came from same-property performance versus acquisitions, dispositions and changes in the reporting portfolio.
- Whether the $8.1m cash-trap balance was released, and whether the company repaid the $58m Senior Notes at the January 2013 put date.
- Actual renovation spending, including the $25m Hyatt Chicago plan and the $31.8m contractual commitments, and any resulting room closures or operating disruption.
- Debt maturities, variable-rate exposure and compliance with debt and preferred-stock covenants; management said it did not expect a Series C preferred-stock ratio violation.
- The effect of common-equity issuance and preferred dividends on per-share returns and cash available for investment and distributions.
- Underlying results excluding sale gains and other unusual items; the filing cautions that non-GAAP measures such as Adjusted EBITDA and Adjusted FFO are not substitutes for GAAP results or cash flow.