Business context and reporting period
Hospitality Properties Trust (HPT; the company now identified in the request as Service Properties Trust) filed this unaudited Form 10-Q for the quarter ended June 30, 2017. HPT was a REIT owning 310 hotels and 199 travel centers; it did not directly operate its properties. Hotel operations were managed by third parties, while all travel centers were leased to TravelCenters of America (TA). Unless stated otherwise, financial amounts below are in millions of dollars.
Financial performance and position
| Metric | Q2 2017 | Q2 2016 | First half 2017 | First half 2016 |
|---|---|---|---|---|
| Total revenue | $570.6 | $550.3 | $1,059.2 | $1,024.4 |
| Operating income | $105.6 | $99.1 | $185.6 | $193.0 |
| Net income | $60.7 | $56.1 | $97.9 | $108.1 |
| Net income available to common shareholders | $60.7 | $50.9 | $86.5 | $97.8 |
| Basic and diluted earnings per share | $0.37 | $0.34 | $0.53 | $0.65 |
Operating margin was approximately 18.5% in Q2 2017 versus 18.0% a year earlier, and 17.5% for the first half versus 18.8%. Q2 revenue rose 3.7% and net income rose 8.3%; first-half revenue rose 3.4%, while operating income and net income declined 3.8% and 9.5%, respectively. First-half common EPS also reflected the higher share count following an August 2016 share offering and a $9.9 million charge for the excess of liquidation preference over carrying value on redeemed preferred shares.
For the first half, operating cash flow was $255.9 million, investing cash outflow $423.0 million, and financing cash inflow $205.9 million; cash and cash equivalents ended June at $49.7 million. Operating cash flow increased from $231.5 million in the prior-year period, while investing outflow rose from $284.9 million, primarily with higher acquisitions. HPT reported first-half FFO of $275.1 million ($1.68 per share), compared with $273.8 million ($1.81 per share); Normalized FFO was $322.4 million ($1.96 per share), versus $305.9 million ($2.02 per share). These are non-GAAP measures; the company cautions they are not substitutes for GAAP earnings or operating cash flow.
At June 30, total assets were $6,973.4 million and total liabilities $4,193.3 million. Debt principal was approximately $3.878 billion: $3.2 billion of senior notes, a $400 million term loan, and $278 million drawn on a $1.0 billion revolver. The company reported $722 million of unused revolver capacity at quarter-end. The revolver matures July 2018, with a conditional one-year extension option; the term loan matures April 2019. HPT said it was in compliance with its debt covenants. The quarterly common distribution was raised to $0.52 per share from $0.51; the next $0.52 distribution was declared in July.
Material changes versus the prior comparable period
- Hotel operating revenue increased 3.5% in Q2, but hotel operating expenses grew 4.5%. Acquisitions contributed to both increases; management also cited wage and benefit costs, marketing and other costs, partially offset by lower costs at hotels under renovation.
- Comparable hotels’ Q2 occupancy fell 0.9 percentage points to 79.8%, ADR rose 0.8% to $127.78, and RevPAR declined 0.3% to $101.97. For the first half, comparable RevPAR rose 0.3%. HPT said its results generally lagged the U.S. hotel industry, citing renovation disruption, new room supply and weaker business activity in some markets.
- Interest expense increased 8.4% in Q2 and 6.6% in the first half, reflecting higher average debt outstanding and interest rates. First-half general and administrative expense increased 17.4%, primarily due to higher estimated business-management incentive fees.
- HPT issued $600 million of senior notes in January, redeemed all $290 million liquidation preference of its Series D preferred shares in February, and repurchased its remaining convertible notes. The preferred redemption eliminated Q2 preferred distributions but resulted in the $9.9 million first-half common-income charge.
- HPT acquired four hotels and one travel center during the first half for aggregate purchase prices of about $362.4 million, including capitalized acquisition costs. Net real estate increased to $6,467.3 million from $6,209.4 million at year-end.
Outlook, commentary, risks and unusual items
Management said operating cash sources and available financing were expected to cover operating and capital expenses, debt service and shareholder distributions for the next 12 months and foreseeable future, but warned that weaker property performance or nonpayment by managers and tenants could require a distribution reduction. The filing provides no formal earnings guidance.
Planned and anticipated investment remained significant: HPT expected about $39.3 million of hotel renovation and improvement spending during the rest of 2017 and $30.7 million in 2018, with additional spending tied to acquisitions. It expected about $32.9 million of travel-center improvements during the remainder of 2017, subject to TA requests. Subsequent to quarter-end, HPT acquired a Columbus hotel and announced or contracted for additional hotel acquisitions; it also sold one hotel and had other sales pending. These transactions were subject to conditions, and completion or terms were not assured.
Property coverage and payment protections were uneven. Four of nine hotel agreements, representing 18% of annual minimum returns and rents, had trailing 12-month coverage below 1.0x (0.72x–0.90x). The Wyndham guarantee was depleted after covering first-half shortfalls; HPT said it could not be sure Wyndham would continue paying minimum returns. Certain Sonesta shortfalls were unguaranteed. Across travel centers, trailing coverage was 1.52x. Overall, 79% of annual minimum returns and rents were covered by guarantees or security deposits, but these protections may be limited, depleted or expire and do not necessarily generate additional cash when applied.
Other notable risks include the Morgans/SBE dispute over The Clift Hotel lease: HPT pursued litigation, incurred legal costs and warned of possible lost rent and substantial renovation needs, although rent had been paid through August 8, 2017. Marriott had notified HPT it would not renew the Kauai hotel lease at its 2019 expiration. HPT also disclosed a business-email-compromise fraud involving a property-acquisition wire transfer; RMR reimbursed the funds in Q2, so it had no financial-statement effect. HPT enhanced electronic-payment controls and said disclosure controls were effective. Related-party arrangements—including management by RMR, TA’s role as largest tenant and Sonesta’s ownership by HPT’s Managing Trustees—are significant. Interest-rate sensitivity was material: a 100-basis-point increase would add approximately $6.8 million of annual interest expense on quarter-end floating-rate debt.
Investor verification priorities
- Confirm current hotel and travel-center coverage, especially the depleted Wyndham guarantee, unguaranteed Sonesta exposure and the ability of operators to pay contractual minimums.
- Track comparable hotel occupancy, ADR and RevPAR, renovation-related disruption, and whether performance improves relative to industry trends.
- Verify the completion, funding and returns of announced acquisitions, dispositions and renovation commitments, including Carlson hotel sales and planned improvements.
- Assess debt refinancing needs, the 2018 revolver maturity, floating-rate exposure, covenant headroom and distribution coverage by cash flow.
- Monitor the Morgans/SBE litigation and Clift Hotel operating, rent and capital requirements; also track the Kauai lease beyond 2019.
- Review related-party governance and fees, including estimated RMR incentive fees, and verify that payment-control enhancements mitigate fraud risk.