Business context and reporting period
Sunstone Hotel Investors, Inc. is a self-managed REIT that owns and asset-manages U.S. hotels operated by third-party managers. This unaudited Form 10-Q covers the quarter and six months ended June 30, 2017. The company held interests in 26 hotels at quarter-end.
Financial and operating performance
| Metric | Q2 2017 | Q2 2016 | Six months 2017 | Six months 2016 |
|---|---|---|---|---|
| Revenue | $318.8m | $322.2m | $599.5m | $596.5m |
| Operating income | $62.7m | $63.4m | $93.0m | $84.5m |
| Operating margin | 19.7% | 19.7% | 15.5% | 14.2% |
| Net income | $51.4m | $65.7m | $115.2m | $67.0m |
| Income attributable to common stockholders | $46.0m | $57.3m | $104.7m | $54.1m |
| Diluted EPS | $0.21 | $0.26 | $0.47 | $0.25 |
| Operating cash flow | — | $154.3m | $149.2m |
Comparable-portfolio RevPAR rose 2.5% in Q2 and 3.9% for the first half; occupancy declined 60 and 30 basis points, respectively, while ADR increased 3.2% and 4.3%. Adjusted EBITDA was $102.3m in Q2 (versus $101.1m) and $171.8m for the first half (versus $163.0m). Adjusted FFO attributable to common stockholders was $84.9m in Q2 (versus $83.2m) and $138.0m for the first half (versus $127.4m).
At June 30, cash and cash equivalents were $597.3m and restricted cash was $66.4m. Notes payable totaled $994.8m principal; total liabilities were $1.15bn. About 77.8% of debt was fixed-rate, including swaps; weighted-average debt interest rate was 4.3%, and weighted-average maturity was approximately six years. A 100-basis-point change in variable rates was estimated to affect annual earnings and cash flows by about $2.0m before the joint-venture noncontrolling interest ($1.5m after it. The company reported a $400m unsecured credit facility; available capacity is not clearly stated in the filing text.
Material changes versus prior comparable periods
- Q2 revenue declined 1.0%, while first-half revenue increased 0.5%. The first-half increase in operating income and net income included higher gains on asset sales and lower interest expense.
- First-half 2017 gain on asset sales was $45.5m, including $44.3m from the Fairmont Newport Beach sale and $1.2m from Marriott Park City. Q2 2017 included only the $1.2m Park City gain, versus $18.2m from the Sheraton Cerritos sale in Q2 2016.
- Interest expense fell 17.6% in Q2 and 32.2% in the first half, partly reflecting lower debt balances and lower derivative losses.
- The company issued $240m of senior notes at 4.69% and 4.79%, due in 2026 and 2028, and used proceeds in part to repay a $176m, 5.58% Marriott Boston Long Wharf loan. It raised $74.8m net through ATM common-stock sales, issuing about 4.7m shares.
- Capital improvements were $59.5m in the first half, versus $100.0m in the prior-year period. Outstanding renovation and construction commitments were $50.3m.
Outlook, commentary, risks and unusual items
The filing provides no formal numerical earnings or operating guidance. Management said it intends to preserve balance-sheet flexibility and low leverage, and expects to fund future acquisitions primarily with cash, equity issuance or asset-sale proceeds. It cited improved results at the Boston Park Plaza and Wailea Beach Resort following repositioning, but also described weak convention calendars in Baltimore and New Orleans, a weak Houston energy market, increased competition in some markets, and elevated new hotel supply in several cities.
In July 2017, after quarter-end, the company acquired the 175-room Oceans Edge Hotel & Marina in Key West for $175m, funded with available cash, sale proceeds and ATM equity proceeds. The company reported pro forma unrestricted cash of $422.3m after that purchase. It had $50.3m of construction commitments and $354.96m of operating lease obligations. Risks discussed include hotel demand and supply, operating-cost inflation, renovations, manager and brand relationships, REIT qualification, debt and covenants, interest rates, geographic concentration, cyber risks and events affecting travel. Management said pending claims and litigation were not expected to have a material adverse effect; the filing lists no legal proceedings and no new risk factors.
The company expects to adopt revenue-recognition changes in 2018 and was evaluating their impact, including possible effects on timing of hotel-sale gains. The filing also identifies upcoming lease-accounting changes and other accounting standards; impacts were generally still under evaluation. Disclosure controls were deemed effective, with no material change in internal control reported.
Important facts for investors to verify
- How much of first-half earnings growth reflects recurring hotel operations versus the $45.5m asset-sale gain, and whether Adjusted EBITDA and FFO trends persist.
- Post-acquisition liquidity, remaining credit-facility availability, debt maturities and the effect of the Oceans Edge purchase on leverage and returns.
- Whether RevPAR growth can continue amid occupancy declines, market-specific weakness, new supply and operating-cost pressures.
- Execution and funding of the $50.3m construction commitments and planned hotel capital needs.
- Potential effects of revenue-recognition and lease-accounting standards, and exposure to geographically concentrated markets and variable interest rates.