Summit Hotel Properties, Inc. (INN) Q3 2012 Earnings Report, Transcript and Summary

Good day, ladies and gentlemen, and welcome to the Q3 2012 Summit Hotel Properties, Inc. Conference Call. My name is Catherine, and I will be your operator for today. [Operator Instructions] As a reminder, this call is being recorded for replay purposes. I would like to turn the call over to Dan Boyum, Vice President of Shareholder Relations. Please proceed, sir.

Thank you, Catherine, and good morning to all. I'm joined today by Summit Hotel Properties' President and Chief Executive Officer, Dan Hansen; and Executive Vice President and Chief Financial Officer, Stuart Becker. Dan and Stuart have prepared comments related to our third quarter release and filing. Following these comments, you will have an opportunity to address any related questions you may have. I remind everyone that many of our comments today are considered forward-looking statements, as defined by federal securities laws. These statements are subject to numerous risks and uncertainties, both known and unknown, as described in our 10-K for 2011 and our other SEC filings. These risks and uncertainties could cause results to differ materially from those expressed or implied by our comments. Forward-looking statements that we make today are effective only as of today, November 8, 2013. We undertake no duty to update them later. Our earnings release contains reconciliations to non-GAAP financial measures referenced during this call. If you do not have a copy of our release, you may view and print it from our website, shpreit.com. Please welcome Summit Hotel Properties' President and Chief Executive Officer, Dan Hansen.

Thanks, Dan. As you have all heard on calls with our peers, the fundamentals of the industry are solid. Demand growth and limited supply continues to provide an attractive environment for rate growth. We acknowledge that there are speed bumps in the road to recovery such as Hurricane Sandy, the fiscal cliff and continued worries in Europe, but the supply outlook for 2013 and 2014 remains at historic lows. And we see this is a terrific time for our industry and for Summit in particular. Our performance in the third quarter was ahead of The Street's expectation and reflects the steady pace of improvement and continued execution of our strategy. This outperformance was not a surprise to us. It has been part of our thesis we outlined in the previous quarters. The embedded growth in our portfolio, our newly renovated hotels, our accretive acquisitions and aggressive asset management strategy are the key drivers of this success. We see this trend continuing through the balance of 2012 and throughout 2013. So I will again reiterate our simple strategy, which is to realize the embedded growth in our existing portfolio and to create value through accretive acquisitions of top brands in top markets at great cap rates. We have been clear with our mission and have consistently delivered on that strategy. Our pro forma RevPAR growth of 11.6% for the third quarter was driven by a balanced mix of rate and occupancy. This compares to the third quarter industry results for upscale RevPAR growth of 5.6% and upper midscale growth of 5.2%. We're seeing exceptional performance in our same-store properties, and the properties we have acquired since our IPO are performing in line with expectations. We have also been very pleased with the performance of our renovated hotels. We said early on…

Thanks, Dan. Good morning, everyone. As Dan has previously noted, we had a very solid third quarter. Our revenue for the quarter was up nearly 27% from the comparable period of 2011. Revenue growth was driven by several factors, including the efficient -- or the effective -- the effective addition of hotels we acquired since third quarter 2011. The acquisitions as a group have met our first year revenue expectations. In addition, we rebranded 10 hotels over the past year. These hotels, as a group, have RevPAR growth ahead of the pace required to replace the lost EBITDA from the rebranding. Although the RevPAR growth from rebranding was exceptional, the 10 hotels amount to less than 10% of our overall revenue. We also completed major renovations at 11 of our hotels in the past year. This group of renovated hotels has met or exceeded our RevPAR expectations. Our portfolio has also benefited as general market conditions continue to improve and our operational team continues to focus hotel by hotel on revenue management. As Dan previously noted, we saw substantial pro forma RevPAR growth in the quarter. Q3 pro forma RevPAR growth was 11.6% as compared from the same quarter in 2011. This marks the second straight quarter of double-digit pro forma RevPAR growth for our company. Further, our pro forma RevPAR growth compares favorably with the U.S. hotel industry's 5.1% growth for the quarter. We're also pleased with the mix of ADR and occupancy realized in the quarter. ADR for the quarter was $97.72, an increase of 5.6% over the comparable period in 2011. Q3 occupancy was 73.9%, an increase of 5.7% over the comparable period in 2011. Considering the relative muted supply growth anticipated over the near term in many of our markets, we remain bullish about our ability…

Thanks, Stu. We appreciate your time and considerations joining our call. And as always, we welcome your questions. So let's open the lines.

[Operator Instructions] And your first question is from the line of Ryan Meliker from MLV & Co.

Just a couple of quick questions. First, with regards to the Minneapolis property, can you give us any detail on what the loan terms are? Are you going to be generating some type of interest income related to that loan until you take over the asset?

This is Stu. I'll take that question. It is -- it will act as a loan initially. We're going to lend them the dollars. Regarding interest, the interest that would be accrued on that would be netted against the fee income, though we'll pay the highest for the development. So at the time we purchase that loan, the net amount would be capitalized to the investment.

Okay. So in essence, you're not really seeing any level of interest income on your income statement, but it will be offset once you acquire the asset?

That is correct.

And can you give us some detail on what the interest rate is that's going to be offsetting that fee stream?

Yes. We're going to use the market rate, so I think somewhere in that 4% to 6% range.

Okay. That's helpful. And then the next question I had was you guys have now had 2 really strong RevPAR growth quarters of, I think, 12.9% same-store in both quarters. I guess how sustainable is this RevPAR growth for you guys, first? And second of all, if you strip out the renovations and rebranding efforts for your same-store portfolio, what would RevPAR have been?

Well, it's a great question. This is Dan. The outperformance is actually fairly balanced across the portfolio. Last quarter, we did break out the rebranded properties. We showed they need to have 22% RevPAR growth for the year to replace the lost EBITDA. And they are still running well ahead of that pace. But they are less than 10% of our EBITDA, so it's not skewing the numbers a whole lot. More telling really is the renovated properties, which are running ahead of the markets, as you pointed out. But we do have several acquisitions that we're seeing significant benefits with our revenue management strategy. So all in all, it's pretty broad based. We don't really comment on individual hotels. We're in 30 separate markets. But as our blend of rate and occupancy shows, we're still running ahead of the industry pace of that kind of mid-5s for upscale and upper midscale.

This is Stu. Ryan, regarding sustainability. You can think about, at least from the Choice disruption, that essentially we've got fourth quarter and first quarter of next year before that impact starts to lessen to some extent. But we think that, that will have some impact through '13. So we can factor that in a little bit in your thinking. As well as Dan talked about, we've seen, in certain markets where the renovation work has been done is really outsized growth to the numbers you're seeing on a nationwide basis. And how long it takes for those to -- we're stabilizing a lot of those assets. And I think that provides some upsize in '13 as well.

So it sounds like the assets that haven't been renovated or reflagged, you're running in, I guess, the mid-single digits but above where industry averages have been, and then it's the renovations and rebrandings that are really pushing that same-store number up to that 4.9%. Is that a good way to think about it?

That's a good way to think about it.

Okay. So then as some of those renovations and rebrandings run off, well, we'll see you guys perform closer to the industry average at least.

The next question comes from the line of Tim Wengerd.

I have a follow-up to Ryan's last question. If you think about the margin impact of the rebranded properties, is that also fairly broad based? Are you seeing that the rebranded properties are also driving a big chunk of that margin improvement as well?

I would think about margin expansion a little bit about thinking about the peak to trough of our company. If you look at us back in 2007, our peak on a RevPAR basis was probably $70, and our margins were more like 40%. Now you have to realize that we were a private company back then. As a public company, our margins won't be near to that 40%, but we think that 35% to 37% range is a reasonable expectation. And on RevPAR, since the last peak, we developed prior to IPO some 19 hotels that are coming on and are -- some of that embedded growth we talked about, plus we have acquired another 21 hotels that have RevPAR that were accretive to our existing portfolio. So we fully expect at the next peak, our RevPAR should be more like $75-plus. And currently, at the kind of trailing 12, we're about $62, $63. So there's plenty of embedded RevPAR growth, we believe, in our portfolio. And back to your question, just on what reasonable margin expansions we expect, yes, we had good margin expansions in part this quarter because we saw a better mix of rate and occupancy. But on a trailing 12 basis, where our margins are 32% or it could be, we believe, it's 400 to 500 basis points of more margin expansion should occur in our portfolio. And so if you think about it that way, I think that, yes, the Choice is having an impact, the renovation have an impact, but I think just the cycle of our portfolio, and we're right in it, should help us add some growth to it.

Okay. And then with respect to the Hyatt portfolio, have you had a chance to review the operations more closely and identify areas to improve margins? And how receptive has Hyatt been to this feedback?

Tim, this is Dan. We spent a lot of time with Hyatt prior to the transaction. So as evidenced by our ability to close it very quickly, we had a very high level of confidence that there were ways that we could work with Hyatt to create better margins and better growth. So they have gone through some reshuffling and have a great team in place. And we are really excited to implement not only our best practices but some creative strategies that they have to get operations better. So yes, part of our thesis is better margins, better operations, and Hyatt is fully engaged in helping us to achieve that.

Okay. In your comments, you mentioned land sales. Before and around the time of the IPO, you took some markdowns on your land. And so far, where have indications been -- pricing indications been for land relative to book value for land?

Right in line with where we have them priced. I mean, we have some properties that were -- have under contract at the same level we purchased them at and some a little less. These were properties, by and large, across middle America. They weren't high-dollar properties in urban centers. So there has -- in a lot of these markets, pricing has been fairly constant. There's not a lot of gain on those, but some of these are opportunities that we saw to buy larger chunks of land and parcel off as restaurant pads. So these were properties that were -- many of them that were never going to be hotels. They were just residual land for sale. So long answer but really more in line, on balance with where we hold them at.

Okay, that's helpful. On the renovations impact for the fourth quarter, I know renovations are not always an easy number to peg, or the renovation impact is not always an easy number to peg. But how much confidence do you have in the renovations impact estimate for the fourth quarter?

Well, we've obviously been doing this a long time through several cycles, up and down. All different brands on all different markets. So we feel our numbers are very tight around that. We've talked before, even last year, about our desire to do renovations in fourth quarter and first quarter where we have less occupancy, and we continue to do that. But again, we've been doing this a long time. So yes, we feel very comfortable with the numbers.

The next question comes from the line of David Loeb from Baird.

Mine aren't going to be all that original. I want to ask, actually, some follow-ups in different perspectives on both sets of those questions. Let me start with Ryan's. On the Hyatt ideal, Dan, can you just talk a little bit more about what you think replacement cost is in that market? Is it a market where new development is realistic or is it tough to develop? And what do you expect the returns from that to be once you take ownership?

All downtown urban CBD markets are tough to develop in. I think Minneapolis has a dynamic different than maybe some people are seeing in Manhattan. You can't build a new select service every mid-block across the city. So this Hyatt Place will be the only Hyatt Place in downtown Minneapolis. When we -- you remember way back from pre-IPO, we toured the building and we saw this as an opportunity. So we've been working on it for 2 years. Since we started working on it, the Vikings have decided to stay in the city. The new stadium is going in across the street. So there's going to be a lot of redevelopment and growth in and around the hub where our hotel is. It's on the skywalk system, which is a great benefit. We have seen several opportunities brought to us because of our presence there. In that $190,000 per key range, which seems to be a fair number as you look at construction cost, we'll be in well south of that. So we feel very comfortable with the price we would potentially be getting in at, the brand and the dynamics of the market.

So if I do the math, you're talking about more like $150,000 a key?

That's correct.

Okay. And what kind of returns do you think that will get? Is it going to take a while to ramp? Or do you think that will be a first year kind of 7% to 9% or in that range?

I think second year, we expect to be in that 8% to 10% cap range. I mean, first year is obviously a ramp year. I think it gets done towards the tail end of season. So we'll miss out on some of that summer business. But we talked early on about our desire to not just be an acquirer or a company that's involved in a big land grab in the space but to create value. And we would do some of these more deeper turns sparingly where it made sense. And this is one that we could have easily done a year ago on our balance sheet, but with the partnership with Hyatt, it was a really effective way for us to take advantage of or avoid some losses and get into an urban market with great upside. So I would say second year is fair to stabilize in that expected deal.

Great. And to Ryan's other question in terms of RevPAR growth and sustainability, can you just --can I flip that around and ask how is transient demand in the markets where you operate? We've heard from a lot of the other REITS, particularly with East Coast presence beneath and West Coast presence, that it looks like demand is slowing a bit in the fourth quarter, maybe in the second half in total. It doesn't look like you're seeing that in the third quarter, but how about the fourth quarter, October trends, things like that? What are you -- what's your outlook for the business travelers that shows up at your hotels?

Yes. It's been strong for us. There's no other way to say it. We're not going to try to put out a soft assessment. We still see strength in business transient and leisure transient. I think the upticks from the market seem to be that business transient is slowing. But we're not seeing it. We're continuing to pick up market share. Our renovated hotels continue to gain occupancy and rate. So the fourth quarter is always a weaker time. But we're not seeing in October a projection of anything less than we anticipate.

I think that's kind of important Stu -- Dan -- or David, this is Stu. But in that fourth quarter, particularly that business transient, we see a slowdown, obviously, that Thanksgiving to Christmas time; it's just a seasonal deal. So that's always a little bit of a choppiness for us relative to our mix of portfolio. But we certainly are not seeing any slowdown on a general basis.

So year-over-year, on a comparable basis, your business travelers are still showing up the way they did last year?

Correct.

Yes.

And finally, on the peak margin issue, I don't know if this is a Stu or a Dan question, but it's very insightful about where those margins and where the RevPAR was. But do you think you can go beyond that in this cycle?

Yes, I think that was -- this is Stu. I was -- one other thing I would like to add to that deal is we mentioned in our comments earlier that we do see muted supply. I just have not seen hotel supply in most of our markets. And so looking at that margin expansion and particularly where we find ourselves today at that 50-50 mix between rate and occupancy, we -- we're very bullish and positive about that margin expansion for the -- in the next few quarters and hopefully driven more by rate. And so without much of the supply coming into the market, we'd hope to hopefully be able to exceed expectations down the road.

It's also, if you look at just the composition of our portfolio, becoming more of an apple and oranges comparison. Our -- Craig Aniszewski, our Chief Operating Officer and I have sat down and gone through on property by property basis, GOP margins and where we can add value and grow. And this tails a little bit back to Tim Wengerd's question. We've got great margin and growth opportunities, fairly broad based across the board. But the hotels, the smaller hotels, many of which we have for sale, are the lower-margin hotels. And as we buy hotels, as we've demonstrated on this last portfolio, they're higher margin and higher RevPAR. So it does create a little bit of a difficult comparison. But as we replace older, smaller hotels with newer, bigger hotels, you would expect not only that margin expansion but that nominal RevPAR dollar to continually grow higher.

The next question comes from the line of Wes Golladay from RBC.

Once again, nice quarter. Looking at your Hyatt portfolio deal, how did you guys choose those assets, the specific ones you have? Was it market that you like? Or was it the asset management opportunities? Or do you gain any synergies with the existing portfolio?

The short answer is yes. We looked at many different assets and many different opportunities with Hyatt. We've been working with Hyatt for about 4 years. We purchased Hyatt properties off of their balance sheet back as a private company. We did one conversion to a Hyatt Place and one to a Holiday Inn Express that was very near the other AmeriSuites. So we've known about the properties. Many of these properties are in markets we're already in. So we know the markets very well. They are a good overlay to what we have. So I think it's exactly the way you laid it out. It's a blend of all the opportunities that make this a great portfolio. We didn't try to pick the top RevPAR hotels in the top markets. We came up with a portfolio that strategically made sense and really rings the bells on all those factors.

Okay. Do you see additional opportunities for another portfolio deal with Hyatt?

Well, we're always open to opportunities. The challenge we have is, as we've talked about before, we keep a fairly active pipeline, and properties come along from time to time and small portfolios that may be more attractive than something else we're currently looking at, and that moves to the top of the list. The Arlington assets are a great example. They were newer. They were running at great operating metrics, and we got them at a great price. So those 2 assets came in relatively late and moved to the top of the list. So our pipeline is fairly fluid. We definitely would not rule out further acquisitions from Hyatt. Part of our thesis is growing relationships with Hyatt and IHG and Hilton and Marriott, and where that makes sense, we'd definitely take a look at it.

Okay. And you also mentioned that you might bring 2014 renovation programs into 2013. Can you give us an idea of the timing, as well as the CapEx for those projects?

On timing, I think it's a little bit challenging. We're finishing our budgets and looking at projects and where we think the points of opportunity are. But as we talked about early on, we were going to do some renovations and show the markets that we were able to get great returns from those. So as we've seen the results of those, some of the best potential ROIs are really within our existing portfolio. So we're still on the process of outlining our plan for 2013, but we're good stewards of investors' capital. And we'll make sure that as we announce those, we'll have very valid reasons for doing so, and where we can identify great opportunities, we will.

Okay. And one last modeling question. On the G&A, it was a little higher than we had expected. Is this a good run rate? Or is there anything onetime in nature going on here?

Yes. I would think that there's a little bit of onetime in nature. We did increase the G&A a little bit. A majority of that had to do with the bonus plan we put in place for management. If you recall, when we came out at IPO on our first year, we had sort of an all-or-nothing bonus plan based on a Hotel EBITDA number. And obviously, with the Choice disruption and all of that issues last year, we stopped accruing for that and didn't pay a bonus in '11. So in '12, second quarter, we've announced a proxy, and we've got a new plan in place. And so within the third quarter, we started accruing some dollars for the bonus plan. It was about $0.5 million in the third quarter. And so that is -- that runway for third and fourth quarter, we assume there'll be another $0.5 million loaded in there in anticipation that we did some hurdles and there's a bonus plan in place. So that's impactful for the balance of the year. I would look at it this way. If you want to look like at our core G&A, on a run rate basis, an annual basis of somewhere between $7 million and $7.5 million, just kind of where we're at, and then figure out a bonus would be on top of that.

[Operator Instructions] The next question is from the line of Dan Donlan from Janney Capital Markets.

Dan, this is the second quarter in a row that you guys handily outperformed your guidance on the RevPAR growth, I think about 400 basis points at least. What's the delta versus what your expectations were going into the quarter? Is it more occupancy driven? Is it more rate driven? Just your thoughts there would be helpful.

You mean what drove the outperformance?

Yes.

I think it was really a balance of the 2. I hate to keep going back to the balance of the 2, but it was fairly broad based. It's pretty easy to look at, the rebranded hotels, and we had a pretty solid run rate for those, and the renovated hotels. But if you think back to our thesis of outside the gateway markets, there was a lagging effect, it just took longer than we thought. It wasn't 9 months like it was in the last cycle. It was probably 15 months. So we wanted to be cautious. And I think that being a little bit aggressive, we could have reduced that delta and dialed it in a little tighter. But now that it's here, we feel real confident in our numbers and still expect to outperform, but not by such a wide margin. Does that help?

Yes. I guess I was just curious, is kind of the short booking window making it harder for you guys to gauge, kind of how demand is trending and that's kind of why you guys have handily outperformed.

I guess that maybe could be part of it. I would say it's -- trends are a trend, absent a significant event like a hurricane or a terrorist attack. Demand just doesn't go up and down. There's not as much volatility as you might think. It would be a trend. So we should be able to identify weakness and softness inside of a quarter and better able to create optics around what that expectation is going to be. So I wouldn't say it's all a shorter booking window that obviously gives us some flexibility. But as of right now, we have -- we've got a pretty good feel for where October was. And that gives us some strong confidence in where we'll end the year.

Okay. And then from a RevPAR growth standpoint by month, do you happen to have that handy?

Month for the third quarter?

Yes. For the same store?

I do not.

Okay. If you don't have, what about -- and sorry to belabor this point, but do you have the number also for what the growth would have been, what the growth would have been x all the former Choice assets?

If you -- Stan, this is Stu. So you want to net out the Choice assets and then look at that RevPAR growth in the quarter?

Yes. Either same store or pro forma.

I would say that, that's still upper single-digit number.

Okay, okay, good. And then as it pertains to the land sales that you guys are anticipating, is that land going to be developed as a hotel? Kind of who is the buyer there? And are any of these land parcels in close proximity to any of your existing assets?

The 2 parcels we have under contract are restaurant pads. So they are in close proximity and would be a benefit to the hotels we have there.

Okay, good. And then as far as the Hyatt Place or the Hyatt portfolio that you bought, did you guys have to show the management agreement to interstate? Or was there anything going on there? Just more or less curious than anything else.

No. Totally separate.

I would now like to turn the call over to sir Dan Hansen for closing remarks.

Thank you. At Summit Hotel Properties, we're confident in our plan to create superior shareholder returns through continued margin expansion in our existing portfolio, accretive acquisitions in top markets and by maintaining a strong balance sheet. We appreciate your time and to join the call today and look forward to our next update. Thanks, everyone.

Ladies and gentlemen, thank you for joining in today's...