Summit Hotel Properties, Inc. (INN) Q3 2015 Earnings Report, Transcript and Summary

Good day, ladies and gentlemen, and welcome to the Q3 2015 Summit Hotel Properties Inc. Earnings Conference Call. At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session and instructions will be given at that time. [Operator Instructions]. As a reminder, this conference is being recorded. I would now like to hand the presentation over to Mr. Adam Wudel, Vice President of Finance. Mr. Wudel, you may begin your conference.

Thank you, Chelsea, and good morning. I’m joined today by Summit Hotel Properties President and Chief Executive Officer, Dan Hansen; and Executive Vice President and Chief Financial Officer, Greg Dowell. Please note that many of our comments today are considered forward-looking statements as defined by federal securities laws. These statements are subject to risks and uncertainties, both known and unknown, as described in our 2014 Form 10-K and other SEC filings. Forward-looking statements that we make today are effective only as of today, November 03, 2015, and we undertake no duty to update them later. You can find copies of our SEC filings and earnings release which contain reconciliations to non-GAAP financial measures contained on this call on our Web site at www.shpreit.com. Please welcome Summit Hotel Properties' President and Chief Executive Officer, Dan Hansen.

Thanks, Adam, and thank you all for joining us today for our third quarter 2015 earnings conference call. We are very pleased with the strong bottom line results that our portfolio delivered and remain encouraged by the fundamentals we see heading into the end of the year. For the third quarter, we recorded adjusted FFO of $32 million, which is a 24.6% increase over the third quarter of 2014. Our AFFO per share increased 24.4% from the third quarter of 2014 to $0.37 per diluted share. On a pro forma basis, we posted RevPAR growth of 4.9% for the quarter, which was in line with our outlook and as a reminder was on top of 15.1% growth in the comparable period last year. Our RevPAR growth was driven by a 5.1% increase in average daily rates and an occupancy decline of 0.2% to 79.7%. When excluding our two Hilton Garden Inn hotels in Houston, Texas and the three hotels that experienced guestroom displacement, pro forma RevPAR growth for the quarter was 5.9%. Our hotels in the Houston market continued to be challenged having posted a RevPAR decline of 8.3% for the quarter as compared to the broader Houston MSA of posting RevPAR decline of 3.7%. Having said that, our Houston hotels outperformed their respective competitive sets by approximately 30 basis points in the quarter, which is a credit to our accounted asset management team and their partnership with our third-party management company. I’d like to provide a bit of color on the hotels that had guestrooms out of service during the quarter. We are nearing completion of the repairs related to a hailstorm that affected our Hyatt House in Denver, which equated to approximately $300,000 of displaced room revenue in the quarter. In addition, the Hampton Inn & Suites in Downtown Austin had the bathrooms renovated in the guestrooms and the Hyatt Place in Downtown Minneapolis had the planned exterior work completed that resulted in approximately $400,000 of additional displacement. A bright spot for summer was the San Francisco market, which continued to be strong having delivered 8.5% RevPAR growth in the third quarter, which compares favorably to the broader San Francisco MSA of 5.5% reported by Smith Travel Research. Our hotel in the Fisherman's Wharf submarket experienced more modest performance posting RevPAR growth of 3.5% in the quarter and our two hotels located near the corporate office park and the San Francisco International Airport performed exceptionally well with 14.4% RevPAR growth in the quarter. Moving on to acquisitions. During the quarter, we closed on two acquisitions for an aggregate purchase price of $56.8 million or approximately $235,000 per guestroom. Subsequent to quarter end, we acquired the Hyatt House in Miami and the Courtyard by Marriott in the Atlanta suburb of Decatur for $83 million or approximately $248,000 per guestroom. We are thrilled with the initial strength in RevPAR growth of our recent acquisitions. The last six hotels we’ve acquired beginning with our Hampton Inn at the Boston suburb of Norwood and ending with the Courtyard by Marriott in the Atlanta suburb of Decatur delivered 80.2% RevPAR growth in the quarter on a pro forma basis. Leading the way for this group of the newly acquired hotels at a stellar 17.6% RevPAR growth for the quarter was our Hotel Indigo in Asheville, North Carolina that we acquired on June 30. To be able to add acquisitions of this quality in geographic locations with exhibit strong growth profiles, multiple demand generators and have the strong operational model of premium select service continues to be a key differentiator of our company and the validation of our strategy we have employed throughout the cycle. We completed the sale of the first tranche of hotels and our capital recycling initiative to affiliates of American Realty Capital Hospitality Trust on October 15, which consist of 10 hotels for a combined price of $150.1 million. The sale of the remaining 16 hotels is scheduled to close in two separate tranches totaling $197.3 million with expected sales dates in December of 2015 and the first quarter of 2016. Since the transaction to sell 26 hotels was announced in June of this year, we have completed $198.8 million of acquisitions and have an additional $109 million under contract. We have match funded the first tranche and on pace to have this transaction fully match funded. Completing this first phase of the transformation to higher RevPAR assets in markets with strong growth profiles is a milestone that demonstrates our team’s thoughtful view on capital allocation and a subsequent value creation. With that, I’ll turn the call over to our CFO, Greg Dowell.

Thanks, Dan, and good morning, everyone. In the third quarter of 2015, we were very pleased with our operating performance and the continued strength of the overall U.S. lodging industry. On a pro forma basis, our hotel EBITDA in the third quarter of 2015 increased to $47.1 million, which was an increase of 5.5% over the same period in 2014. Third quarter pro forma hotel EBITDA margins contracted by 38 basis points to 37.4% as a result of pressure from property taxes and some timing issues around incentive management fees. On a pro forma basis, the third quarter margins were held back 92 basis points due a $1 million or 23% increase in property taxes and to 43 basis points due to a $0.7 million or 17% increase in third-party management fees. It’s important to note that the timing in which incentive management fees has been earned has varied from the prior year and even in 11 of our 12 hotels managed by affiliates of Hyatt are in their last year of a management fee rent, which accounted for approximately $0.2 million of the $0.7 million increase. A key takeaway regarding margins is that we remain confident in achieving the high end of our previously stated 50 to 100 basis point range of margin expansion for the year. For the third quarter of 2015, our adjusted EBITDA grew to $43.7 million, an increase of 7 million or 19.1% over the same quarter in the prior year. Moving on to our balance sheet. We continue to utilize our strong balance sheet to facilitate improvements to the portfolio and maintain a healthy liquidity position. At September 30, 2015, we had total outstanding debt of $770 million with a weighted average interest rate of 3.97%. We ended the quarter with a net debt to trailing 12-month adjusted EBITDA of five times, which is near the high end of our stated range. This short-term increase in leverage is the result of us executing on our capital recycling strategy, which includes acquiring assets before selling to minimize earnings disruption to our shareholders. As of October 28, we have reduced total net debt to trailing 12-month adjusted EBITDA by over half turn to 4.4 times and have total outstanding debt of approximately $689.8 million with a weighted average interest rate of 3.94%. In addition, in the month of October, we retired $40.7 million of the $90 million of 2016 debt maturities outstanding at September 30, 2015 through advances on our senior unsecured credit facility and without any prepayment penalties. As of October 28, we had $145 million available to borrow under our facility. Turning to our outlook for 2015. In our release, you will see that we again increased guidance for the full year 2015 to incorporate our strong results from the first nine months and the transactions we have completed since our last guidance update. For the full year 2015, we increased our AFFO guidance to $1.20 to $1.22 per share for the fourth quarter 2015. We are providing guidance for AFFO of $0.22 to $0.24 per share. Metrics supporting our guidance are provided in our release. For the full year 2015, we are tightening our pro forma RevPAR growth projections to a range of 6.75% to 7.25% and maintaining the midpoint of 7%. Our same-store RevPAR growth outlook for the quarter is 4% to 6% and we are increasing the full year same-store RevPAR growth outlook by 75 basis points at the midpoint to 7.5% to 8%. Finally, we have increased the amount of capital investment for the full year 2015 to a range of $41 million to $44 million as a result of the recent acquisition activity. As a reminder, our guidance assumes no additional acquisitions, dispositions or capital market activities in the fourth quarter of 2015. With that, I’ll turn the call back to Dan.

Thanks, Greg. In summary, we’re absolutely thrilled with the performance of our portfolios and the continued successful execution by our team. We see a window of opportunities today to create value for shareholders through thoughtful capital allocation in premium select service hotels, which today's guests love. We continue to identify the right brands in key locations with outside growth drivers and the operational upside that is possible with the higher margin operating model of premium select service. With that, we’ll open the call to your questions.

[Operator Instructions]. Our first question comes from Gaurav Mehta with Cantor Fitzgerald. Your line is now open.

Yes, good morning. Thanks for taking my question. Going back to your recycling activities and I know that you provide 470 basis points EBITDA margin premium for two hotels that you acquired in October, but I was wondering if you have that number for all the hotels that you have acquired since you announced sales activity in June?

We don’t. I don’t think we’ve telegraphed that at this point yet. I think there will be a lot better clarity once all three tranches are closed and we’ll have better clarity and be able to put that out in a more fulsome format.

Okay. And going back to your margins for 3Q, you said 22% up taken property taxes. Could you share with us in which markets did you see pressure on the property taxes side?

Yes, I think probably the greatest increase we saw was New Orleans and some of the California properties.

Gaurav, this is Dan. I think the one thing we want to make sure people don’t forget is this is sheer number of acquisitions we have done over the last couple of years relative to our size. It puts us in a position where logically there would be more property tax reassessments from the purchase of those assets. But it is something that wade again this quarter.

Okay. Thank you. That’s all I had.

Our next question comes from Shaun Kelley with Bank of America. Your line is now open.

Hi. Good morning, Dan. Good morning, everyone. I was just wondering if you guys could give us a little bit more color on what you’re seeing in the transaction activity market right now on the private side? Maybe any color on cap rates or just general activity levels since things have sort of been a little bit rocky out there in the public markets for the group over the last three to six months.

Thanks, Shaun. This is Dan. I’m not sure we’ve got a view on the broader cap rates for the transaction market. Most of our work was done early as we started the capital recycling initiative. We haven’t seen as we’re still very active out there discussing opportunities that there is any backup in cap rates. But that’s been pretty consistent for quite some time in the spaces that we’re looking. We’re not chasing assets in downtown, Cobb [ph] and gateway cities. Most of our acquisitions are in urban markets or outside of probably the top seven or eight markets. So I wouldn’t say from our view that we’ve seen any change in cap rates, because you’ve also seen many of the private companies be much less aggressive. So I think while you would expect there to be some better objects around that transaction, there just haven’t been enough I think to be meaningful to make an assessment from our seat.

Got it, that’s helpful. And then one just more on kind of the current fundamental environment, but Dan we’ve heard a number of companies kind of comment throughout this quarter that at least in October, they saw a little bit less corporate business and they thought they might be seeing at this point in time, they all kind of worded it slightly different but they were basically saying that the month was coming in a little lighter on the corporate side. Can you just remind us of sort of your – just your mix across corporate, leisure transient? I know you don’t get a bit much if any relative group but a, just minus of those mixes and then b, any color on whether or not you saw any softness on October?

Yes. This is Dan. Our mix between business and leisure is probably 65% as some sort of business traveler. We don’t have a lot of group or government business, so our portfolio is the majority of it being transient. We haven’t seen a drop off. So we are very well diversified in a lot of different markets across the country. So I think we’d be a good barometer and still think the fundamental for that in both business and leisure transient guests are strong.

Great. Thank you very much.

Thanks, Shaun.

Our next question comes from Wes Golladay with RBC Capital Markets. Your line is now open.

Good morning, guys. If we stick with that last line of questioning, I’m just wondering if you’ve I guess been more aggressive in the fourth quarter on revenue management or are you staying the same or you’ve seen the headwinds that your peers are facing and maybe dialing it back a little bit trying to get a little bit more longer lead time business on the books if you can as you look to build business for the first quarter and second quarter of next year? Has your revenue management changed at all?

It hasn’t. I think to say that we’ve become more aggressive would imply that we were ever less aggressive, which really isn’t the case. We’ve got a great team of revenue managers and asset managers in-house that are fully engaged day-in and day-out. So I think for us, it just continues to be business as usual uncovering every opportunity that we can and having courage. I think one of the challenges that you see in this environment is in pricing and is having courage. And it’s a lot easier to have courage when you’re sold out every night. When you’re not, I think trying to find that optimum balance between – of the mix between business and leisure and local negotiated rate and transient is just truly ours, and I firmly believe we are best in class and that focus remains intact.

Okay. And then on the expense side, you mentioned a little bit of a timing issue for taxes and incentive management fees. Do you have your expectations for year-over-year growth for those line items and do you see any of that spilling over into next year?

Wes, this is Greg. On property taxes on a year-to-date basis, we’re up about 13.5%. Our forecast is saying by the time we get to the end of the year that will be about 14%. So we think that’s kind of a straight kind of movement into Q4. But when you look at the management fees, that’s kind of where we see more of a timing issue. For the first nine months, we’re up about 12% but we think that will be about 8% by the time we get done with the year. So, so much of the choppiness has to do with the timing of the incentive management fees.

Okay. And you mentioned a burn off of, call it maybe [indiscernible] rates for some of these brand fees or initial management fees. Do you see that continuing into next year or is it just something that was more of a 2015 issue?

Wes, this is Dan. That was just a stabilization or the group of assets that we bought, so that is complete. It’s ramped this year.

Okay. And then just on the capital deployment, you have – I guess you have the two tranches to deploy $197 million. Would you look to deploy all of that capital or would you save some for – keep some dry powder? How much do you have to deploy and I know you guys have the preferred next to retire, so would you keep some of that available to retire that piece of equity?

Wes, this is Dan; great question. We did, as this transaction was structured in a 10-31 exchange, need to redeploy a minimum of $250 million, which we will have done. Beyond that, we do have options. As you pointed out, we’ve got a Series A preferred that matures in October of next year. So, yes, we want to make sure we do maintain optionality and we look at every opportunity whether it be an acquisition or extinguishment of debt as a way to create value. So to the extent that one has greater opportunity than the other, we’re certainly open to the different options available to us. So, I wouldn’t say that we have any bias other than to create the most value we can with the proceeds.

Okay. Thanks a lot.

Thanks, Wes.

Thanks.

Our next question comes from Ryan Meliker with Canaccord Genuity. Your line is now open.

Hi. Good morning, guys. Thanks for the color on margins in the third quarter. I just wanted to follow up in regards to full year and I guess 4Q margin assumptions. Are there any tailwinds that you’re expecting that are going to drive stronger margin growth in the fourth quarter, because obviously you’re building in some much stronger margins in the fourth quarter than you saw in the third quarter or even year-to-date? Are some of those incentive management fees? Were those timing issues where they’re not going to show up in 4Q and they did last year where you have a tailwind, just some color on that would be helpful?

Yes, I guess the only item that kind of stands out there is those incentive management fees and yes, since we’re sitting at kind of a 12% increase and we think we’re going to wind up at an 8%, yes, we’re expecting a little bit of lift in Q4 as it relates to the timing of those fees kind of hit heavy in Q4 last year. They’re hitting a little heavy for Q3 of this year. Those were all calculated on an asset-by-asset basis, so it’s kind of – that choppiness comes based upon which assets are performing and at what time. And then also I think in the script we mentioned the ramp up in the Hyatt fees will start flattening out.

Great, that’s helpful. And then the second question I had for you guys was, can you give us some color – I know it’s a little early but maybe some color on what you’re looking at from a renovation perspective for 2016? Are you expecting any quarters where you’re going to see a material increase in renovations year-over-year or any material increase in disruptions associated with those renovations?

Yes. This is Dan. We’re in the budgeting process right now, so I think in general we’d always expect to have renovation a little heavier in fourth quarter and then first quarter. Second and third quarters are typically the least affected by renovation and I wouldn’t see next year as any different.

Right, so that’s not an increase in first quarter versus the prior year, it’s more just – that’s when you do it, so you’re not really looking at any changes from a renovation standpoint or a disruption standpoint. Is that correct?

That’s correct.

Great. Thanks, Dan. That’s it for me. Nice quarter.

Thanks, Ryan.

Our next question comes from Austin Wurschmidt with KeyBanc Capital Markets. Your line is now open.

Hi. Good morning. Thanks for taking the question. As you look across the recent acquisitions you’ve made, I was curious if you guys are seeing better opportunities to drive occupancy or ADR? And how exactly across those properties do operating margins stack up versus the balance sheet to your portfolio?

Thanks, Austin. It’s Dan. Clearly, the hotels we’re buying have stronger margins. I think if you look at just the pure metrics, we do have in the portfolio of newly required assets a higher occupancy. So on a go-forward basis, I think there is – despite where we are in the cycle, which is an environment where the majority of the gains in RevPAR should be based on the rate, the assets we’re buying exhibit that simply because they do run a higher occupancy but also have the higher rate of opportunity. And that’s really a function of our asset management, revenue management team finding ways to either fix the mix or implement pricing strategies to outsized returns.

So do you think that – given that you think that there is really good rate opportunity on that portfolio that you could continue to drive outsized margin growth in the new acquisitions versus sort of your legacy assets?

Yes, there an interesting thing happens when you sell hotels that you have managed for a long time. I would be – I have to say that new assets with our management team breed new opportunities. And every time we find a new hotel, we look at ways to shift and modify both mix and operational efficiencies. So, yes, I think it’s one of the benefits of the recycling of capital and buy new properties is simply new opportunities to add value based on a proven model of achieving outsized performance.

Thanks for the detail. And then just last one, I was just curious how the 8.2% growth compared to you guys as underwriting?

As a whole, it was right on track. I think it’s always challenging to implement all the efficiencies and opportunities you want. I think that’s a process that our asset management and revenue management team goes through over the first couple of years. You can’t change the functioning of the hotel at the snap of fingers. It is truly an art that has to be implemented over time. But so far everything is meeting our expectations.

Great. Thanks for the detail.

Thanks, Austin.

[Operator Instructions]. Our next question comes from Bill Crow with Raymond James. Your line is now open.

Good morning, guys. Two quick questions, Dan, if I could. First of all, in your discussions with ARCH, any indication of how the equity raise is going and confidence from your in the December tranche sale?

Yes, and there’s risk in any transaction but we’re very confident. We have restructured it and the partnership with the team at ARC Hospitality has been terrific. They’ve been incredibly transparent and a good group to work with. So we still remain highly confident in the closings in December and first part of next year.

That’s helpful. Thanks. Second, as you look into the early part of next year, there is a Super Bowl in San Francisco. Could you talk about your assets there, what you’re seeing? It may be early. I’m not sure if you’re part of the NFL block or not but any indication of the lift you might get there?

Yes, one of our hotels is part of the NFL block. It’s probably a little bit earlier. We kind of pride ourselves because of the type of rapport that we have being as flexible as possible and trying to work towards that last room of availability at the highest rates. So I think we’ve got as good of an opportunity as anybody in the market to take advantage of the compression there. I think there’s been plenty said about B&B and I think it’s yet to be determined how much affect that will have on the actual compression. But as you may have heard in our comments, that doesn’t specifically affect all markets. I think each submarket acts a little bit different than the overall market and I think strong asset management teams can exploit those opportunities and outperform over time. So lodging – we at least have that operational component that there are a lot of other properties we don’t have because our leases are by and large daily. So quite frankly, our operations matter and I’m proud of the team and the assets we’ve purchased and we’d expect to always perform at the highest level.

Great. And then Greg, maybe you can help with this one. Just remind us when the Series A and Series B can be repurchased?

Series A is October of '16 and Series B is December of '17.

Okay. All right, great. Thank you. That’s it for me.

Thanks, Bill.

I’m not showing any further questions at this time. I would now like to hand the call back to Mr. Dan Hansen, President and CEO of Summit Hotel Properties Inc. for any closing remarks.

Well, thank you all for joining us today. We remain encouraged by the continuation of the industry fundamentals and the limited supply growth that we continue to see gives us confidence in our outlook. Our renovated properties and operational expertise continue to deliver strong results and we’re looking forward to the balance of the year. I wish you all the best, have a terrific day and we look forward to talking again next quarter.

Ladies and gentlemen, thank you for participating in today’s conference. This does conclude the program and you may all disconnect. Everyone, have a wonderful day.