Service Properties Trust (SVC) Q2 2015 Earnings Report, Transcript and Summary

Good day, and welcome to the Hospitality Properties Trust's Second Quarter Financial Results Conference Call. This call is being recorded. All participants will be in a listen-only mode [Operator Instructions] After today's presentation, there will be an opportunity for analysts to ask question. Please note, this event is being recorded. I would like to turn the conference over to Katie Strohacker, Director of Investor Relations. Please go ahead.

Thanks, Kerry, and good morning everyone. On today's call, John Murray, President and Mark Kleifges, Chief Financial Officer, will make a short presentation, which will be followed by a question-and-answer session. Please note that the recording, retransmission and transcription of today's conference call is prohibited without the prior written consent of HPT. I would like to point out that today's conference call contains forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995 and other securities laws. These forward-looking statements are based on HPT's present beliefs and expectations as of today, August 10, 2015. The company undertakes no obligation to revise or publicly release the results of any revision to the forward-looking statements made in today's conference call, other than through filings with the Securities and Exchange Commission or SEC. In addition, this call may contain non-GAAP financial measures, including normalized funds from operations or normalized FFO. A reconciliation of normalized FFO and adjusted EBITDA to net income, as well as components to calculate AFFO, are available in our supplemental package found in the Investor Relations section of the company's website. Actual results may differ materially from those projected in these forward-looking statements. Additional information concerning factors that could cause those differences is contained in our Form 10-Q to be filed later today with the SEC and in our supplemental operating and financial data found, once again, on our website at www.hptreit.com. Investors are cautioned not to place undue reliance upon any forward-looking statements. And with that, I'll turn the call over to John.

Thank you, Katie. Good morning, and welcome to our second quarter 2015 earnings call. Today, I'm going to provide a summary of our quarterly performance, including investment activity and our outlook for the balance of 2015, after that I'll turn the call over to Mark for a more detailed look at the quarter's results. This morning, HPT reported second quarter normalized FFO of $0.98 per share that reflects the continued execution of our strategy to own a geographically diverse portfolio of well-maintained hotels and travel centers operated under long-term management and lease agreements. Once again, we benefited from our extensive hotel renovation program that began in 2010. Starting with performance of the travel center investments. Second quarter results reflected continued strong performance at HPT's travel centers, with increasing fuel volumes sold and non-fuel sales and margins growth. While per-gallon fuel margins were strong, they declined quarter-over-quarter as expected due to challenging comparable periods marked by declining oil prices. Second quarter property level rent coverage for the quarter remains strong at 1.73 times. Turning to hotels, second quarter RevPAR growth was 10.7% across HPT’s 290 comprable hotels well above industry growth levels for the tenth consecutive quarter. This performance which was 76% rate driven, reflects strong growth at the 26 hotels that completed renovations during 2014, with RevPAR gains of 31.2% and the 59 hotels that completed renovation during 2013 with RevPAR gains of 12.1%. Our asset management team has been working closely with our hotel managers to maximize and sustain ADR growth and we believe our RevPAR results reflect these efforts. The second quarter continued a positive RevPAR margin growth momentum we have developed over the past couple of years and strength was broad based with eight of our nine hotel operating agreements exceeding the hotel industry’s RevPAR performance and all nine of our hotel operating agreements exhibiting GOP margin improvement. Sonesta portfolio's comparable second quarter of RevPAR increased 23.4% and GOP margin percentage improved 7.1% points versus second quarter 2014 to 34.4%. The Royal Sonesta, New Orleans and the Somerset, New Jersey ES Suites were under renovation throughout the quarter while three other Sonesta hotels completed renovations during the quarter. Nonetheless portfolio revenue was up $10.4 million were 17.8% versus second quarter of 2014 and hotel-level EBITDA was up $6.6 million or approximately 59% over the prior year quarter. However, with five hotels in a portfolio impacted by renovations during the second quarter, operations are not yet where we want them. Sonesta’s performance continues to improve and we are hopefully that reconcepted hotels, outstanding guest service and increased brand awareness will lead to continued significant revenue and EBITDA improvement. Our Wyndham portfolio increased RevPAR by 14% and GOP margin percentage over 190 basis points versus second quarter 2014, attributable to double digit gains in both our full-service and extended-stay hotels. We expect above industry results to continue for this portfolio throughout 2015 as the more recently renovated hotels in the portfolio ramp up performance. Our Carlson portfolio's second quarter RevPAR increased 12% and GOP margin percentage improved 350 basis points versus second quarter of 2014. All the two hotels in this portfolio exceeded industry RevPAR growth during the quarter with the largest increase experienced at the Radisson, Nashville. Our portfolio's strong performance continues to be balanced across property types. RevPAR and gross profit margin percentage among our comparable full-service hotels were up 11.4% and 370 basis points. Our comparable select-service hotels were up 8.7% and 220 basis points, and our comparable extended-stay hotels were up 11.6% and 260 basis points, respectively this quarter. Turning to transaction activity. In May, we have acquired 364 rooms full-service hotel located Denver, Colorado were $77.3 million. We expect to complete a full renovation during the first two years of ownership at additional investments of approximately $13 million. This Crowne Plaza branded hotel was added to our existing portfolio management contract with IHT. In July we acquired non-extended stay hotels was 1094 suites located in eight states for $85 million. We converted these hotels to the Sonesta ES suite hotel and added these hotels to our management agreements with Sonesta. We expect to invest of approximately $45 million to substantially renovate these hotels in connection with a conversion to the upscale of extended stay Sonesta ES suite hotel brand. In June, we acquired 12 travel centers and certain assets related to 10 other travel centers for an aggregate purchase price of $227.9 million. Also in June, we sold five travel centers to TA for 445 million and recognized the gain on sale of $11 million. Annual net renew increases from the purchase and sale activities that occurred in June related to this transaction was $15.7 million. In connection with the same transaction agreement with TA, we expect to acquire two additional travel centers and certain assets later this year to $51.5 million and to acquire leaseback five development properties for a purchase price equal to estimated development of no more than $180 million in 2016 and 2017. Also, in June we announced a transaction involving our manager, REIT Management and Research or RMR where we acquired a 16.2% economic interest in our manager in exchange for $57.8 million and also amended our management agreements with RMR extend the term for 20 years. As part of the purchase of RMR, we issued 1490,000 shares of HPT valued of $45.2 million and the remainder of the purchase price was paid in cash. The shares we issued are subject to 10-year lockup agreements with the historical owners RMR. As part of this transaction we have agreed to distribute half of our RMR shares to our shareholders as the special dividend and RMR has agreed to facilitate this distribution by filing a registration statement with the SEC and by seeking and listing on a National Stock Exchange. We currently expect to complete the distribution of RMR’s share to our shareholders by the end of 2015 or we cannot distribute the shares until RMR’s registration statements is declared effective by the SEC. We believe this investment management was at the compelling price and we believe the transaction benefits HPT and its shareholders specifically we relieved this transaction further aligned to the interest of RMR management, HPT and our shareholders provides greater transparency and allows us to continue benefitting from a low cost management structure. Looking ahead, we and our operators are optimistic about the second half of 2015 as we told you in February our operators budgeted fully a RevPAR growth generally in the 6% to 8% range and GOP margin percentage improvement of 150 to 200 basis points versus 2014.Our operators are running ahead of expectations through the second half and accordingly both RevPAR and GOP margin percentage growth for 2015 have been revised more favorably. Currently our operators are anticipating second half RevPAR growth generally in the 7% to 9% range, and GOP margin percentage improvement of 200 to 250 basis points versus the same period in 2014. We remain optimistic about this lodging cycle due to steady demand as economic growth continues. With high occupancy levels, we are well positioned for continued rate growth and GOP margin improvement particularly with our renovated hotel portfolio. I’ll now turn the call over to Mark.

Thanks, John. Operating results at our comparable hotels were strong this quarter, with RevPAR up 10.7%, a 290 basis point increase in GOP margin percentage and 19.4% growth in cash flow available to pay HPT's minimum returns and rents. The 10.7% RevPAR growth this quarter at our comparable hotels was driven by a 1.9% point increase in occupancy and ADR growth of 8.1%. This quarter's results benefited from the RevPAR outperformance of the seven hotels that were under renovation during the 2014 second quarter, with RevPAR up 31.4% at these hotels on occupancy and ADR gains of 11.3 points and 13.1%, respectively, in the current quarter. RevPAR at the nine hotels under renovation during this quarter was down 4.2% on lower occupancy. Our portfolios with the highest RevPAR growth this quarter were our Sonesta, Wyndham, and Carlson portfolios, with increases of 22%, 13.8% and 12.2%, respectively versus the prior year quarter. RevPAR was up 38.2% at the 16 Sonesta hotels not undergoing renovations during the quarter. All of our hotel portfolios exceed this respective previous peak Q2 RevPAR performance this quarter. GOP margin percentage for our comparable hotels increased 290 basis points from the 2014 quarter to 44%. Our Sonesta and Carlson portfolios had the strongest margin growth in the quarter with gross operating profit margin percentage up 650 and 350 basis points respectively versus the 2014 quarter. The combination of strong RevPAR growth and GOP margin expansion resulted in a $24.6 million or 19.2% increase from the 2014 quarter in cash flow available to pay our minimum returns and rents. As a result, cash flow coverage of our minimum rents and returns improved for eight of our hotels agreements versus the prior year quarter and the portfolio-wide coverage increased to 1.28-times for the quarter and 1.03 times for the trailing 12 months. All but Sonesta, Wyndham, and our Marriott Hyatt hotel are above 1-times coverage under trailing 12-month basis. We also had $15 million of guarantee and security deposit replenishments during the 2015 second quarter. Operating results of our travel center portfolio were positive this quarter with property level EBITDAR of $1 million or 0.9% from the 2014 quarter. Fuel margin declined 5% quarter-over-quarter as a result of a decline in per gallon margin, which was only partially offset by a 1.3% increase in total gallons sold. The decline in per gallon fuel margins was due to the rise in fuel prices that occurred during the quarter. Non-fuel revenue and margin growth at our travel centers was strong this quarter with increases of 5.7% and 7.7% respectively versus the 2014 quarter. Property level rent coverage for the 2015 second quarter averaged 1.73 times for our five TA leases. Last Thursday, TA reported consolidated adjusted EBITDAR of $93.3 million for the 2015 second quarter a 3.8% decline from the prior year quarter. The decline was due primarily to lower per gallon fuel margins as well as [in accretion] (Ph) cost associated with recent acquisitions. TA’s consolidated adjusted EBITDAR coverage of cash rent and interest was still strong at 1.41 times for the second quarter. Turning to HPT’s consolidated operating results for the second quarter, this morning we reported FFO of $146.9 million compared to normalized FFO of $129.7 million in the 2014 second quarter. The $17.2 million or 13.3% increase in normalized FFO was due primarily to the $15.8 million in minimum returns in rents earned this quarter with the largest increases generated from our Sonesta, IHG and TA agreements. On a per share basis, second quarter 2015 normalized FFO was $0.98, a 12.6% increase from the 2014 second quarter. We paid a $0.50 per share common dividend in the quarter and our normalized FFO payout ratio was only 51.1%. Adjusted EBITDA was $189.8 million in the 2015 second quarter, a 10.3% increase from the 2014 quarter. Our adjusted EBITDA to total fixed charges coverage ratio for the quarter remains strong at 4.6 times and debt-to-adjusted EBITDA was only 4.1 times at quarter end. Turning to our capital commitments, liquidity at quarter end, we funded $12.3 million of retail improvements and $20.2 million of travel center improvements in the second quarter. We currently expect to fund an additional $48.9 million of hotel improvements and $34.6 million of travel center improvements during the remainder of 2015. With respect to our liquidity at quarter end, we had approximately $18.4 million of cash, which excludes $39.1 million of cash escrowed for improvements to our hotels and $431 million of availability under our revolving credit facility. Debt-to-total book capitalization was approximately 51% as of June 30. Operator that concludes our prepared remarks, we are ready to open it up for questions.

Very good [Operator Institutions] Our first question comes from David Loeb of Baird. Please go ahead.

Good morning gentlemen. Mark I want to start with the balance sheet, you have really been over 50% to book, you have got lot of commitments to acquisitions, you had the July acquisitions and other stuff in the pipeline. What is your thought about the level of debt relative to equity and kind of what you might do to change that in the quarters ahead?

Yes, so as I mentioned in the prepared remarks, debt-to-total book capitalization is about 51% at quarter end, as you know we generally want to run the company at 45 to 50 debt-to-total book capitalization. If you look out at second half of this year, we’ll probably with our acquisition pipeline and capital improvement funding add another $100 million of incremental debt by year-end which would take us up to just under 52% debt-to-total book capitalization. You know while we at some point David need to raise equity and bring leverage back down to the 45% to 50% range as you and others on the call are well aware, REIT stocks and lodging stocks in particular have not performed well over the last several months. So it’s just not an opportune time for us to access the capital markets. We’re very comfortable running the company at this level of leverage with plenty of liquidity left on our line, our credit metrics are still very strong, so I guess the way to sum it up is we’re kind of in wait and see mode and we’ll wait until markets are more favorable before we address our leverage.

It is the board more comfortable holding more leverage for an indiscriminate amount of time.

Yes, I mean if you look, at we still at one of the strongest balance sheet in the REIT space and with plenty of liquidity, plenty of coverage on our interest rate EBITDA to interest rate coverage ratios, so we don’t feel any pressure to do anything before the markets turn more favorable.

Okay, and John one operational question Sonesta clearly had a very quarter, seasonally strong, but still some disruption. When do you think that you have four quarters that come out to a year about a 100% coverage 1.0 coverage, is that still several quarters away, is that future out in the future.

I don’t think they are going to have one times coverage in the current year, they forecast that. We are hopeful that because they are seeing strong improvement that they may get there next year, but we have also added just recently nine additional hotels, so that we are kind of expecting that because of one times coverage on a comparable basis next year, probably not for those nine, coz those nine will be under renovation during the year so.

They are getting closer by the four quarter ending fourth quarter of 2016, do you think that the comparables will be pretty close.

Yes, I think that’s a reasonable expectation.

Okay, great, well thank you.

Our next question comes from Jeffrey Donnelly of Wells Fargo. Please go ahead.

Hi, good morning guys, actually just sticking with the extend stay-transaction you just did ,I think you are going to be all-in for those hotels, I think at around a 120,000 a key. I was just curious on how that compared pricing for extended-stay hotel transactions are managed by other brands like Marriott, Hilton or EFA.

Well, I mean every hotel is different right Jeff, I think that our cost is less even all-in than what I’ve seen there have been a number of other lodging REITS that are one-off extended-stay hotels. I have seen prices per key in excess of 200,000 a key. So to be in it, on 125 is good. In fairness, these are older generation, former residents and [indiscernible], so you would expect them to trade at a more favorable price than the most current generations. And I haven’t studied the other reeds you know individual select service acquisition that costly to get an exact comparison for you, but I think that this all-in is pretty favorable cost per key metrics.

And may I apologize if I missed it, is how are you guys kind of thinking about like the yield on cost after the renovation for these assets?

We expect after they stabilize post renovation that we’ll get at least of 8% cash return on the investment.

Okay, and then…

Next year we won’t, because that predominantly one of those nine hotels will be under renovation, but we are seeing good coverage from our other extended-stay hotel that are we have branded to Sonesta ES suites, their coverage has improved nicely and they have been pretty well received in the marketplace, because they are a very good value.

And for modeling purposes are you able to give focus an estimate of what sort of either EBITDA or disruption you expect from those hotels in 2016, I know there is going to be kind of undergoing renovation, I’m just trying to think of just be accurate with our estimates, maybe in estimate what you thought they would have produced and the disruption you expect?

I don’t have that handy for the call, we are expecting if my memory is correct, we’re expecting that coverage for those nine hotels will be in the 5%-ish level next year because of the renovation displacement and then in the year following that they will get to better than one times coverage.

And, I can follow-up with you offline on that and maybe a question for Mark. I’m not sure you will be able to help me here, we might have to follow-up also offline is, we are actually very close I think on your top line revenues with the expense came in a little bit higher than we would have typically anticipated. I’m just curious of anything might have changed in your expense load at the corporate or hotel level that would have led to the higher expenses than we are expecting or maybe we can follow.

Yes. Nothing comes to mind, Jeff, it probably makes sense that we talk offline and so I’m just not ignore you with what you’re modeling but we…

Understood.

More than happy to talk to you offline.

Yes. Understood. Thanks.

Yes.

Our next question comes from Ryan Meliker of Canaccord Genuity. Please go ahead.

Good morning, guys. First of all nice quarter, nice to see double-digit RevPAR growth again. First question, with regards to RevPAR growth I think your last couple of quarters you’d indicated that your initial budgets from your operators were in the 6% to 8% RevPAR growth range for the first half of the year. It seems like, well, some guys were concerned and 2Q came in later than expected you guys are now tracking over 10% for the first half of the year, was this in line with what your operators were expecting for the first half of the year for your portfolio or is it a little elevated, should we expect things to moderate pretty dramatically in 3Q and 4Q?

I’d say that this quarter, our operators did a little better than expected, actually in the first quarter they did better than expected but the first quarter is weaker than - one of the weakest quarters of the year. So we were reluctant to increase us too much spend, but since we exceeded, since our operators exceeded expectation again in the second quarter we have upped our estimates. So that we’re expecting second half RevPAR growth of 7% to 9%. And which is up from the 6% to 8% that they have been forecasting and we’re expecting 200 to 250 basis point GOP margin percentage improvement which is up from 150 to 200 basis points as of the beginning of the year.

That’s helpful. Thanks. And I’m assuming that’s in the 4Q aided because of the counted disparities?

You know what, I just have it for the whole.

Okay. Fair enough.

And I have it broken down by quarter. We expect both quarters to be strong now.

Now that sounds good. Second thing I wanted to ask you guys about was, so obviously there is no gun to your head in terms of reducing leverage immediately. But as you alluded to with David, it sounds like you will be patient about tapping the equity markets, would you look at potentially moving forward with asset sales if the equity markets continue to be misaligned with private market for hotels.

We’re not currently looking at any dispositions, it’s a possibility we evaluate our portfolio on a regular basis, at least quarterly with our board.

Ryan, keep in mind that under restructure of our agreements all of our hotels and travel centers are subject to long-term agreements. So they’re more or less has to be an agreement on with manager or tenant to sell also. So it’s a little more complicated for us to cherry pick our portfolio if you will to sell assets than it is with another REIT without or agreement structure.

Now that’s understood. And then a couple quick little things, when you guys announced the TA deal, I think back in May, you had said you are expecting $30.2 million in incremental rents. As we think about the phased closings of those assets, is that reasonable to assume that that $30.2 million in annualized trends will be evenly distributed per each property that you require.

Yes. More or less. Yes.

All right. That’s helpful. And then also I was curious I didn’t see in the income statement of the balance sheet anything associated with the asset from the RMR stake that you took or the income generated from the RMR stake, I’m just wondering where that shows up.

Are you talking about the income?

Yes. On both the income statement and the balance sheet.

Well, on the income statement, it will be accounted 400, the cost method, which means from an income statement standpoint the only thing that will flow through our income statement or is dividend income.

Right.

On the balance sheet, it’s in other assets.

Okay. It’s in the other asset line. That’s helpful.

Yes.

All right. That’s all from me. Thanks a lot.

All right.

[Operator Instructions] Our next question comes from Bryan Maher of Brean Capital. Please go ahead.

Good morning guys. So you stepped up to the plate again with the more TAs and I’m curious with respect to their significant and increasing acquisition of C-stores. Once they get folded into the TA portfolio, is that an avenue that you would consider going down in the future picking off large portions of those?

No, Bryan. We’re not planning to invest in C-stores, we told investors before that we do like the travel centers but we are not planning to be acquirers of C-stores.

All right. That’s it. Thanks. End of Q&A

I’m showing no further questions on this end. So this would conclude our question-and-answer session. I would like to turn the conference back over to John Murray for any closing remarks. John G. Murray Thank you very much for joining us on the call today.