Service Properties Trust (SVC) Q3 2015 Earnings Report, Transcript and Summary

Good day. And welcome to the Hospitality Properties Trust's Third Quarter 2015 Financial Results Conference Call. All participants will be in listen-only mode. [Operator Instructions] After today's presentation, there will be an opportunity to ask questions. [Operator Instructions] Please note this event is being recorded. I would now like to turn the conference over to Katie Strohacker, Director of Investor Relations. Please go ahead.

Thank you. Good afternoon, 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 for analysts. Please note that the recording, retransmission and transcription of today's conference call is prohibited without the prior written consent of HPT. I’d 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, November 9, 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, included -- 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 afternoon. And welcome to our third quarter 2015 earnings call. Today, I'm going to provide a summary of our quarterly performance, which I believe was strong, I will discuss our investment activity, our outlook for the balance of 2015 and then turn the call over to Mark for more detailed look at this quarter’s results. This morning, HPT reported third quarter normalized FFO of $0.99 per share, that reflects the continued execution of our strategy to own a geographically diverse portfolio of well-maintained Hotels and TravelCenters operated under long-term management and lease agreements. Once again, we benefited from owning a primarily upscale and recently renovated portfolio. Starting with performance at HPT’s TravelCenters, third quarter results reflected continued strong performance, with increasing fuel volumes and non-fuel sales and margin growth. While third quarter per gallon fuel margins were strong. They declined versus the same period last year as expected due to challenging comparable periods marked by declining oil prices. Third quarter property level rent coverage for the quarter remained strong at 1.75 times. Turning to our Hotels, the third quarter continued deposit of RevPAR and margin growth momentum we have developed over the past couple of years. Third quarter RevPAR growth was 7.8% across HPT's 291 comparable hotels, almost 200 basis points above industry growth levels again this quarter. This marks the 11th consecutive quarter where we have exceeded industry RevPAR growth. This performance which was 82% rate driven is particularly encouraging given the continued strength we are seeing from some of our earliest renovations, starting with those that occurred in 2010. 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. This quarter’s strong ADR growth resulted in continued margin expansion, with GOP margin percentage up 200 basis points for the 2014 -- from the 2014 quarter. Seven of our nine hotel operating agreements exceeded the hotel industry’s RevPAR performance in the third quarter and all nine of our hotel operating agreements exhibiting GOP margin improvement. The Sonesta portfolio's comparable third quarter RevPAR increased 13.2% and comparable hotel GOP margin percentage improved 5 percentage points versus the third quarter 2014 to 29.3%. The Royal Sonesta, New Orleans and the Somerset, New Jersey ES Suites were under renovation for all of part of the 2015 third quarter. Excluding these two hotels, Sonesta’s comparable hotel RevPAR increased by 22.8%. Our comparable Sonesta ES hotels drove the portfolio’s performance as the hotels regained occupancy following last year’s renovation activity at higher rates. RevPAR at our full-service Sonesta hotels was negatively impacted by the Royal Sonesta, New Orleans renovation and the Royal Sonesta, Houston as a result of soft market conditions. Our Wyndham portfolio increased RevPAR by 10.7% and GOP margin percentage by 60 basis points versus the third quarter 2014. Post-renovation we believe this portfolio is progressing well and in particular, we are pleased with Wyndham’s ability to drive double-digit rate growth this quarter. Negotiated accounts are seeing the value of these hotels and the portfolio is becoming less dependent on online business to drive growth. We expect the above industry results to continue for this portfolio for the remainder of the year as the more recently renovated hotels in the portfolio continue to ramp up. Our Hyatt portfolio’s third quarter RevPAR increased 8.7% and GOP margin percentage improved 40 basis points versus third quarter 2014. This reflects successful revenue management, shifting mix from negotiated corporate rated room nights to the retail segment during periods of higher occupancy in order to maximize average daily rate. Our hotel’s portfolio strong performance continues to be balanced across property types. RevPAR and gross profit margin percentage among our comparable extended stay hotels were up 10% and 240 basis points respectively. Our comparable select service hotels were up 7.4% and 120 basis points. Our 37 full service comparable hotels that were not under renovation during the quarter were up 7.7% and 240 basis points respectively. In each of these cases, rate was the principal driver behind RevPAR growth. Turning to transaction activity. As we previously disclosed, in July, we acquired nine extended stay hotels with 1095 suites located in eight states for $85 million. We converted these hotels to the Sonesta ES Suites brand and added them to our management agreement with Sonesta. We expect to invest approximately $45 million over the next nine months to substantially renovate these hotels in connection with their conversion to the upscale extended stay at Sonesta ES Suites brand. In September, we acquired two additional travel centers and certain other assets for $51.5 million, which we leased back to TA for an annual rent increase of $4.4 million. This acquisition was part of the TA transaction we announced back in June. While that remains open from this transaction is to purchase and leaseback five to be developed travel centers for an aggregate purchase price equal to estimated development cost of up to $280 million. We expect these acquisitions to close in 2016 and early 2017. In October, we entered in an agreement to acquire two extended stay hotels with 262 suites located in Cleveland and Westlake, Ohio for $12 million. We plan to convert these hotels to Sonesta ES Suites and add them to our management agreement with Sonesta. We also acquired the land and certain improvements at a travel center in Waterloo, New York which we previously leased to third party and subleased to TA, the $50 million excluding acquisition cost. Looking ahead, we and our hotel managers were optimistic about the balance of 2015. In August, we told you we’re anticipating second half RevPAR growth generally in the 7% to 9% range and GOP margin percentage improvement of 200 to 250 basis points for our comparable hotels versus the same period in 2014. Actual third quarter results fell within these ranges with RevPAR and GOP margin percentages up 7.8% and 200 basis points respectively. A few of our managers have modestly adjusted their RevPAR expectations lower for the fourth quarter due primarily to continued weak market conditions in Houston, increased supply impacts in select markets and renovation delays at the New Orleans, Royal Sonesta. As a result, we are anticipating RevPAR growth for the fourth quarter in the 6% to 8% range and continue to expect GOP margin improvement of 200 to 250 basis points. Although we are early in the 2016 budgeting process, we believe our hotel portfolio is well-positioned for continued rate growth and GOP margin improvement particularly at our more recently renovated hotel properties. I’ll now turn the call over to Mark.

Thanks John. Operating results at our comparable hotels were strong again this quarter with RevPAR up 7.8%, a 200 basis increase in GOP margin percentage and growth in cash flow available to pay HPT's minimum returns and rents of 12.8%. The 7.8% increase in RevPAR this quarter was driven by a 1.1 percentage point increase in occupancy and ADR growth of 6.3%. This quarter’s RevPAR growth benefited from the outperformance of the five hotels that were under renovation during the 2014 third quarter with RevPAR up 28.3% at these hotels but was impacted by the 29.2% decline in RevPAR at the four hotels under renovation during this quarter. Our portfolios with the highest RevPAR growth this quarter were our Wyndham, Hyatt and Carlson portfolios with increases of 10.7%, 8.7% and 7.4% respectively versus the prior year quarter. RevPAR was up 22.8% this quarter at the 20 comparable Sonesta hotels not undergoing renovations during the quarter. GOP margin percentage for our comparable hotels increased 200 basis points from the 2014 quarter to 42.2%. Of our portfolios, Sonesta and IHG had the strongest margin growth in the quarter, with gross operating profit margin percentage for comparable hotels of 500% and 230 basis points respectively versus the 2014 quarter. The combination of RevPAR growth and GOP margin expansion resulted in a $12.9 million or 10% 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 nine hotel agreements versus the prior year quarter and portfolio wide coverage increased to 1.17 times for the quarter and 1.05 times for the trailing 12 month. All but our Sonesta and Wyndham portfolios and our [Marriott Qawwalis] [ph] are above one times coverage on a trailing 12 month basis. Hotel cash flows in excess of the minimum returns and rents payable to HPT during 2015 third quarter, resulted in guaranty and security deposit replenishments of $12 million and the payment for HPT of hotel profits in excess of our minimum returns of $5.8 million. Operating results of our travel center portfolio were also positive this quarter, with property level EBITDA of $4 million or 3.8% from the 2014 quarter. Fuel margin declined 1.8% quarter-over-quarter as a result of a decline in per gallon margin, which was partially offset by a 4.3% increase in total gallon sold. The decline in per gallon fuel margins was primarily due to the more favorable purchasing environment during the 2014 third quarter. Non-fuel revenue and margin growth at our travel centers was strong this quarter, with increases of 5.5% and 7.2% respectively versus the 2014 quarter. Property level rent coverage for the 2015 third quarter averaged 1.75 times for our five TA leases. Earlier this morning, TA reported consolidated adjusted EBITDA of $99.1 million for the 2015 third quarter, a 1.9% increase from the prior year quarter. TA’s consolidated adjusted EBITDA’s coverage of cash rent and interest was strong at 1.41 times for the third quarter. Turning to HPT's consolidated operating results for the third quarter. This morning, we reported normalized FFO of a $149.7 million compared to normalized FFO of a $129.2 million in the 2014 third quarter. The $20.5 million, or 15.9% increase in normalized FFO, was due primarily to the $10.7 million increase in realized minimum returns and rents, with the largest increases generated from our TA, Sonesta and IHG agreements. The $5.8 million of additional returns realized under our Marriott No. 1 and IHG agreements and the $3.2 million of previously deferred rent under our TA leases, which we began amortizing to income over the remaining terms of these leases in June of this year. On a per share basis, third quarter 2015 normalized FFO was $0.99 per share, a 15.1% increase from the 2014 third quarter. We paid a $0.50 per share common dividend in the quarter and our normalized FFO payout ratio was only 50.6%. Adjusted EBITDA was $192.7 million in the 2015 third quarter, a 13% increase from the 2014 quarter. Our adjusted EBITDA to total fixed charges coverage ratio for the quarter remained strong at 4.6 times and debt to adjusted EBITDA was only 4.2 times at quarter end. As we approach the fourth and final quarter of the year, I’d like to take a moment to discuss incentive fees under the terms of our business management agreement. As you know, incentive management fees are generally payable under our business management agreement if HPT's common share total return as defined exceeds the total return of the SNL REIT Hotel Index. In calculating net income in equivalence with GAAP, we record estimated business management incentive fee expense, if any, each quarter. Although we recognize this expense each quarter for purposes of calculating net income, we do not include incentive management fee expense in the calculation of normalized FFO and adjusted EBITDA amounts until the fourth quarter, which is when the actual incentive management fee amount for the year if any is determined. Incentive management fees for 2015, if any, will be payable in cash in January 2016. You should refer to our Form 8-K dated December 31st -- December 23, 2013 for a detailed description of how incentive fees are determined under our business management agreement. In calculating net income for the nine months ended September 30, 2015, HPT has expensed $17.4 million of estimated incentive management fees, which are included in general and administrative expense in our income statement. As I previously noted, this expense amount has been excluded from our calculation of normalized FFO. Once again, we will not know of any incentive fees are payable 2008 until the end of the year and we will deduct any such fees payable in our calculations for the fourth quarter normalized FFO. Turning to our capital commitments, we funded $22.6 million of hotel improvements and $30 million of travel center improvements in the third quarter. We currently expect to fund an additional $39.7 million of hotel improvements and $20 million of travel center improvements in the 2015 fourth quarter. With respect to our liquidity at quarter end, we had approximately $7.4 million of cash, which excludes $44.3 million of cash escrowed for improvements to our hotels and $296 million of availability under our revolving credit facility. As of September 30th, debt to total book capitalization was approximately 52.4% and debt to total gross book value of real estate was only 40%. Operator, that concludes our prepared remarks. We are ready to take questions.

[Operator Instructions] The first question comes from Ryan Meliker of Canaccord Genuity. Please go ahead.

Hey, good afternoon, guys. Congratulations on a great quarter. Just I think I wanted to talk a little bit about Sonesta. It looks like you guys had a solid quarter in Sonesta. It sounds like there was some kind of renovation disruption there as well. I'm just wondering what your take is on the performance of that portfolio from when you guys made the decision a few years back to convert all the properties to Sonesta versus today, where it seems like most of the properties should have now ramped out of the renovations that ended I guess middle of last year. I am just wondering if you’re comfortable, if you have any numbers you can put on the returns or how things have unfolded relative to your underwriting. Thanks.

Well, Ryan, this is John. We expected that Sonesta would be doing a little bit better today than it is, and that's largely because we expected that they would have been able to start and complete many of the renovations earlier than they did. And so while they are continuing to ramp up well and continuing to move in the right direction, they are -- on the timeline basis they are behind where we thought they would be. And I think I don’t have all the data on the calendar right in front of me, but I think that the biggest hotels are still under renovation right now. So I don't know that it’s completely accurate to say they were done early to mid last year with most of the renovations. And I think we’ve had a lot of the renovations going through this year, including the heaviest hitter in the portfolio, which is Sonesta in New Orleans.

Ryan, just in terms of, if you look at the 20 comparable Sonesta hotels that weren’t under renovation this quarter, as I mentioned, I think both John and I mentioned in our prepared remarks RevPAR at those hotels up 22.8%, GOP margins at those hotels were up 770 basis points, and cash flow available to pay our returns was up slightly over 90% in coverage of our minimum returns at those hotels this quarter was 0.93 times. So I think we’re seeing the hotels once they come out of renovation ramp up as we had expected.

Okay. That’s helpful. And how much ramp do you guys think you have left in the portfolio? Are we talking one or two more quarters, or are we talking one or two more years?

I mean, obviously, it varies by hotel. The ones at in Orlando and Burlington, which were ES Suites that we renovated first, I think have a couple of quarters, maybe a year and half, somewhere in that range of above market growth, the ones that are still under renovation like we completed the one in New Jersey just this quarter and we are going to next, this coming quarter, the current quarter that we are in, we are going to complete the Sonesta, New Orleans. So those have much longer ramp up period ahead, but I think that we’re going to be pleased with the -- especially New Orleans, I think we’re going to see very strong growth once that renovation is complete in December.

Got you. So there is still quite a bit left, that’s what I was trying to get at. That’s helpful. And then can you just refresh your memories with regards to the Sonesta contract? I know that you don't have a deposit or guarantee from Sonesta. I guess what is subordinate to your return, is it the base management fees, is it incentive management fees? I am not quite sure what the minimum return is I guess superior to in the capital stack?

The minimum return is -- has a priority over incentive fees. Sonesta doesn’t have the ability to earn incentive fees until we are earning an 8% return on the entire portfolio in total, plus an imputed FF&E reserve equal to 5% of total hotel revenues.

So similar to a typical management incentive fee contract that was across the U.S. where there is a hurdle rate before the manager can get their incentive fee. That’s what I was wondering you know there. Thanks. And then last question I had was, I know we talked about this last quarter, I am curious Mark what your take is now. You guys are as you said earlier 52.4% levered. You said historically that you cannot like to be over 50% levered. I know that there is no gun to your head, there is no time constraints, etcetera but with another $118 million in acquisitions already under contract for next year, what's the delay in just pulling the trigger and issuing equity, or is it just that you’re waiting for stock price to be at a higher price?

Yes, I think clearly the stock price is the issue in terms of accessing the equity markets. It's true leverage is up about -- debt to total book capitalization is up about 370 basis points this year to 52.4%. But if you look at some of our other credit metrics, they continue to improve, adjusted EBITDA coverage of interest expense was 5.3 times this quarter versus 4.6 times in the fourth quarter last year, and debt to annualized adjusted EBITDA has actually declined from the end of last year from 4.3 times to 4.2 times. So we feel more than comfortable with debt where it is.

I mean, more than comfortable as in no need to raise equity, or just that you’re willing to…

No need to raise equity at these prices.

Right, at these prices. Got you. And then I’m curious, do your leverage parameters or your view of leverage parameters change at all as the Sonesta portfolio grows since that doesn’t have the security deposit or corporate guarantee associated with it from more of a traditional management contract with a hotel that involves a lot more volatility in the cash flows?

No, I don’t think that that will impact our overall views on leverage, that portfolio is 10%, 11% of our total minimum returns and rents. And it’s not like it’s going to go to zero in the downturn. So we don’t think that has any impact on our long-term leverage levels.

All right. I’ll jump back in queue with anything else. Thanks a lot.

Thanks.

[Operator Instructions] The next question comes from Michael Bellisario of Baird. Please go ahead.

Good afternoon, guys. Two questions for you, one on the brands and then the second on portfolio, potential portfolio acquisitions. I guess the first part is, are the 8% returns that you're targeting, are they too high in today's environment for the brands to be willing to partner with you? I guess really I'm asking is, do they need your capital to do real estate deals today and then how does that affect your acquisition strategy going forward?

The hotel acquisition space is very competitive and capital availability ebbs and flows and we try to be competitive. We offer a different style transaction and we’re a different type of partner to the operators we do business with. And typically, there are strategic reason why our operators might do a transaction with us, what seems like a slightly higher rate than they might get through other avenues. And we've done -- in the last 12 months we’ve done a couple of transactions with IHG where we’ve helped them obtain a longer term management contracts in markets where they might have lost branding. And so it enabled them to maintain their asset-light strategy to do business with a very strong capital partner. And I think that was a strategic benefit for both, them and us. And I think that there will continue to be transactions like that, not just with IHG and not just with Sonesta, but with other brands as well. So, I won't dispute that an 8% return seems high relative to current interest rate levels, but we don't think it's too high given that it's 100% long-term value financing.

And is it fair based on your comment that those deals are more defensive deals for the brand or is there any change in kind of their appetite to be more offensive or is it really just a defensive nature?

I wouldn’t describe it as defensive. The Crowne Plaza that we acquired in Denver enabled IHG to take over management. So I think growing their management platform, you could easily consider as an offensive move. So I think that you will see both offensive and defensive reasons for them to team up at different times. More offensive one is a good portfolio variable with the right stability characteristics.

That's fair. And then just lastly, you focused and you mentioned on Sonesta and IHG. Do you expect to continue partnering with them going forward? And then are there any options for you to maybe partner with new brands?

Seems like there is a lot of new brands. I do see us over time investing in additional assets that branded with IHG and Sonesta. We have bid with other management companies over the last 12 months on hotels. We don’t always get chosen. We’re trying up to overpay. So we locked a couple otherwise we could have other deals with other brands. But we’ll continue to look at acquisition opportunities and look at what branding is available. Sometimes you can re-brand, sometimes you can’t, sometimes many other brands already exist in the marketplace. So it varies deal to deal

All right. Thanks. That’s all for me.

This concludes our question-and-answer session. I would like to turn the conference back over to John Murray for any closing remarks.

Thank you all for your time today. We look forward to seeing some or all of you at the NAREIT conference coming up in a couple of weeks. Thanks.