Service Properties Trust (SVC) Q1 2016 Earnings Report, Transcript and Summary

Welcome to the Hospitality Property Trust First Quarter Financial Results Conference Call. [Operator Instructions]. I would now like to turn the conference over to Katie Strohacker, Senior Director of Investor Relations. Please go ahead, ma'am.

Good morning. 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 the recording, retransmission and transcription of today's conference call is prohibited without the prior written consent of HPT. Today's conference call contains forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995 and other securities law. These forward-looking statements are based on HPT's present beliefs and expectations as of today May 10, 2016. The Company undertakes no obligation to revise or publicly release the results of any revision to the forward-looking statements made in today's call other than through filings with the Securities and Exchange Commission or SEC. In addition, the call may contain non-GAAP financial measures including the 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 filed 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 first quarter 2016 earnings call. It was another solid operating quarter for HPT. This morning I'm going to provide a summary of our performance, discuss our investment activity and our outlook for the balance of 2016 and then Mark will provide a more detailed look at this quarter's financial results. Earlier today, HPT reported first quarter normalized FFO of $0.93 per share, a12% increase compared to the $0.83 reported in the first quarter of 2015 due primarily to the impact of HPT's Travel Center and hotel acquisitions and improved hotel operating results. We believe this reflects the continued execution of our strategy to own a diverse portfolio of well-maintained Travel Centers and hotels predominantly Select Service and Extended Stay hotels in near-urban locations operated under long term lease and management agreements. Our geographically diverse, recently renovated, primarily upscale hotel portfolio and our continued asset management focus on revenue and flow-through improvement were the principal factors behind our hotel portfolio's performance during the quarter. First quarter results for HPT's Travel Centers reflected flat fuel volumes sold and per gallon fuel margins that declined as expected versus the comparable 2015 period which had unusually favorable purchasing and pricing environment. The decline in fuel gross margin more than offset increases in non-fuel sales and margin growth. Property-level rent coverage for the last 12 months through March 31, was 1.6 times. Turning to our hotels, the first quarter continued our positive RevPAR and margin growth momentum with RevPAR growth of 4.4% across HPT's 291 comparable hotels, well above industry growth levels again this quarter. This could RevPAR growth which was 91% rate driven continued to be broad-based. For example our 224 hotels that were renovated from 2010 through 2013 improved RevPAR by 3.7%. This quarter's ADR growth resulted in continued margin expansion with comparable GOP margin percentage up 80 basis points from the 2015 quarter. This represented a 57% flow-through of this quarter's revenue increase. On a comparable basis, 7 of our 9 hotel operating agreements exceeded the hotel's industry's RevPAR performance in the first quarter and 6 of our 9 hotel operating agreements exhibited GOP margin improvement. Our Marriott 234 portfolio led to HPT's portfolios in the first quarter, increasing RevPAR by 5.2% and GOP margin by 90 basis points driven by our Courtyard and Residence Inn hotels. This portfolio benefited from the ramp-up in four hotels under renovation, in last year's quarter, especially our Emeryville, California Courtyard. Our Hyatt portfolio increased RevPAR 4.7% and GOP margin percentage improved 270 basis points versus the first quarter 2015 as five hotels renovated in 2015 regained occupancy and initiatives such as higher rates for rooms on higher floors showed success. Our comparable IHG portfolio increased RevPAR by 4.3% led by strong result in our Staybridge Suites and Crowne Plaza brands influenced by outsized growth in our West Coast locations. These results were balanced against challenging environments at our InterContinental Hotel in Austin as the Texas legislature is not in session this year and hotel room supply growth has been significant, negatively impacting occupancy. In addition concerns about the Zika virus caused cancellations of group business at our Intercontinental Hotel in San Juan. Our Marriott number one portfolio continued its strong performance during the first quarter. RevPAR increased 4.1% and GOP margin percentage improved 130 basis point versus the first quarter of 2015. Solid ADR gains in corporate-negotiated rates and double-digit RevPAR growth in our Washington, DC area hotels were the key drivers for this portfolio in the 2016 quarter. Our Sonesta portfolio's comparable first quarter RevPAR increased 6.4% and comparable hotel GOP margin percentage improved 2.2 percentage points versus the first quarter of 2015 to 25.8%. Our comparable Sonesta ES Suite hotels once again drove the portfolio's performance following recent renovations. An early and cold Mardi Gras, fewer citywide events and energy sector weakness all held back performance at the Royal Sonesta New Orleans which completed room renovations in December. The energy sector's weakness also continues to weigh on results at the Royal Sonesta Houston and Houston ES Suites. Our Carlton portfolio's RevPAR decreased by 5% during the quarter primarily due to modest Super Bowl-related results at one Silicon Valley hotel in 2016 compared to strong Super Bowl growth at two Phoenix hotels in the first quarter of 2015. Our Wyndham portfolio RevPAR increased 1.3% during first quarter 2016. Results were held back by RevPAR declines at our Wyndham Floor on Park caused in part by executive turnover; to Wyndham Houston, due to weak energy sector; and now Wyndham Grand Chicago, due to weak convention calendar during the first quarter. Across property types, RevPAR and gross profit margin percentage continue to be strongest among our Extended Stay and Select Service portfolios. Our 157 comparable extended stay hotels were up 5.5% and 90 basis points respectively. Our 95 comparable Select Service hotels were up 5.1% and 140 basis points. In both cases, rate was the principal driver of the growth. RevPAR at our 39 full-service comparable hotels was up 2.4% and margins were flat. Generally full-service performance was negatively impacted by energy-reliant markets, softer city-wide calendars in certain markets especially with the timing of Easter in March this year and tough comps in Phoenix which hosted the 2015 Super Bowl. Turning to transaction activity, as previously announced in February, we acquired for $12 million two Extended Stay hotels with 262 suites located in Ohio and converted them to Sonesta ES suites. Also, in March, we acquired for $114 million, the hotel Monaco in downtown Portland, Oregon. This lifestyle hotel has 221 rooms, the successful Red Star Tavern restaurant and bar, over 8000 square feet of meeting space and a full service spa. The hotel Monaco was added to our management contract with IHG. We're being very selective as we consider additional hotel acquisition opportunities. In light of weakened global economic conditions, modest domestic growth and challenging secured debt markets for hotel real estate transactions, we believe hotel pricing may moderate. On March 31, we acquired from TA a newly developed travel center near Dallas for $19.7 million. This property features 200 truck parking spots, 18,000 square foot truck service shop, large convenience store and a virtual range of sports Cafe, among other amenities. We added this property to our TA number four lease; our animal minimum rent associated with this property is $1.7 million. Remember we're committed to acquire several more newly developed TA sites later this year and next. Looking ahead, we and our hotel operators remain optimistic about 2016. Industry experts continue to forecast RevPAR growth in the 5% to 5.5% range for 2016, well above historic long term average growth rates. Our operators are forecasting full-year 2016 RevPAR growth at our hotels generally in the 5% to 7% range and GOP margin percentage improvement of 100 to 150 basis points versus 2015. This implies steady high occupancy and continued above industry average RevPAR growth driven almost entirely by rate growth for the balance of 2016. We're continuing to benefit from renovations that have impacted most of our hotel portfolio. Our total hotel portfolio's high 71.3% average occupancy rate positions our managers well to continue to improve average daily rate in guest segmentation which translates to GOP improvement and increased EBITDA. Improving group trends versus 2015 are expected to help our managers achieve this improved performance despite a tepid pace of U.S. economic growth. We continue to monitor supply growth which is near historic run rates. While much of the new supply remains concentrated in a limited number of urban markets, it is becoming a broader issue impacting occupancy and rate growth in an increasing number of markets. However, we do not expect supply growth to be material headwind to HPT's hotel portfolio performance in 2016. I'll now turn the call over to Mark.

Thanks, John. Starting with the performance of our Travel Center investments, property-level operating results for the 2016 first quarter declined versus very tough prior year comps, but remained strong. As you may recall, in the 2015 first quarter, our TravelCenters realized very high per gallon fuel margins as a result of the favorable fuel-purchasing environment. These conditions did not occur in 2016 and, as a result, our TravelCenters experienced a 25% decline versus the prior year quarter in fuel gross margin. Our TravelCenters did continue to grow non-fuel revenue and non-fuel gross margin which increased 2.9% and 6.4% respectively versus the prior year. As a result of these changes, first quarter property level EBITDAR of our Travel Centers declined by $24.8 million or 21.7% compared to the first quarter of 2015. Coverage of HPT's annual minimum rents, however, remained strong at 1.4 times for the seasonably weaker first quarter and 1.6 times for the 12 months ended March 31. Operating results at our comparable hotels were sound again this quarter with RevPAR up 4.4%, an 80 basis point increase in GOP margin percentage and growth in cash flow available to pay HPT's minimum returns and rents of 6.8%. The 4.4% increase in RevPAR this quarter was driven by ADR growth of 4% and a 3 basis-point increase in occupancy. This quarter's RevPAR growth benefited from the outperformance of the eight comparable hotels that were under renovation during the 2015 first quarter with RevPAR up 14.8% at these hotels; but was also impacted by the 22.2% decline in RevPAR at the two comparable hotels under renovation during this quarter. The portfolios with the highest RevPAR growth this quarter were our Marriott number 234, Hyatt and Marriott number 1 portfolios with increases of 5.2%, 4.7% and 4.1%, respectively versus the prior-year quarter. RevPAR was up 6.4% this quarter at our 22 comparable Sonesta hotels. GOP margin percentage for our comparable hotels increased 80 basis points from the 2015 quarter to 39.8%. Of our portfolios, Hyatt and Marriott number 1 had the strongest margin growth in the quarter with gross operating profit margin percentage up 270 and 130 basis points, respectively versus the 2015 quarter. The combination of strong RevPAR growth and GOP margin expansion at our comparable hotels resulted in a $7.4 million or 6.8% increase from the 2015 quarter in cash flow available to pay our minimum returns and rents. The portfolios with the largest increases in cash flow were our comparable Sonesta and Hyatt portfolios with increases of 21.8% and 16.1% respectively. Cash flow coverage of our minimum rents and returns improved for 5 of our 9 hotel agreements versus the prior-year quarter and portfolio-wide coverage increased to 0.95 times for this traditionally weaker quarter and 1.08 times for the trailing 12 months. All but our Sonesta and Wyndham portfolios and our Marriott Kawai hotel were above 1 times coverage on a trailing 12-month basis. The above 1 times coverage for several of our hotel portfolios resulted in net guarantee and security deposit replenishments of $2.2 million during the first quarter of 2016; and IHG provided HPT an additional $9 million security deposit in connection with the Hotel Monaco acquisition. Also during the first quarter, the final $4 million of guaranty available under our Wyndham management agreement was utilized. Wyndham did pay HPT the full amount of minimum returns and rents due in the first quarter as well as the amounts due for April and May. We currently expect coverage for this portfolio to exceed 1 times for the 2016 year and the guaranty balance to be replenished to $4 million by year end. Turning to HPT's consolidated operating results for the first quarter, this morning we reported normalized FFO of $140.4 million compared to normalized FFO of $126 million in the 2015 first quarter. On a per share basis, first quarter 2016 normalized FFO was $0.93, a 12% increase from the 2015 first quarter. This increase was due primarily to the impact of HPT's hotel and Travel Centers acquisitions and capital improvement funding since January 1, 2015 and the continued improvement in operating results at certain of our hotels. Adjusted EBITDA was $188 million in the 2016 first quarter, an 11.5% increase from the 2015 quarter. Our normalized FFO payout ratio was 54% in the 2016 first quarter. And in April, we increased our quarterly dividend by $0.01 to $0.51 per common share or $2.04 per share, per year. Turning to our capital commitments and financing activities. We funded $12.5 million of hotel improvements and $20.6 million of Travel Center improvements in the first quarter. We currently expect to fund an additional $69 million of hotel improvements and $129 million of Travel Center improvements in 2016. We expect to have 14 hotels under renovation for all or part of the second quarter including the 9 Sonesta ES suites hotels and 2 full-service IHG hotels we acquired in 2015. In the second and fourth quarters of 2016, we expect to purchase two more of the newly developed Travel Centers we previously agreed to acquire and lease back to TA for an aggregate purchase price of $47.5 million. As we previously disclosed, on March 3, we issued $750 million of unsecured senior notes which included $400 million of 4.25% notes due in 2021 and $350 million of 5.25% notes due in 2026. The net proceeds from these offerings were approximately $732 million. On March 11, we redeemed at par all $275 million of our 6.3% senior notes. We have no additional debt maturities until March of 2017. With respect to our balance sheet and liquidity, at March 31, we had approximately $15.8 million of cash which excludes $55.9 million of cash escrowed for improvements to our hotels and had $770 million of availability under our unsecured revolving credit facility. As of quarter end, our debt to total gross book value of real estate was 41.3% and our adjusted EBITDA to total fixed charges coverage and debt to adjusted EBITDA ratios remain strong at 4 times and 4.7 times, respectively. Operator, we're ready to open up the call to questions.

[Operator Instructions]. And the first question comes from Wes Golladay with RBC Capital Markets.

With looking at the Wyndham contract, you mentioned you think you can refill the $4 million guarantee. What type of scenario are you baking into the second half of the year for this to occur?

Their projections for this year projected that they would have greater than one times coverage; the first and fourth quarters are typically the weakest the way the cash flow waterfall works. There's a shortfall in the early part of the year. The guarantee is drawn upon to replenish the shortfalls and, as you move through the year, it's sort of a rolling putback month to month on the waterfall and so we expect that the second and third quarters, in particular, will be much stronger and that the guarantee will be in the same place at the end of the year that it was at the beginning.

Yes, Wes, if you look back at quarterly performance, the second quarter of last year, coverage for that portfolio was 1.3 times. And in the third quarter, it was almost 1.1 times. And we're expecting similar operating results this quarter which will help build back that guarantee in those two quarters.

Okay and looking at the mechanics of that, say we're still below one times coverage for the second quarter. It'll probably have a little bit of an earnings impact but if you get caught up for the year in the revenue third quarter, would you get it all back in what you have for the shortfall in the second quarter? Is that how the mechanics work?

It's a calendar year waterfall, so the first that'll happen is the guarantee will get replenished. Once the guarantee has been replenished, the next line item in the waterfall would be to fund the FF in the reserve.

And then looking at the Sonesta portfolio, there's a lot of moving parts in that. You have obviously the renovations, but you also had seven properties under renovation last year, so you probably had a little bit of an easy comp there. How much of it is just the rebranding of the hotels you bought last year that's impacting the results? And then when do you see the portfolio being stabilized for a good run rate?

There has been a lot of growth in the portfolio in terms of adding hotels. So a lot of the RevPAR growth that you see is properties continuing to restabilize after the acquisitions and improve occupancy. But the core Extended Stay properties, that were the first ones rebranded to Sonesta ES Suites Hotel, should be generating stabilized results by midyear this year. And we'll continue to report the recently acquired hotels that are under renovation separately from the others, so you'll be able to see that, I think

I think if you kind of bifurcate the portfolio into the comparable hotels versus the 11 properties that were acquired, 9 in July last year and 2 in the first quarter of this year; it's two different stories. The comp hotels, as I said, cash flow available to pay our rents and returns was up about 22% for those hotels and would have been even stronger if not for the negative impact that the Houston and New Orleans hotels had on the portfolio this quarter. Those are 2 of the 3 largest hotels from a cash-flow contribution standpoint in that portfolio. And both have been hit hard by the energy sector downturn. If you strip those two properties out of the comp hotels, cash flows for the remaining hotels was up over 180%. So there is a lot of noise in that portfolio; but, if you peel it back, the underlying format of the renovated hotels is pretty strong.

[Operator Instructions]. The next question comes from Bryan Maher with FBR & Company.

On the acquisition front, can you drill down a little bit deeper on what you're seeing out there? I know you made mention that you thought pricing would come in a bit given where supply is picking up to, but how much you think it could come in and over what period of time and are you seeing a pickup in the number of select-service assets being marketed?

I'm not sure over what period of time. I think that most of the lodging REITs have, on their earning calls, have indicated that they are more likely to be sellers than buyers. I think the secured debt markets have become a little bit more challenging. Still by historical standards, debt is still cheap, but it's becoming maybe a little bit harder to obtain. And so I think that will cause some of the private equity shops to expect higher yields. I think maybe it takes the balance of this year to see a moderating trend, but I do think the prices will moderate this year. In terms of select service hotels, we see a lot of one-offs, but the pace of one-off opportunities maybe has slowed just a slight bit. And we're seeing less portfolios of select service hotels in the market as well, a lot of full-service hotels.

You are seeing a lot of full-service hotels?

Yes.

Okay. And on the Travel Center front, we know you made a big purchase last year in the summer. Is there still an appetite at HPT for more of those; and, if so, are you just simply waiting for the existing ones, that TA already owns to stabilize before moving forward? Or do you think you have as much as you want for now?

First of all, obviously, I think you know, Brian, that we're committed to acquire several development locations from TA, a couple more this year and one next. Fundamentally, we think that the Travel Center business is a very good one. We have on a rolling 12-month basis, we have 1.6 times coverage there, so we think that it's a secure portfolio. We believe in the fundamentals there; it's really an infrastructure business in a lot of ways. So we don't have any bias against investing in TravelCenters. But we're more focused on hotels and acquisitions; that is our primary focus. And for the balance of 2016, aside from a couple of newly developed sites, if you see acquisition activity from HPT, it's most likely going to be hotels.

Lastly, outside of hotels and Travel Centers, are there any other kind of verticals that you've been exploring or that you think you might explore in the future? Or is it just going to stay hotels and Travel Centers for the time being?

We're not looking at any other property types. We're really focused on hotel acquisitions and improving our portfolio

[Operator Instructions]. All right, as there is nothing else at the present time, I would like to turn return the call to John Murray for any closing comments.

Thank you for joining us this morning. We look forward to hopefully seeing some of you at the NYU hotel conference in Erie. Thanks again.

Thank you. The conference is now concluded. Thank you for attending today's presentation. You may now disconnect.