Service Properties Trust (SVC) Q3 2016 Earnings Report, Transcript and Summary

Good day and welcome to the Hospitality Properties Trust Third Quarter 2016 Financial Results Conference Call. All participants will be in listen-only mode. [Operator Instructions] Please note this event is being recorded. I would now like to turn the conference over to Katie Strohacker, Senior Director of Investor Relations. Please go ahead.

Thank you. 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'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, 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 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 on our website at www.hptreit.com. Investors are cautioned not to place undue reliance upon any forward-looking statements. With that, I'll turn the call over to John.

Thank you, Katie. Good morning and welcome to our third quarter 2016 earnings call. It was another strong operating quarter for HPT, which reflects the continued execution of our strategy to own a diverse portfolio of well-maintained travel centers and hotels, predominantly select service in 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 hotel asset management focus on revenue growth and flow through improvement, were the principal factors behind our hotel portfolio’s performance during the quarter. Among this quarter's highlights, normalized FFO per share increased year over year by 4% to $1.03. Aggregate coverage of our minimum returns and rents improved over the prior quarter for our hotel and travel center portfolios. Comparable hotel RevPAR growth of 3.8% exceeded the hotel industry's performance for the 15th consecutive quarter. Cash available for our minimum rents and returns for our comparable hotels increased by $10.6 million or 7.5%. We completed a common equity issuance that raised net proceeds of approximately $372 million, and we acquired a recently developed Travel Center for $16.6 million, and entered agreements to acquire 3 full service hotels to be operated by 3 of our existing managers, for total consideration of $141.7 million. Turning to operational details, third quarter results for HPT’s 198 Travel Centers reflected reduced diesel fuel volume sold, more than offset by higher cents per gallon diesel fuel margins versus the comparable 2015 period, resulting in a 2.2%, or $1.9 million increase in fuel margins. Nonfuel gross margin increased $8.4 million or 3.8% led by improvements in the stores, repair shop, and quick service restaurants in our Travel Centers. Property level rent coverage for the quarter increased to 1.78 times, despite a 6.7% increase in rent to HPT due to our increased investments. Turning to our hotels, third quarter continued our positive RevPAR in margin growth momentum, with RevPAR growth of 3.8% across HPT’s 293 comparable hotels above industry growth levels again this quarter. This RevPAR growth, which was primarily rate driven, combined with operating expense control, resulted in continued margin expansion, with comparable GOP margin percentage up 98 basis points from the 2015 quarter. This represented a 73% flow through of this quarter's revenue increase. As a result, coverage of our minimum rents and returns for our comparable hotels continued to improve to 1.27 times this quarter, versus 1.19 times in the 2015 quarter. Carlton was one of our best performing portfolios in the third quarter, increasing RevPAR by 7% through both occupancy and rate gains. 8 of our 11 Carlton properties experienced above industry RevPAR improvement during the quarter. In particular, the Radisson Salt Lake City took advantage of increased citywide events to increase their base occupancy and drive rate in transient group segments. Revenue flow through to GOP was a strong 70% this quarter and cash available to pay our returns increased 10.6%. Our Wyndham portfolio increased RevPAR 4.4% led by the Wyndham full service hotels and strong group performance this quarter, particularly in our Dallas, Irvine and Chicago Wyndham hotels. Overall RevPAR growth was driven by a 2% increase in rate and a 1.8 percentage point increase in occupancy. GOP margin percentage for the portfolio improved 211 basis points, primarily attributable to room revenue improvement, and reduced overhead expenses. While this portfolio is still experiencing some negative impact from hotels in Houston and suburban Chicago, flow through of revenue increases to GOP was 109%. Our IHG portfolio increased RevPAR by 3.7% driven primarily by rate increases and by strong performance at our 19 Staybridge Suites hotels with RevPAR increases of 8.8%. Our Sonesta portfolio’s comparable third quarter RevPAR increased 10.5%, and comparable hotel GOP margin percentage improved 391 basis points versus the third quarter 2015 to 33.2%. Our full service hotels drove the portfolio’s performance due to positive renovation impact, delegation business at our Royal Sonesta Baltimore, and the impact of the Democratic National Convention on our Sonesta Philadelphia. The Royal Sonesta New Orleans experienced strong double digit RevPAR growth, driven largely by occupancy gains post renovations. The hotel’s positive performance came despite fewer citywide events and ongoing energy sector weakness. Energy sector weakness continues to weigh on the results at the Royal Sonesta Houston and Houston ES Suites. Across property types, RevPAR and gross profit margin percentage was strongest among our 41 comparable full service hotels, up 6.2% and 197 basis points. Our 157 comparable extended stay hotels were up 4.2% and 59 basis points. In both cases, rate was the principal driver of the growth. RevPAR 95 comparable Select Service hotels was up 0.9% and margins improved 36 basis points. Softer Select Service results were due primarily to our Marriott Courtyard hotels, which had a poor July due to 5 weekends, and July 4th falling on a weekday, weakness at our 7 Boston Area Courtyards from fewer compression nights and new supply impacts. Turning to transaction activity, on September 30, we acquired a newly developed travel center located in Caryville, Tennessee for $16.6 million as part of our previously announced transaction with TA. In October, we entered into a revised contract to acquire an independent full service hotel located in Milpitas, California for $46 million. This hotel is well located near San Jose and Santa Clara, with convenient freeway access, and should benefit from the growing tech presence in north San Jose. We expect to add this hotel to our management agreement with Sonesta in December 2016. Also in October, we entered into agreement to acquire a full service hotel with 101 rooms located in Addison, Texas approximately 15 miles north of Dallas, for $9 million. We plan to add this Radisson branded hotel to our management agreement with Carlton during the first quarter of 2017. This month, we entered into an agreement to acquire a full service hotel with 483 rooms located in Chicago, Illinois for $86.7 million, which we plan to add to our agreement with Intercontinental during the first quarter 2017. On August 30, Marriott gave us notice of their intent not to extend the term of the lease agreement for the Marriott Kauai Resort when it expires in December 2019. The notice was sent well in advance of the required notice timing indicating Marriott would like to discuss possible changes to our agreement going forward. It's too early to predict how any discussions may go, or if this will remain a Marriott branded hotel. This hotel represents approximately 1% of portfolio rents and returns and coverage for the trailing 12 months was 0.73 times. So the impact of any changes are unlikely to be material to HPT’s performance. Looking ahead, we and our hotel managers remain optimistic about 2016. Although our operators have continued to reduce expectations from last quarter, to account for weaker than expected transient room nights, fewer compression nights, supply growth and continued energy related weakness. Industry experts now forecast RevPAR growth just over 3% for 2016, in line with historic long-term average growth rates. Our operators are forecasting full year 2016 RevPAR growth generally in the 3.5% to 4.5% range and GOP margin percentage improvement of 75 to 125 basis points versus 2015. Our managers are projecting that for the balance of 2016, we will continue to experience steady high occupancy, but a more modest level of rate increases, such that fourth quarter RevPAR growth may be in the 2.5% to 3% range. GOP margins should continue to improve by 75 to 100 basis points. We're continuing to benefit from a well maintained, geographically diverse hotel portfolio. Our hotel portfolios’ high average occupancy positions are managed as well to continue to improve average daily rate, and deliver continued GOP improvement and increased EBITDA. 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 third quarter improved versus the prior year quarter. Fuel gross margin increased 2.2% versus the prior year quarter as a result of a 4% decline in total gallons sold that was more than offset by a 6.5% increase in per gallon gross margin. Our travel centers also continued to grow nonfuel revenue and nonfuel gross margin, which increased 0.6% and 3.8% respectively versus the prior year. Approximately 72% of the total gross margin of our travel centers during the quarter was from the more stable nonfuel segment of the business. Site level operating expenses were well controlled, increasing only 0.2% versus the prior year. As a result of these changes, third quarter profit level EBITDA of our travel centers increased by $9.8 million or 9% compared to the third quarter of 2015. Minimum rent under our travel center leases remained well covered at 1.78 times for the third quarter and 1.59 times for the 12 months ended September 30. Operating results at our comparable hotels were strong again this quarter, with RevPAR up 3.8%, a 98 basis point increase in GOP margin percentage and growth in cash flow available to pay HPT’s minimum returns and rents of 7.5%. The 3.8% increase in RevPAR this quarter resulted from ADR growth of 3.3% and a 40 basis point increase in occupancy. The portfolios with the highest RevPAR growth this quarter were our Sonesta, Carlton and Wyndham portfolios, with increases of 7.6%, 7%, and 4.4% respectively versus the prior year quarter. RevPAR was up 10.5% this quarter at our 22 comparable Sonesta Hotels, while RevPAR at the 11 non-comp Sonesta Hotels declined 7.1% this quarter, due to the majority of these hotels undergoing renovations for all or part of the third quarter. GOP margin percentage for our comparable hotels increased 98 basis points from the 2015 quarter to 43.4%. Of our portfolios, Sonesta and Wyndham had the strongest margin growth this quarter, with gross operating profit margin percentage up 333, and 211 basis points respectively versus the 2015 quarter. The combined increases in RevPAR and GOP margin percentage at our comparable hotels resulted in a $10.6 million or 7.5% 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 Carlton, Wyndham, and IHT portfolios with increases of 10.6%, 9.1%, and 6.8% respectively. Cash flow available to pay our minimum returns increased 33.4% at our comparable Sonesta Hotels. Cash flow coverage of our minimum rents and returns improved for seven of our nine hotel agreements versus the prior year quarter and portfolio wide coverage increased to 1.25 times for the current quarter. Coverage for our 22 comparable Sonesta Hotels was 0.94 times for the quarter, up from 0.72 times in the prior year quarter. The above one times coverage for several of our hotel portfolios resulted in guarantee and security deposit replenishments of $15.4 million during the third quarter. In addition, our Marriott No. 1 and IHT agreements generated a total of $7.9 million of income to HPT this quarter, in excess of our minimum returns. Turning to HPT’s consolidated operating results, normalized FFO was $162.1 million in the 2016 third quarter, an 8.3% increase from the 2015 quarter. This increase was due primarily to the improved operating results of our comparable Sonesta Hotels, the minimum returns and rents we earned from our acquisitions and improvement funding since July 1, 2015, and the increase from the prior year quarter and the amount of excess returns earned from our Marriott No. 1 and IHT portfolios. These increases were partially offset by the impact of higher interest in G&A expense compared to the prior year quarter. On a per share basis, third quarter 2016 normalized FFO was $1.03, a 4% increase from the 2015 third quarter. HPT’s weighted average share count was up 3.9% versus the prior year quarter due to our common share offering in August. Adjusted EBITDA was $210.5 million in the 2016 third quarter, a 9.2% increase from the 2015 quarter. As a reminder, when calculating both normalized FFO and adjusted EBITDA during the first three quarters of the year, we add back any estimated incentive business management fee expense recorded in our calculation of GAAP net income. As of September 30, 2016, we have accrued $56.3 million of estimated incentive management fee expense in our calculation of GAAP net income. We will include a deduction for incentive fee expense in our fourth quarter normalized FFO and adjusted EBITDA calculations when the actual expense amount for the year is known. In October we announced a regular quarterly dividend of $0.51 per common share or $2.04 per share per year. Our normalized FFO payout ratio was only 49.5% in the 2016 third quarter. Turning to our capital and acquisition commitments, we funded $15.9 million of hotel improvements, and $20.3 million of travel center improvements in the third quarter. In the fourth quarter, we expect to fund $53 million of hotel improvements, $30 million of Travel Center improvements, and the $46 million acquisition of the Milpitas California hotel. In the 2017 first quarter, we expect to acquire the one remaining newly developed Travel Center at a purchase price equal to its development costs not to exceed $29 million, and to acquire the Addison Texas and Chicago hotels for an aggregate purchase price of $95.7 million. We plan to provide estimates of 2017 hotel and Travel Center capital improvement fundings during our fourth quarter earnings call. Turning to our third quarter financing activities, in August we sold 12.65 million common shares at a price of $30.75 in a public offering, raising net proceeds of approximately $372 million. In late September, we redeemed at par all $300 million of our outstanding 5% and 5.8% senior notes due in March 2017. This redemption, in combination with our equity offering and other activities that took place during the quarter, reduced our ratio of debt to total gross assets to 34.6% at quarter end. For the quarter, our adjusted EBITDA to total fixed charges coverage ratio remained strong at 4.5 times. With respect to our liquidity at September 30, we had approximately $9.5 million in cash, which excludes $60.6 million of cash escrowed for future improvements to our hotels, and had $850 million of availability under our revolving credit facility. Operator, that concludes our prepared remarks. We'd like to open it up for questions.

Thank you. We will now begin the question and answer session. [Operator instructions] Our first question comes from Michael Kodesch of Canaccord. Please go ahead.

Hey. Good morning guys, and thanks for taking my questions. I guess the first question I have as it relates to the Radisson and Addison Texas, I guess just what happened with the contract to delay it, and then redo it. And then if you could speak to, or give any color on the pricing, the new pricing of that as well, it looks like it was a little bit lower. Thanks.

Sure. Thanks for the question I think you may have mixed up a couple of our transactions. The Radisson that we’re acquiring in Addison Texas is a newly announced transaction for $9 million. We expect the next 12 months yield on that, the cap rate to be about 8.4%, so there hasn't been any change in that. We had the hotel in Milpitas under contract $52 million. We announced that last quarter. As a result of our diligence, the necessary capital was higher than we had expected to properly renovate the hotel and as a result we sought a purchase price adjustment. And so that's the difference between the $52 million and the $46 million and we expect -- the going in yield there really isn't as meaningful. It's in the 7.5% to 8% range, but the hotel has not received a significant amount of capital in a number of years, and it’s been operated as an independent with a small independent third party manager as the operator. So we expect that once the hotel is fully renovated, given its excellent location, that it's going to provide strong returns for our portfolio.

Great, thanks. That's helpful color, and sorry for misspeaking, and mixing those up. I appreciate the color on Addison as well, but then did you have a cap rate on Chicago?

We have a strong cap rate there. The important thing is that we're going to get a base yield -- cash yield on our purchase price of 8% from IHT, and they're going to be providing credit support as well, so our going in yield is strong, but the purchase price is north of 8% as a cap rate.

Great. Thanks. And then as it relates Sonesta renovations, RevPAR got a nice boost there in the quarter. I believe is up 7.6% at Sonesta. Just how did that compare to internal expectations and then what are you seeing for the Sonesta brand in the next few quarters?

Well, on the initial 22 hotels, we had hoped that we would get renovations completed sooner than we did, and as a result, we had hoped that we'd see improved cash flow earlier than we did, but we are pleased to see that the hotel portfolio continues to ramp up nicely now that the renovations on those first 22 are all complete. And in addition, we've just completed the renovations on the 11 most recently acquired Sonesta ES suites hotel. So we're expecting to see good RevPAR growth as well as hotels bounce back from the renovation impact. So I think we have positive expectations about the direction that Sonesta is headed and look forward to continued growth.

Great, and then just one more for me. So it sounds like we still have a little bit of time on those, but just as a whole for renovations, when do you expect to lap the renovation period and start to see I guess more normalized results? Thanks.

I think next year we should see normalized results for the initial 22 hotels, the comparable hotels that we've been talking about today. And it will be about midway through next year before we have I think comparable performance on the newest 11.

Great. I really appreciate it.

Generally next year.

Great. I appreciate it, and thanks again for taking all my questions.

Our next question comes from Bryan Maher of FBR & Company. Please go ahead.

Good morning John and Mark. A quick question. It seems apparent that you’re a little bit more skewed in your acquisitions towards full service from select service. I don't know if that's a coincidence between the performances you just showed on your full service and select service or if there's some type of benefit on the cap rates going in? Can you talk a little bit about how you're thinking about that strategically? I mean you historically were more of a select service, extended stay company. It seems like you’re getting more and more full service. Is their strategic shift here or is it just opportunistic?

I would say it's a combination of strategic and opportunistic. We’ve been making some acquisitions with IHT recently that have been full service hotels. We have a very good and long-term successful relationship with IHT. And so when there are opportunities to work together with them to help them grow their brand, and to help us grow our portfolio, we're interested to do it. We've kind of felt like there were -- that the Carlton portfolio was one of our smaller portfolios and so we've been keeping an eye out for opportunities to improve the diversity of that portfolio. And so when we had discussions this summer with Carlton and they asked if we would consider working with them on this Addison property, we were willing to do so really because we have a good structure there and a good relationship with Carlton and would like to see that grow. So it wasn't so much a decision about really wanting full service hotels or select service hotels. Overall, we prefer extended stay hotels and select service hotels like the Courtyards and high places that we own. They have lower fixed costs and steady revenue performance. So the cash flow has been fairly predictable and secure. So that's -- in the ordinary world, that's still our preferred type of hotel to invest in.

And then what are you seeing in the way of kind of volume of deals and who the sellers are and are you seeing a shift in pricing?

That's a tough one. There are a lot of transactions in the market and that the sellers range from some of our competitor REITS, to some of the private equity funds, to just hotel owners from other walks of life. And some of them are portfolios of select service hotels, and a lot of them are individual assets. We feel like the number of bidders may be shrinking in transactions and that the prices may be moderating a little bit, but the closer you get to strategic markets or very strong performing markets, the more likely you are to run in to foreign capital coming in to buy. So prices haven't moderated in those situations as much as you might hope or expect.

Thanks. That was helpful, John.

[Operator Instructions]

All right, thank you everybody for joining us today. We look forward to seeing you hopefully at NAREIT coming up next week. Thank you.