Service Properties Trust (SVC) Q1 2018 Earnings Report, Transcript and Summary

Good day, and welcome to the Hospitality Properties Trust First Quarter 2018 Financial Results Conference Call. All participants will be in listen-only mode. [Operator Instructions] After today’s presentation there’ll be an opportunity to ask questions. Please note, this event is being recorded. I would now like to turn the conference over to Katie Strohacker, Senior Director, Investor Relations. Please go ahead.

Good morning. Thanks for joining us today. 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 with 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, May 9, 2018. 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 Murray.

Thank you, Katie, and good morning. Earlier this morning, we reported first quarter normalized FFO of $0.94 per share, an increase of 3.3% compared to the $0.91 reported in the first quarter of 2017, due primarily to increased minimum rents and returns resulting from prior year hotel acquisitions and owner funded capital improvements at our hotels and travel centers. Starting with performance of HPT’s travel centers. Fuel margin increased by $18 million or 31.5% in the first quarter due to a retroactive $21.2 million federal biodiesel tax credit related to 2017 that was received in the first quarter 2018. Excluding the biodiesel tax credit, fuel margin decreased by $3.1 million or 5.5% due to a 0.4% decline in fuel volumes sold and a 5% decline in cents per gallon fuel margin. Nonfuel gross margin increased $11.8 million or 5.3%, and site level operating expenses increased $1.8 million or 0.9% compared to 2017. Mark will provide more details on these changes in a moment. Property level rent coverage for the quarter, excluding the biodiesel tax credit, was 1.26x, up from 1.2x in last year’s quarter, despite HPT’s rent increasing 2.9% compared to 2017 due to HPT’s increased investments. Turning to performance of HPT’s hotels. First quarter 2018 comparable RevPAR increased by 2% versus the 2017 quarter, driven mostly by rate growth, while comparable GOP margins decreased by 97 basis points versus the 2017 quarter to 37.8%, primarily due to higher wage and benefit costs and higher food and beverage expenses. Aggregate coverage of annual minimum returns and rents at all of our hotels was 0.82x this quarter, down from 0.88x in 2017. Factors that positively impacted first quarter results included strong performance at our full-service hotels, which benefited from increases in group bookings, ramp-up from renovations and demand related to winter storm activity. However, new room supply continues to impede RevPAR performance as an increasing number of HPT hotels, particularly our upscale hotels. As you may know, in the first quarter, the Smith Travel Research upscale chain scale reported the highest percentage of growth in rooms available and the second lowest year-over-year RevPAR growth. HPT’s comparable upscale properties experienced similar low-growth trends. In addition to new room supply, renovations had a negative impact on RevPAR this quarter, with 23 comparable hotels under renovation in the 2018 quarter compared to 10 hotels last year. While many of these are normally recurrent soft good renovations, which don’t require construction, they do cause disruption. A comparable portfolio RevPAR’s growth, excluding hotels under renovation, was 2.7%. A comparable Sonesta portfolio reported strong revenue growth this quarter with RevPAR increasing by 6%, led by occupancy increases of 3.6 percentage points and rate growth of 0.4%. Performance was driven by ramp-up of the extended-stay hotels that were required in 2015 and 2016 and subsequently ramping. These hotels increased RevPAR by 7.3%. In addition, the portfolio’s comparable full-service hotels had a strong quarter as material gains were recognized at the Royal Sonesta, New Orleans; Royal Sonesta, Boston; Sonesta Philadelphia; and Sonesta Gwinnett Hotels. For the comparable Sonesta portfolio, GOP margin percentage improved 1.3 percentage points and cash flow available to pay our minimum return increased 13.7%. IHG’s comparable hotel RevPAR increased 3.5%, driven by a 3.7% increase in rate, primarily -- partially offset by 20 basis point decrease in occupancy. Our comparable full-service hotels grew RevPAR above industry, driven by our InterContinental Hotels in San Juan and Toronto, which benefited from hurricane-relief business and competitive set closures due to renovation. And the Crowne Plaza, Denver, which experienced strong growth following renovation last year. Our Radisson portfolio grew RevPAR 2.5% in the first quarter, led by 2.1% increase in rate and 0.3 percentage point increase in occupancy. Excluding the 2 hotels under renovation in the first quarter, Radisson’s RevPAR would have increased 4.6%. Strong group demand, mix-shift higher-rated segments and the Super Bowl drove RevPAR increases. Our Wyndham portfolio RevPAR grew a modest 1.4%. As expected, the Wyndham Florham Park Hotel had strong growth in the first quarter following renovation displaced in last year, a trend we expect will continue throughout this year. The Hawthorn Suites quarter-over-quarter RevPAR declined as a result of the timing of project business at various hotels. Wyndham’s GOP flow-through increased 12%. Under our agreement with Wyndham, if they guarantee of our hotel management agreement is depleted and cash available to pay our returns is insufficient to pay the contractually due amounts, to avoid the fall, Wyndham must pay the greater of available cash flow or 85% of the contractual amount due. During the three months ended March 31, 2018, Wyndham paid HPT 85% of the minimum returns due under the management agreement or approximately $1 million less than the contractual amounts due. Renovations that took place in the quarter were predominantly in the Marriott portfolios, and these were the agreements that had the weakest revenue performance this quarter. Our Marriott 234 portfolio RevPAR decreased 0.8% and GOP margin percentage decreased by 141 basis points. This portfolio had six Residence Inn hotels under renovation this quarter, which negatively impacted RevPAR growth by 2.3%. Excluding the six hotels under renovation, this portfolio is seeing room night growth in the corporate negotiated and group segments and implementing revenue management initiative to improve revenue performance in supply impacted markets. Coverage of the required annual returns at this portfolio was 1.11x for the last 12 months. Our Marriott No. 1 portfolio RevPAR decreased 0.5% this quarter, also attributable to renovation displacement at 13 hotels during the quarter. They had a combined RevPAR decline of 12% in the first quarter. Many of the hotels in this portfolio performed at above the industry growth this quarter. For those that have grappling with supply absorption, strategies to drive better revenue management are being employed. At 1.23x coverage for the last 12 months, Marriott No. 1 remains among our best covered agreements. As we’ve mentioned previously, we expect to be more focused on renovations and acquisitions this year. 19 of the 20 hotels acquired in 2017 required significant renovations. In addition to normal recurring primarily softwood renovations at over 50 comparable hotels in the portfolio. We expect to fund the majority of renovations pending from FF&E reserves or free cash flow. Yesterday, the lease agreement for the Clift Hotel was terminated. Morgans surrendered possession of the hotel to us, and the hotel was rebranded to the Clift Royal Sonesta Hotel and added to our management agreement with Sonesta. The terms of the management agreement are consistent with the terms of our other management agreements with Sonesta for full-service hotels. This hotel was in need of significant renovation, which is scheduled to begin later this year and continue into 2020. This luxury hotel is well located in Union Square, in the heart of San Francisco and other Financial District in Moscone Convention Center. Looking ahead, our management is continuing to project that the 2018, we will experience growth through rate improvement such the comparable RevPAR will increase 1% to 2% with GOP margin percentage in the flat to down 50 basis point range, possibly due to increased wages and benefit costs. The first quarter is typically the weakest quarter for HPT’s hotels and travel centers, and our hotels that concentrated in the upscale select-service segment focused on business travel. We expect performance will pick up over the next couple of quarters, but we’ll continue to see supply growth, experience renovation impact and respond to wage-related cost pressures. So it’s premature to change our full year outlook, which was already higher than many of our peers. I’ll now turn the call over to Mark.

Thanks, John. Starting with the performance of our travel center investments. Property level EBITDAR in the 2018 first quarter was higher than the 2017 quarter, due primarily to the benefit of a retroactive tax credit and increases in nonfuel revenues in gross margin percentage. For the quarter, fuel gross margin increased by $18 million or 31.5% due to a $21.2 million federal biodiesel tax credit that was retroactively reinstated for 2017 in February of this year. Excluding the credit, TA’s fuel gross margin decreased by $3.1 million or 5.5% versus the prior year quarter as a result of a 0.4% decline in fuel sales volume and a 5% decrease in cents per gallon margin. A slight fuel volume decline was due to the continued effects of truck fuel efficiency gains and increased competition, while the decline versus the prior year in cents per gallon margin was due primarily to the more favorable fuel purchasing environment experienced in the 2017 first quarter. Nonfuel travel center revenues increased 4.1% versus the prior year due primarily to growth in truck service and reserve parking. Nonfuel gross margin percentage increased 70 basis points from the prior year quarter to 61.9%. As a result, our travel centers grew nonfuel gross margin $11.8 million or 5.3% versus the 2017 quarter to $234.8 million. And nonfuel sales generated approximately 70% of the total gross margin dollars of our travel centers in the quarter. Site level operating expenses increased only 0.9% versus the prior year despite the higher labor costs associated with the increase in nonfuel sales. Excluding the $21.2 million impact of the biodiesel tax credit, first quarter property level EBITDAR of our travel centers still increased by approximately $6.9 million or 8.2% compared to the first quarter of 2017. Annual minimum rent coverage under our travel center leases, excluding the impact of the tax credit, was a strong 1.26 times for the seasonally weaker first quarter compared to 1.2 times last year. Turning to our hotel investments. Operating results were mixed at our 303 comparable hotels this quarter, with RevPAR up 2%, a 97 basis point decrease in GOP margin percentage and a decrease in cash flow available to pay HPT’s minimum returns and rents of 2.1%. The 2% increase in RevPAR this quarter resulted from a 1.8% increase in ADR and 0.1 percentage point increase in occupancy. Excluding the impact, 23 hotels under renovation during the quarter, comparable hotel RevPAR growth was 2.7%. The portfolios with the highest RevPAR growth this quarter were our comparable Sonesta and IHG portfolios, with increases of 6% and 3.5%, respectively, versus the prior year quarter. Our Marriott No. 234 and Marriott No. 1 portfolios had the weakest RevPAR performance with declines of 0.8% and 0.5%, respectively, versus the prior year quarter. Both portfolios were negatively impacted this quarter by renovations. 13 in our Marriott No. 1 portfolio and 6 in our Marriott 234 portfolio as well as increased supply. GOP margin percentage for our comparable hotels decreased 97 basis points from the 2017 quarter to 37.8% and gross operating profit decreased approximately $747,000 or 0.4% from the 2017 first quarter. Of our portfolios, the Radisson and comparable Sonesta portfolios had the largest increases in GOP margin percentage in the quarter, up 163 basis points and 126 basis points, respectively. While our Marriott No. 1 and comparable IHG portfolios had the weakest margin performance in the quarter, with GOP margin percentage down 199 basis points and 182 basis points, respectively, versus the 2017 first quarter. The decrease in gross operating profit combined with the 3.2% increase in below the line -- below the GOP line cost resulted in a $2.4 million or 2.1% decrease from the 2017 quarter in cash flow available to pay our minimum returns and rents for our comparable hotels. The two portfolios with the largest percentage increases in cash flow were our comparable Sonesta and Radisson portfolios with increases of 13.7% and 4.5%, respectively. The two portfolios with the largest declines in cash flow were our Marriott No. 1 and Marriott No. 234 portfolios with decreases of 7.6% and 4.1%, respectively. Cash flow coverage of our minimum rents and returns for our nine hotel agreements was 0.82x for the 2018 quarter compared to 0.88x for the prior year quarter. Excluding hotels under renovation this quarter, coverage for comparable hotels was unchanged between years at 0.89x. With coverage for the 2018 quarter below 1x for certain of our portfolios, a net $5.4 million of security deposit and guarantee balances were utilized during the quarter. Turning to HPT’s consolidated financial results. Normalized FFO was $154.9 million in the 2018 first quarter compared to normalized FFO of $148.8 million in the 2017 quarter. Normalized FFO per share was $0.94 for the first quarter, an increase of $0.03 or 3.3% from the 2017 quarter. This increase was due primarily to the $7.9 million or 4.2% increase in minimum returns and rents, partially offset by an increase in interest expense. Adjusted EBITDA was $203 million in the 2018 first quarter, a 4.3% increase from the 2017 quarter. Our adjusted EBITDA to total fixed charges coverage ratio was 4.3x for the quarter and debt-to-adjusted EBITDA was 5.1x at quarter end. In February, we paid a regular quarterly distribution to our common shareholders of $0.52 per share. In April, we announced an increase in our quarterly common dividend to $0.53 per share or $2.12 per year. Turning to our capital improvement fundings and commitments. We funded $17 million of hotel improvements and $13.1 million of travel center improvements in the first quarter. For the rest of 2018, we expect to fund approximately $190 million of hotel improvements and $38 million of travel center improvements. The majority of these improvements are expected to be funded from operating cash flow. We plan to have 28 hotels under renovation for all or part of 2018 second quarter, 14 of which are comparable hotels. Turning to our balance sheet and financing activities. As of quarter end, debt was 41.4% of total gross assets, and we had $16.8 million of cash on hand, which excludes $59.5 million of cash escrow for future improvements to our hotels. In February, HPT issued $400 million of 4.375% senior notes due in 2030. The net proceeds from this offering were approximately $386.5 million and were used to reduce borrowings under our revolving credit facility. At quarter end, we had $86 million outstanding on our credit facility. Operator, that concludes our prepared remarks. We’d like to open the call up for questions now, please.

[Operator Instructions] The first question come from Amanda Sweitzer of Baird. Please go ahead.

I wanted to focus on the Clift transition. What was kind of the settlement amount with Morgans? And then how much do you expect to spend on that renovation?

The settlement-related costs were very minimal. Essentially, a working capital settlement true-up. The renovation is well underway in its planning, but we don’t have a fine-tuned budget estimate quite yet, but it’s fair to say that it’s going to be in the neighborhood between room and public space upgrades and the facade upgrades of approximately $60 million. I think -- I don’t know, if you’ve been to San Francisco lately, but currently, the two sides of the hotel facing Geary and Taylor Street are covenant scaffolding because of Morgans had allowed the facade to deteriorate. So that -- it’s going to be an expensive renovation and it’s going to take probably till the middle of 2020 to complete.

And most of those costs will be incurred in 2019 and possibly 2020.

That’s helpful. And then did you guys consider any other brands for that hotel?

We did. We reviewed the options with our independent trustees. But in the end, we thought that because of the duration and magnitude of the required renovations and because of the nature of the, I think, seven different union agreements that it was going to be the -- that the best outcome for our shareholders was to move this hotel to Sonesta rather than try to work out a management agreement with other operators that where we were held up over those issues.

That makes sense. And then, lastly, from me. Can you just talk about how the board thought about the recent dividend increase, just relative to your current leverage levels and then relative to some of your continued renovation activity?

Yes. So we increased -- in April, when we declared a dividend payable this month, we increased the dividend $0.01 a quarter. I think the -- I’ll call that a modest increase. It was our seventh consecutive year with an increase, but really payout ratio remains relatively low. I think -- we think what’s worked well for our shareholders the last several years as we’ve had this continuous, call it, between $200 million and $300 million of capital improvements at our hotels and travel centers that we’ve funded, that we’ve retained between $200 million and $250 million a year of excess cash flow after payment of dividends and used that money to fund our capital improvement program. In looking at the dividends for the remainder of this year, as I mentioned in the prepared remarks, we expect the majority of the capital that we’re going to fund over the remainder of 2018 to be funded from free cash flow. So we’re comfortable where the dividend and our leverage is right now.

[Operator Instructions] 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 very much for joining us this morning. We look forward to seeing some or maybe all of you at either the NYU Conference or NAREIT conferences coming up the next few weeks. Thanks.

The conference has now concluded. Thank you for attending today’s presentation. You may now disconnect.