Service Properties Trust (SVC) Q2 2022 Earnings Report, Transcript and Summary

Good morning and welcome to Service Properties Trust Second Quarter 2022 Financial Results Conference Call. This call is being recorded. [Operator Instructions] At this time for opening remarks and introduction, I'd like to turn the call over to the Director of Investor Relations, Kristin Brown. Please go ahead.

Good morning. Joining me on today's call are Todd Hargreaves, President and Chief Finance -- Investment Officer, and Brian Donley, Treasurer and Chief Financial Officer. Today's call includes the presentation by management, 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 SVC. I would like to point out that today's conference call contains forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995 and other security laws. These forward-looking statements are based on SVC's present beliefs and expectations as of today, August 5th, 2022. The company undertakes no obligation to revise or publicly release the results of any revision to the forward-looking statements made on 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 and adjusted EBITDAre. Reconciliations of these non-GAAP financial measures 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 on file with the SEC and in our supplemental operating and financial data found on our website at www.svcreit.com. Investors are cautioned not to place undue reliance upon any forward-looking statements. And with that, I'll turn the call over to you, Todd.

Thank you, Kristin, and good morning. Our second quarter results reflect sequential monthly improvement in our hotel portfolio throughout the period, as comparable RevPAR increased from 81% of 2019 levels in April to 86% of 2019 in June, resulting in Q2 2022 RevPAR that was 83% of the 2019 second quarter compared with 67% of 2019 in Q1. The recovery of SVC urban full service and suburban select service hotels contributed to the improvement as more workplaces reopened and employees returned to the office. As a result when combined with the solid performance of our leisure and extended stay portfolios, room rates have now surpassed 2019 figures with ADR increasing from 95% of 2019 levels in April to 101% of 2019 levels in June. This trend has continued into the third quarter with preliminary July ADR of $142, 103% above 2019 levels. Notably our full service RevPAR -- our full service portfolio RevPAR in June increased to 93% of 2019 levels highlighted by considerable occupancy increases as some of our city center hotels. This segment of our lodging portfolio, specifically the hotels in the Midwest and Northeast has trailed in the recovery, but we are now experienced a significant and quantifiable improvement. Examples include our three Chicago hotels where occupancy increased to 50% in Q2 from 15% in Q1 and the Royal Sonesta Cambridge, where occupancy increased to 63% in Q2 from 50% in Q1. Our full service hotel EBITDA in Q2 was $51.1 million compared to negative $1.5 million in Q1, with over half of that improvement driven by occupancy increases at our urban hotels. We have been extremely successful in maximizing rate of many of our hotels located in resort markets with ADRs well above 2019 levels. Two of our top performers, Sonesta Miami Airport and Sonesta Hilton Head achieved Q2 2022 rates of 165% and 137%, respectively, of 2019 Q2 ADR and our leisure hotels market such as San Juan, Kauai and New Orleans, each reported Q2 2022 ADR of more than 110% of 2019 levels. While the recovery of our select service portfolio was trailing our other service levels, the GAAP relative to industry is tightening. Relative to Q2 2021, RevPAR for our select service hotels improved 54%, outpacing industry RevPAR growth by 15 percentage points. Specifically our Sonesta Select portfolio increased RevPAR by 63% year-over-year. In terms of segmentation, Group mix grew to 16% in the second quarter, up from 7% during the previous year quarter, is now back in line with 2019 levels. This increase was largely driven by elevated leisure group demand, the post-pandemic ramp of corporate group and an increase in citywide events. The largest gains were reported in Chicago, Boston, Nashville, New Orleans and Philadelphia. With the increase in Group in corporate negotiated demand, SVC's portfolio witnessed a significant decline in its OTA bookings as its percentage of room revenues during Q2 from these more costly channels dropped from 37% to 30% from the previous year quarter. This is a trend we expect to continue into the third quarter. While hotel EBITDA has not back to 2019 levels, the improvement of our hotel portfolio during the second quarter has now put us back in compliance with our debt covenants, an important milestone in our recovery, giving us flexibility going forward in terms of operating the business and addressing our upcoming debt maturities, which Brian will discuss in further detail in a moment. As it relates to our ongoing plan to sell 68 Sonesta branded hotels, we have now closed on 60 hotels for aggregate proceeds of $518 million and are under purchase and sale agreements for four additional hotels for an aggregate price of $24 million. The other four hotels remained for sale, and two of these are under letter of intent with potential buyers. We believe we have effectively navigated the volatile transaction markets and remain on track to achieve the pricing and expectations we set last year. As we had hoped, we have successfully sold a large percentage of these hotels, encumber of long-term Sonesta franchise agreements, as SVC views franchising is a platform that can facilitate Sonesta's future unit growth, scale, and brand exposure and as we have highlighted in the past, SVC will directly benefit through its 34% ownership share in Sonesta. As previously disclosed we are marketing our remaining 16 Marriott branded hotels for sale on an unencumbered basis and are pleased with a strong level of interest. We have received from a wide range of investors. I would also like to reiterate the superior relative RevPAR margin and growth prospects of the hotels we are retaining versus those we are exiting. We believe our disposition initiative has and will allow SVC and its operators to focus on a more profitable, higher quality lodging portfolio. Turning to net lease. Our diversified portfolio of real estate net lease asset, our retail net lease assets continues to provide SVC with a steady, secure cash flow stream and our largest net lease tenant TravelCenters of America reported another exceptional quarter earlier this week. Our holdings of 8% of TA's common equity provides additional value to SVC, as TA continues to perform. Our other net lease tenants are also operating at a high-level, reporting increased rent coverage from prior periods. In the second half of 2022, we have 302,000 square feet of leases expiring, representing 2% of our net lease rents, excluding TA. This is comprised of four tenants across multiple properties known to be vacating, and represents approximately $2.5 million of annual revenues. We are evaluating both leasing and sale options for these properties. During the quarter, we sold 11 vacant net lease properties for an aggregate sales price of $7.7 million. Subsequent to quarter-end, we have sold two additional vacant net lease properties for an aggregate sales price of $400,000. Overall, we are extremely encouraged by the recovery in lodging demand we saw this quarter across our portfolio. We are optimistic that our operating performance will continue to improve through the second half of the year with positive trends in business travel benefiting our hotel portfolio, steady performance from our net lease portfolio and added flexibility in managing our balance sheet now that we are back in compliance with our debt covenants. I'll now turn the call over to Brian to discuss our financial results in more detail.

Thank you, Todd and good morning. Starting with our consolidated financial results for the second quarter of 2022, normalized FFO was $89.2 million or $0.54 per share, a $63.3 million increase over the prior year quarter. Adjusted EBITDAre was $181.9 million for the second quarter, a $63.3 million increase over the prior year quarter. The major drivers impacting normalized FFO over the prior year quarter was the improving performance of our hotel portfolio, which generated $90 million of hotel EBITDA for the second quarter of 2022 compared to $30 million in the prior year quarter. Guaranteed payments that supported our hotel returns under our historical agreements declined $5.3 million, negatively impacting year-over-year comparisons. Net operating income from our leased properties for the second quarter of 2022 increased $2.2 million over the prior year quarter, primarily as a result of a decrease in reserves for uncollectible rents for certain tenants. Interest expense decreased $1.6 million over the prior year quarter, as a result of repaying $200 million of the outstanding balance on our revolving credit facility in April, and the early redemption of $500 million of 5% senior notes due in August in mid-June. Our share of normalized FFO recognized from our 34% ownership interest in Sonesta increased $1.3 million or $0.01 per share over the prior year quarter. Lastly, G&A expense decreased $815,000 or 6% to $12.7 million in the current year quarter, primarily as a result of lower business management fees due to RMR partially offset by increased legal and professional service costs during the quarter. Turning to our hotel portfolio results. For our 244 comparable hotels this quarter, RevPAR increased 57%, gross operating profit margin percentage increased by 29.4 percentage points to 36%, and gross operating profit increased by approximately $74.1 million from the prior year period. Below the GOP line costs at our comparable hotels increased $11 million from the prior year with increased management fees driven by higher revenues at our hotels and an increase in insurance costs, partially offset by a decrease in real estate taxes. Overall, RevPAR increased 45% sequentially to $92.19 this quarter due to strong occupancy gains in our urban full service hotels and a more gradual recovery in our suburban select service hotels. Our consolidated portfolio of 247 hotels generated hotel EBITDA of $90 million, resulting in a net margin of 21.5%. This compared with $6.9 million in the first quarter and $25.4 million in the prior year quarter. The increase was driven primarily by improvement in our 49 full service hotels, which generated $51.1 million of hotel EBITDA during the quarter compared with losses of $1.5 million in the first quarter and positive EBITDA of $3.7 million in the prior year quarter. Our full service portfolio exceeded industry trends driven from elevated leisure demand, increased citywide events and the continued ramp-up of business travel. Our 82 select service hotels also improved, generating hotel EBITDA of $13 million in the second quarter compared with losses of $2.2 million in the first quarter and hotel EBITDA of $2.5 million in the prior year quarter. Our 116 extended stay hotels continued to deliver solid performance, generating $26.1 million of hotel EBITDA during the quarter compared with $10.6 million in the first quarter and $19.4 million in the prior year quarter. Revenue management and sales strategies to increase RevPAR were successful during the quarter by capitalizing on increased summer demand, increased rates for long-term guests and reducing various discount offerings. The 24 hotels that are expected to be sold, which includes the 16 Marriott hotels currently being marketed for sale, generated hotel EBITDA of $3.6 million in the second quarter compared to $87.1 million for the non-exit hotels. Looking ahead to the third quarter, we are currently projecting full quarter Q3 RevPAR of $88 to $91. Hotel EBITDA is projected to be in the $90 million to $97 million range, with net margins in the 21% to 24% range. Preliminary July RevPAR was $95.97 and we do expect a seasonal slowdown in demand in late August and early September. Turning next to our net lease portfolio. As of June 30, 2022, we owned 775 service oriented retail net lease properties, including our travel centers, with 13.4 million square feet, requiring annual minimum rents of $372 million. Representing 45% of our overall portfolio based on investment, our net lease assets were 98.8% leased by 176 tenants with a weighted average lease term of 10 years and operating under 134 brands in 20 distinct industries as of quarter-end. The aggregate coverage of our net lease portfolios minimum rents was 2.8 times on a trailing 12-month basis as of June 30th, 2022, an increase versus last quarter and an improvement from 2.29 times in the same period last year, led by our travel center properties and tenants and industries that continue to ramp up, including movie theaters and fitness centers. It's worth noting for TA, our largest tenant, site level rent coverage on a trailing 12-month basis was 2.46 times, up from 2.18 times last quarter. TA had another strong quarter and continues to produce high margins. We believe TA's performance contributes to the significant underlying value of our travel centers and along with other net lease retail properties continue to be a stable investment portfolio for SVC. Turning to the balance sheet. In April, we successfully amended our revolving credit facility and extended the maturity date to January 2023, and we have one six-month extension option remaining. As part of the amendment, we reduced the size of the facility to $800 million and extended covenant relief through year-end. In June, we redeemed $500 million of senior notes that were maturing in August 2022. Our improving hotel operating results this quarter put us in compliance with the financial covenants required under our debt agreements as of June 30th, ahead of schedule to our previous estimates. This will give us greater flexibility in managing the balance sheet. We currently have over $790 million of cash. And today, we are repaying $650 million of the amounts outstanding on our revolving credit facility in order to manage our exposure to rising interest rates versus sitting on significant cash balances. Our next debt maturity is $500 million of 4.5% senior notes due in June 2023, which we expect to either refinance or redeem with cash on hand. We will continue to monitor market conditions and reevaluate strategies on our debt maturities, but we'll also remain patient and look to execute on the most cost efficient options that may be available to us. Turning to investing activity. We made $20.7 million of capital improvements at our properties during the second quarter, and $49.5 million year-to-date. We currently expect our capital spend for the rest of the year to be in the $80 million to $100 million range, bringing our total for the year to an expected range of $130 million to $150 million, a decrease to our previous guidance of $200 million. Capital projects have been moving slower than anticipated, as we're being mindful of project scoping and timing due to inflationary pressures and supply chain challenges and some of the projected spend could carryover to 2023, as we strategically planned deployment during seasonally weaker months to minimize operational disruption. Also during the second quarter, we made a $45.5 million capital contribution to Sonesta to partially fund their previously announced portfolio acquisition of four hotels in New York City. Finally, regarding our common dividend. As a reminder, as part of our credit agreement amendments, our common distributions were currently limited to $0.01 per share per quarter through the end of 2022. Operator, that concludes our prepared remarks. We're ready to open the line up for questions.

We will now begin the question-and-answer session. [Operator Instructions] The first question comes from Bryan Maher with B. Riley FBR. Please go ahead.

Good morning and thanks for those comments and that was a terrific quarter you guys put up. So, good news there. Can you talk a little bit more about the margin improvement? I think you guided in your prepared comments, 4% for 3Q. Is it safe to say that the performance like in 1Q, 2022 that's behind us and we should stay at kind of these elevated 20-plus margin levels?

Bryan, thank you and good morning. That's a great question. I think the guidance I just mentioned for Q3, where we have pretty good visibility in the low 20s range is what we expect. I do expect Q4 to trail-off, as we get through the late fall surge of demand into the holiday season. We could see anything from a 15% to 20% reduction in RevPAR as we go through the end of the year. But I do believe Q1, 2022 was an anomaly barring any repeat of the shutdown and Omicron and all that stuff, I expect more normalized, albeit seasonally weaker demand, but higher -- certainly higher than Q1 2022.

Yeah. And I'll just -- good morning, Bryan. I'll just jump in as well. As Brian mentioned, certainly, Q1 was impacted by Omicron probably five weeks or six weeks, but it was also impacted by the performance of some of our urban full service hotels is really where we saw the underperformance in Q1, and that's really where we saw the improvement in Q2, specifically Chicago and San Francisco and those markets just hadn't fully reopened yet. So, we don't -- again, like Brian said that's Q1 is likely an outlier. So, short of any strains that -- of COVID that impacts performance, we don't see it returning to that level.

Okay. And then moving onto the net lease asset sales, and I know dollar-wise, they've been pretty small, but what's driving that? Is it just pruning the portfolio of non-core, non-strategic assets? And is there any kind of common theme among what it is you're selling?

Yeah. You're right. It is -- they're more granular assets. And I think you'll see this more of a long-term trend with our net lease assets outside of TA is that, a lot of these assets when they're purchased or when there's a long-term sale leaseback done, a lot of these assets -- if you don't renew them, they're ending kind of the end of -- they're nearing the end of their useful life. So, sometimes the best exit is to either demo the building and send them -- sell them for land value. So, I think you'll see that continue into the future. I think, obviously, we'll first try to renew them. But I think a lot of our peers in the net lease space, you'll see the same thing. And again, we bought this portfolio back at the end of 2019. COVID hit early in 2020. We didn't really get back into -- we weren't acquiring properties over the past couple of years. So, I think, with that portfolio, you'll see us exit some of those types of properties and recycle that back into longer term leases with some of our current tenants through sale leasebacks or through acquisitions just from third parties. But most of those -- the ones we're selling, a lot of them were former Pizza Huts that were -- the concept with the larger footprints with it and Pizza Huts as -- a lot of those tenants -- types of tenants have kind of moved towards the smaller footprints, focused more on takeout mobile orders rather than sit down, a lot of these were more tertiary markets. A lot of these properties we identified back in 2019 as non-core properties and properties that we knew may be vacating. So, that's a lot of what we've sold this quarter and over the last couple of quarters. And a lot of these, we take to auction and sell them through auction rather through third-party brokers.

Okay. And just last for me, on the Sonesta capital contributions. I'm guessing that, that was related to the four New York City assets that were acquired earlier this year. Is there any thoughts or dialogue going on between SVC and Sonesta, kind of what the scope of investment in owned Sonesta's might be over the next year or two?

Sure. That's a good question. It's -- for the owned Sonesta's and the majority of those really are those four New York City hotels. There's over 900 keys across the Royal full service and extended stay and select. The way that deal was structured, it was financed, and the loan was structured so that the lender funded a certain percentage of the purchase price. And then, all the additional improvements are funded 100% by the lender through additional funding. So, the major capital outlay at those hotels and really for any of the Sonesta owned hotels that would require additional contribution through SVC's 34% ownership share, that's going to be funded 100% by the lender. So really, at the four New York hotels, the major project is they're, they're doing a major renovation at the former Benjamin, which is the Royal Sonesta on 50th, and that will not require any additional contribution -- equity contribution from either Sonesta or SVC. That will be 100% funded by the lender. So, long way, I answer your question that it's very limited.

Okay. Maybe just one more on CapEx. It seems like some of the stuff for this year is probably supply chain issues. How should we be thinking about 2023? Is the $150 million number, plus or minus in the ZIP code or $150 million to $175 million. Any initial thoughts there?

Sure. Bryan, I'll take that one. I think given some of the delays we've seen and sort of going back to the drawing board to control costs to make sure not only we deliver good product, but also contain costs. Some of that will get pushed into the first quarter, but we still behind that our planning renovations we had expected in the Sonesta portfolio. The big one we're trying to get out of the gate is the Hyatt portfolio, which we agreed to renovate, which we do expect to start in the fourth quarter and into the first quarter. But I think to answer your question, it could be elevated in the $200 million to $250 million range next year, if all goes to plan and we get a dozen or so or 15 Sonesta's off the ground as far as repositioning and renovating.

Okay. Thank you.

Thank you.

The next question comes from Tyler Batory with Oppenheimer & Company. Please go ahead.

Hey, good morning. Just to follow-up on that last line of question in terms of the CapEx, that $200 million to $250 million, you just cited. I'm assuming that includes maintenance CapEx as well? And what are you thinking in terms of a maintenance CapEx number? And then, in the past, I think you talked about $600 million to $700 million spending at the Sonesta portfolio over three years to four years. Is that still in the ballpark of what we should assume in terms of total spending there?

Tyler, thank you for that. Yes. I think from a maintenance capital standpoint, that is included in the all in number. And we historically quote around $65 million to $75 million of maintenance CapEx. As far as the longer term capital spend -- and I think, yeah, over the next three years to four or maybe even five years depending on how quickly we can deploy stuff, that sort of $200 million per year is probably a good number for that horizon.

Okay. Great. And then in terms of the 16 Marriott hotels for sale, talk a little bit more about interest pricing, I mean, a little bit of a difficult environment out there. So, how are you thinking about the timing for these assets as well?

Sure. Good morning, Tyler. Thanks for the question. So, in terms of those 16 hotels, you're right that the markets have been extremely volatile, I would say. I think they've settled down a little bit with the benchmark 10-year treasury coming in considerably. And I think now lenders have a better idea of where deals are going to get priced. So, you're seeing lenders come back into the market. There was a point in time probably four or five weeks ago where we saw transactions, for the most part come to a standstill and we're pulling deals from the market. And anyone who is relying on any type of leverage couldn't get anything done. But again, I think things have settled back. In terms of these hotels, specifically, we took these to market. We had our first round call for offers on July 20th, so a couple of weeks ago. And interest exceeded our expectations, at least given the market environment we have received interest from groups -- several groups that want to buy the entire portfolio. We've received interest from groups that want to buy portions of the portfolio. We've received most of the interest is from hotel operators, hotel owner/operators, but we've also received interest from multi-family developers for the three extended stay hotels. But I think we said on the last call, maybe our net carrying value is just under $100 million for those hotels. And with the caveat that we're in a volatile transact -- volatile market right now with where debt is, I would say, I fully expect to exceed that amount. And yeah, again, very strong interest. I think we've had the benefit of -- we've had a lot of success with the 68 sale hotel portfolio, a lot of success with those buyers. A lot of those same buyers were strongly considering this time around as well, which is important, because it's even more critical right now to be able to really fully understand who you're selling to, who can deliver, who is well-capitalized, who's going to require financing. So, I think in this process, it's going to be very critical to vet these buyers, so we understand who can close and who can't.

Okay. Appreciate that. And last question for me, the hotel performance, really strong. When you look at Sonesta broadly, when I look at your Sonesta properties, can you see an indication that you're starting to take some market share perhaps and there's brand awareness for Sonesta that's really starting to improve, and is really contributing to some of these better performance metrics?

Sure. Yeah. I think the answer is yes, and it varies by kind of service level. A lot of the improvement this quarter came from our Royal Sonesta hotels, but we also saw significant improvement on our Sonesta Select hotels as well, which is really our primary area of focus. Brian and I are spending a lot of time working with our hotel asset management team, Sonesta's operations team to really drive performance at those hotels. That's really where we see most of the opportunity for growth and most of the gap to close to get back market share and get back to where the previous operator was operating these hotels. And we're really looking closely at the analytics there and looking at the performance and setting goals for each specific hotel and taking different initiatives to really look at improving both the top line and the bottom line. And the Sonesta Select, for example, the market share in January was 66%, and in June, it was 80%. So, we are seeing significant improvement. And we're -- it's a very high-level of priority for the management team here at SVC.

Okay. That's all for me. Thank you for the detail.

Of course. Thank you

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

Thank you everyone for joining today's call, and we appreciate your continued interest in SVC. Thank you.

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