It is that time of year again when we get fresh data with which to work. Earnings season tends to come with increased volatility, which translates to opportunity for those ahead of the market. This article will detail my predictions and reasoning as to which REITs will beat and which will miss estimates. Let us begin with a table of incoming earnings reports:
Earnings Release date
1Q12 Comp in FFO per share
1Q13 Estimated FFO per share
Associated Estates (NYSE:AEC)
Ashford Hospitality Trust (NYSE:AHT)
Strategic Hotels (NYSE:BEE)
CBL and Associates (NYSE:CBL)
Mack Cali (NYSE:CLI)
Winthrop Realty (NYSE:FUR)
Lexington Realty (NYSE:LXP)
Sotherly Hotels (NASDAQ:SOHO)
Data from SNL Financial
Why these REITs?
Clearly the list above is not all inclusive, so why have I picked these particular ones? Well, many REITs have not yet announced the date of their release. I have further narrowed it down to the REITs that I have studied in depth such that my insight has value. If I were to provide predictions on stocks outside my expertise, it would be a disservice to my readers.
Any estimate or prediction is based on incomplete information and comes with no guarantee of accuracy. Please consider the reasoning and predictions as strictly supplemental to your own research. This will get lengthy, so those of you who came to read about a particular stock should feel free to scroll down to that section as each company will have a bolded headline.
Multi-family properties have been performing well, with peak occupancy and record setting rental rates. Class A apartments, like those in AEC's portfolio, have performed especially well. In addition to the sector's good fortune, AEC has a history of providing very conservative guidance, which it has repeatedly beat. I expect AEC to slightly beat the $0.32 first quarter FFO estimate.
Ashford Hospitality Trust
The full-year FactSet consensus estimate for AHT's FFO/share is $1.70, yet its 1st quarter estimate is only $0.35. Such a discrepancy is based on the hotel industry's seasonality, as the 2nd and 3rd quarters tend to be stronger than the 1st or 4th. However, Ashford does not seem to share this seasonality with its peers. Over 5 recent quarters, its revenues barely fluctuated.
Screenshot from SNL Financial
Perhaps the reason for this lack of seasonality is that Ashford owns a lot of hotels in warm locations such that the winter of the 1st and 4th quarters is less of a travel deterrent for them. If this year proves to be equally steady, $1.70 annual FFO/share would equate to $0.425 FFO/share.
In addition to adjusting for the lack of seasonality, we should account for the phenomenal RevPAR figures the industry has enjoyed in the first quarter. Occupancy has been steadily up and ADR (average daily rate) was up even more. Furthermore, there has been a resurgence of business travel and Ashford's upscale or upper-upscale properties make excellent conference destinations.
I cannot say whether AHT will beat the FFO estimate, as its extensive use of derivatives to hedge interest rate risk make its FFO rather variable, but I feel confident in saying that its AFFO/share will beat the estimates.
A similar argument could be made for BEE in that the annual estimated $0.38 FFO/share is in discrepancy with its 1Q estimate. However, BEE seems to be much more seasonal, as shown in the table below (dollars in thousands).
Net gain (loss)
Of the 5 quarters, the 3 largest losses occurred in the fourth, first and fourth quarters. This is the typical seasonal pattern for hotel companies and would suggest that the $0.03 is a fairly good estimate.
BEE has enjoyed similar strength in RevPAR, but it may have missed out on the business travel. Companies have had the confidence to book hotels for conferences, but they are not yet ready to dish out the premium prices associated with Strategic Hotel's resort locations. Expect the standing estimate for BEE's 1Q earnings to be fairly accurate.
CBL and Associates
In the first quarter, CBL had positive and negative forces that somewhat nullified each other. The positive force was reasonably strong consumer sentiment. For a shopping mall REIT, this translates into better tenancy and rental rates. However, the first quarter sales bump normally associated with tax refunds may not have been as pronounced this year. For many, the receipt of the refund occurred much later than in previous years such that some of the related spending was pushed into the 2nd quarter. In my opinion, these factors mostly canceled out and the stated $0.51 FFO/share seems to be an accurate first quarter estimate.
CLI's first quarter report could be very interesting, as the company seems to be hitting rock bottom somewhere between now and the 3rd quarter. This, in my opinion, is the good kind of rock bottom, as it is the result of a slew of healthy acquisitions and developments that are being financed now, but have not yet begun producing earnings.
Expect a mixed positive and negative report, as the seemingly accurate $0.63 estimate will be a disappointment compared to last year's $0.74, but it may also disclose some accretive details about its expansion activity. Why do I think they have such a strong pipeline? Well, on 4/15/13, CLI announced a cut in its dividend from $1.80 to $1.20 annually. Given expected 2013 FFO of $2.55, even the bigger dividend is easily covered, so this is clearly an elective decision resulting from superior uses for the capital. Mitchell Hersh was quoted as saying "with the current demand for office space, the dividend reduction represents a prudent step in retaining cash to invest in our multifamily residential platform."
With a market cap of only $391mm, and an extremely high-risk-high-reward strategy, analysts have a difficult job in forming estimates. Most likely, any estimate put out will include a weighted average expected risk such that clean performance for any given quarter will cause FUR to beat the estimates, while adverse events can make it miss. In the case of the first quarter, FUR seems to be positioned to materially beat the $0.27 estimate.
Here's why: Between mezzanine lending and subordinate interest, FUR's inherently risky business practices create occasional losses. It has, however, been very good about announcing such losses the moment they occur and it appears that operations went smoothly through the first quarter. In addition to the seeming absence of losses, which were likely factored into the estimates, Winthrop made some 4th quarter acquisitions that generated cash for the 1st quarter.
- $6mm preferred equity investment in a California office building for 12% priority return
- $5.2mm seller's loan with 8.25% interest
- Originated a $20.5mm mezzanine loan at LIBOR + 14.25%, of which it sold half, keeping a remaining interest of $10.25mm.
- Originated a $40mm first mortgage loan at LIBOR + 11.50%
Each of these comes with a fair amount of risk, so they are not necessarily good for FUR, but these acquisitions are definitely good for its first quarter performance. Expect a substantial upside surprise.
Lexington Realty Trust
A $0.26/share Q1 FFO estimate compared to 2013 full year guidance of $1.01-$1.04 suggests that ¼ of LXP's 2013 FFO will be obtained in the first quarter. For triple-net REITs, this is usually the case, but LXP has had some events that break the continuity of its earnings. Events that shift the FFO balance in favor of the later quarters, including:
- On 3/12/13, LXP issued 20mm common shares with an additional 3mm going to overallotment. While the accretive acquisitions to which LXP has access make the stock offering overall beneficial, almost none of that benefit will be seen in the first quarter accounting period.
- A further $36.9mm of common equity was issued through its at-the-market program by 2/25/13. This capital will also not see full benefit in the first quarter.
- On 2/21/13, LXP announced that it had closed on the new or extended leasing of 325K sq. feet. Depending on when in the first quarter this took place, much of the effects may not be seen until the 2nd quarter.
These three events suggest that LXP will not have linear 2013 earnings, but rather a ramping up as the year progresses. This leads me to conclude that LXP will miss its 1st quarter estimate on May 2nd but make up for it in the subsequent quarters to hit the full-year guidance.
Until recently, this company was known as MHI Hospitality under the ticker (MDH). Since it is so small, not enough analysts follow it to form a consensus estimate for Q1. Instead, we can compare to the prior year's 1Q FFO/share of $0.05. SOHO will almost unquestionably crush the prior year, as it expects to earn between $0.55 and $0.72 per share in 2013.
SOHO does experience a slight seasonality, as its revenues last year ranged from $25mm in 2Q to the low of $20mm in Q1. If we are conservative, using the low end of guidance at $0.55 and factor in the seasonality, it equates to at least $0.10/share for 1Q13. Even the most conservative reasonable estimate shows SOHO doubling last year's report.
If we factor in what we know of hotel operations in the first quarter, the upside is even more staggering. RevPAR has shown impressive YoY growth, with most of the gains coming from room rates. Such gains bode especially well for low margin, highly leveraged companies like SOHO and should drastically improve the bottom line. It should also see added benefit from business travel as it holds excellent hotels for conference hosting. As there is no consensus estimate for SOHO, I will provide my own: FFO/share for 1Q13 should fall somewhere in the vicinity of $0.13/share.
Beat, Hit or Miss estimate
Impressive multi-family fundamentals
Estimate over-compensated for seasonality and didn't account for hotel demand strength
Estimate correctly accounts for BEE's seasonality
Conflicting fundamental forces nullify one another
Hit with upside announcements
Voluntary dividend cut suggests superior use of capital in multi-family acquisitions or developments
In such a high risk business, the absence of disaster is itself a catalyst
Temporary share dilution from various offerings unaccounted for by the estimate
Substantial beat of 1Q12
Strong industry fundamentals and increased business travel
While it would be helpful to know which companies will beat or miss estimates going into this season, it is more important to know why. Knowing the reasoning behind the earnings is the source of opportunistic purchase. Some of these can be played prior to earnings, while information about others can be used post-hoc. For example, if I am correct, one would want to own AEC going in to the report so as to ride the upside surprise, whereas one would want to wait for the market disappointment in LXP's miss to pick it up opportunistically. By knowing that the cause of the miss was temporary dilution and not weakness, investors could exploit the temporarily incorrect market pricing.
As previously mentioned, this is not an inclusive list of the REIT earnings reports nor of the potential plays going into them, but the method applies universally. Know what to expect and, more importantly why, so as to take advantage of temporary mispricing that invariably occurs as new information comes about.
Disclosure: 2nd Market Capital and its affiliated accounts are long AEC, AHT, CBL, LXP and SOHO. I am personally long AEC, AHT, LXP and SOHO. This article is for informational purposes only. It is not a recommendation to buy or sell any security and is strictly the opinion of the writer.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.