Hospitality Properties Trust (HPT) Q1 2014 Results - Earnings Call Transcript

| About: Hospitality Properties (HPT)

Hospitality Properties Trust (NYSE:HPT)

Q1 2014 Earnings Call

May 06, 2014 1:00 pm ET

Executives

Katie Strohacker -

John G. Murray - Principal Executive Officer, President, Chief Operating Officer, Assistant Secretary and Executive Vice President of Reit Management & Research LLC

Mark Lawrence Kleifges - Chief Financial Officer, Principal Accounting Officer and Treasurer

Analysts

Jeffrey J. Donnelly - Wells Fargo Securities, LLC, Research Division

Ryan Meliker - MLV & Co LLC, Research Division

Wes Golladay - RBC Capital Markets, LLC, Research Division

Bryan A. Maher - Craig-Hallum Capital Group LLC, Research Division

Operator

Good day, and welcome to the Hospitality Properties Trust 1 Quarter 2014 Financial Results Conference Call. This call is being recorded. At this time, for opening remarks and introductions, I would like to turn the call over to our Director of Investor Relations, Kathryn Strohacker. Please go ahead, ma'am.

Katie Strohacker

Thank you. Good afternoon, everyone. Joining me on today's call are John Murray, President; and Mark Kleifges, Chief Financial Officer. John and Mark will make a short presentation, which will be followed by a question-and-answer session. The reporting, retransmission and transcription of today's conference call is prohibited without the prior written consent of HPT.

Before we begin today's call, I would like to read our Safe Harbor statement. 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 6, 2014. 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 filed 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.

Before I turn the call over to John, you should be aware that TravelCenters of America has not completed its year end 2013 or first quarter 2014 reporting. And accordingly, the company's remarks today with respect to TA's operating results will be limited and we won't be able to respond to questions related to TA's first quarter 2014 performance.

And with that, I'll turn the call over to John Murray.

John G. Murray

Thank you, Katie. Good afternoon, welcome to our first quarter 2014 earnings call. Today, HPT reported first quarter normalized FFO of $0.75 per share. As Katie noted, we are not yet able to update you on TA's performance for the full year 2013, nor first quarter 2014, because they have not yet reported their results. TA is working to complete its filings as soon as possible and we will then be able to update our disclosures on their performance. TA remains current on its rent payments to HPT.

Turning to HPT's hotel investments, first quarter RevPAR was up 10.1% across HPT's 289 comparable hotels. Ongoing hotel renovations continue to impact our results. Excluding non-comparable hotels and the 18 hotels under renovation during the quarter, RevPAR was up 11.6% this quarter. The strong top line performance, which was comprised of both occupancy and rate gains, reflects strong results at the 61 hotels that completed renovations during 2013, with RevPAR gains of 29%. This helped to offset performance at our 18 renovation hotels this quarter, which experienced RevPAR declines of 4.2%, all from lost occupancy. 12 of the 18 comparable hotels under renovation this quarter were Wyndham and Sonesta hotels.

This was an especially tough winter from Philadelphia to Toronto and our mid-Atlantic, New England and Canadian regions each showed RevPAR declines. In addition to the harsh winter, our mid-Atlantic region was negatively impacted by difficult Superstorm Sandy comparisons, which caused RevPAR at our New Jersey hotels to decline 8.2% in the first quarter of 2014. On the positive side, we continued to see strong RevPAR performance in the East North Central, Pacific and South Atlantic regions, up 19.2%, 14.7% and 13.3%, respectively.

While the hotels renovated during 2013 had the most significant positive impact on first quarter 2014 performance as they ramp back up, we are encouraged that our hotels renovated in earlier periods continued to experience above market level growth as well. The 120 hotels that completed renovations in 2012 grew RevPAR 10.8% and expanded margins by 140 basis points this quarter. Also our comparable portfolio strong performance this quarter was balanced across property types. Among our comparable full-service hotels, RevPAR and gross profit margin percentage were up 12.4% and 460 basis points, respectively. Among our select service hotels, RevPAR and gross profit margin increased 7.4% and 30 basis points, respectively. Finally, among our extended stay hotels, RevPAR and gross profit margin percentage jumped 10.6% and 180 basis points this quarter.

While our extensive portfolio renovation program has begun to wind down, we expect 22 hotels will be under renovation during the second quarter, 13 in the third quarter and 2 in the fourth quarter of 2014. This renovation activity will be principally at our Sonesta Hotels.

Looking forward, our operators are generally optimistic about the year ahead, as high occupancies and continued steady demand are expected to allow strong rate growth. Hotels along the West and East Coast are expected to lead the way, especially those in and around top 25 markets. In addition, most of the hotels in our portfolio have now recently been significantly renovated, so our product quality is very good as we move through 2014.

Despite our strong first quarter performance, the first quarter contributed the least to the full year performance and, accordingly, our managers have not materially changed their forecast for full year 2014. However, based on the strong first quarter, we now expect an average RevPAR increase of between 6% and 8% and an average GOP margin percentage increase of 175 to 225 basis points across our comparable hotel portfolio for the full year.

Turning to disposition and acquisition activity. In February, we terminated the purchase agreement related to a previously announced full-service hotel in Orlando. We were unable to resolve diligence issues there. On March 31, we agreed to acquire a 240-room hotel in Fort Lauderdale, Florida and an adjacent parcel of land for $65 million. We have completed the diligence and expect to close on this acquisition at the end of May. The hotel was completely renovated, with essentially all new systems and design in 2010 and is currently an independent lifestyle hotel. We plan to convert this hotel to a Sonesta Hotel to take advantage of Sonesta's strong South Florida reputation.

Aside from new signage, there's very little capital expected to be needed for this hotel in 2014 or 2015. In addition to the 240 ocean-facing guestrooms, the hotel has approximately 9,000 square feet of top floor meeting space with amazing ocean views. There are 2 restaurants, 3 bars, an infinity pool and fitness center. The cap rate on 2013 cash flow on the hotel component of this acquisition was 6.7%, and we expect Sonesta to generate improved results due to their brand awareness in South Florida. However, there will be some onetime conversion costs in 2014.

We continue to see a healthy pipeline of hotel acquisition opportunities. We face competition for acquisitions from private equity investors, other lodging REITs and institutional investors, but we expect to continue to generate acquisition growth. We will maintain our discipline. When we acquire select service assets, we try to do so in a portfolio contract format, with all non-renewals, pooled FF&E reserves and subordinated management fees. When we look at full-service hotels, we will acquire one-off assets if they can be added to existing portfolios.

We remain optimistic about this lodging cycle due to the low-to-moderate room supply growth and steady demand. This allows for increases in room rates and GOP improvement, particularly as we continue to move towards the fully renovated hotel portfolio. This, in turn, creates confidence to increase our dividend, which we did in April 2014. Our management and trustees will continue to evaluate the dividend rate on a quarterly basis.

I'll now turn the call over to Mark.

Mark Lawrence Kleifges

Thanks, John. Operating results at our 289 comparable hotels were strong this quarter, with RevPAR up 10.1% and a 230-basis-point increase in GOP margin percentage. Hotel renovations continued to have both a positive and negative impact on hotel operations this quarter. RevPAR, at our 271 comparable hotels not under renovation this quarter was up 11.6%, versus the prior year quarter, on a 5.5 percentage point increase in occupancy and ADR growth of 3%.

This quarter's results benefited from the RevPAR outperformance of the 39 hotels that were under renovation during the 2013 first quarter, with RevPAR up 32.4% at these hotels on occupancy and ADR gains of 14.1 points and 5.3%, respectively, in the current quarter. This strong performance was partially offset by the weak results at the 18 hotels under renovation this quarter, with RevPAR down 4.2% at these hotels on lower occupancy. Our portfolios with the highest RevPAR growth this quarter were our Wyndham and IHG portfolios, with increases of 18.3% and 17%, respectively, versus the prior year quarter.

Growth in hotel profitability was also strong this quarter, with gross operating profit for our 289 comparable hotels up $18.9 million, or approximately 17.6% from the 2013 quarter, and GOP margin percentage up 230 basis points to 35.6%. Our IHG portfolio continued its outstanding performance this quarter, with gross operating profit up over 28% and GOP margin percentage up 380 basis points, versus the 2013 quarter.

Turning to 2014 first quarter coverage. Hotel cash flow available to pay our minimum returns and rents this quarter increased $8.9 million, or approximately 12% from the 2013 quarter. As a result of this growth, coverage for the quarter under 7 of our 9 agreements improved, versus the prior year quarter, and portfolio-wide coverage for our hotels increased to 0.74x from 0.7x in the 2013 quarter. The improvement in coverage between periods was mitigated by the $6.5 million, or 6.1%, increase in minimum rents and returns that resulted from our funding of hotel improvements, and the scheduled increases in FF&E reserve escrow requirements under our IHG and Marriott 234 agreements. Despite these increases, coverage was 1x for our IHG agreement this quarter and 4 agreements had coverage above 0.8x for the seasonally weak first quarter. Information regarding all of our security deposit and guaranteed balances at quarter end is included in our supplemental.

Turning to HPT's consolidated operating results for the first quarter. This morning, we reported normalized FFO of $112.7 million, compared to normalized FFO of $93.2 million for the 2013 first quarter. The increase in normalized FFO from the 2013 quarter is due primarily to a $10.2 million increase in minimum returns and rents, and a $5.6 million increase in FF&E reserve contributions.

First quarter 2014 normalized FFO per share of $0.75 was up from $0.74 for the 2013 first quarter. The more limited growth in normalized FFO per share was due to the impact of a higher weighted average share count in the 2014 quarter as a result of our March and November 2013 equity issuances. We paid a $0.48 per share common dividend in the quarter and our normalized FFO payout ratio was approximately 64%. Adjusted EBITDA was $155 million in the 2014 first quarter, a 12.7% increase from the 2013 quarter. Our adjusted EBITDA to total fixed charges coverage ratio for the quarter remained strong at 3.8x, and debt to adjusted EBITDA was only 4.4x at quarter end.

Turning to our recent capital markets activities. In January, we amended our $1.15 billion credit facilities agreement, which includes our $750 million revolving credit facility and $400 million term loan. The amendment extended our revolver maturity date by almost 3 years to July 2018, and lowered the annual interest rate by 20 basis points. The amendment also extended the maturity date of our term loan by approximately 2 years to April 2019 and reduced the annual interest rate by 25 basis points. In February, we redeemed at par our $300 million of 7.875% senior notes. And in March we issued $350 million of 4.65% senior notes due in 2024.

Next, I'll provide an update on where HPT stands with its capital funding commitments and liquidity at quarter end. To complete our hotel renovation program, we expect to fund improvements of $170 million in 2014, which is a $2 million increase from our previous estimate, and $33 million in 2015. We funded $36 million of these improvements in the first quarter.

In addition to our hotel renovation fundings, we expect to fund approximately $80 million of improvements to our TravelCenters in 2014, of which $6 million was funded this quarter. With respect to our balance sheet and liquidity, at quarter end we had approximately $33.8 million of cash, which excludes $26.9 million of cash escrowed for improvements to our hotels, and we had no amounts outstanding under our $750 million revolving credit facility. Our debt-to-total-book capitalization at the end of the quarter was 47.5%.

In closing, we remain optimistic about the prospect of continued strong operating results, including the positive impact our extensive renovation program is having on the performance of our hotels.

With that, operator, we're ready to open it up for questions.

Question-and-Answer Session

Operator

[Operator Instructions] We'll go to the line of Jeff Donnelly with Wells Fargo.

Jeffrey J. Donnelly - Wells Fargo Securities, LLC, Research Division

Mark, I might have missed it, you mentioned some of the figures for, I guess, the support of the strong RevPAR in Q1. What was the RevPAR for the segment of hotels that were not under renovation, I guess, in either 2014 or 2013? I was just trying to kind of carve those out.

Mark Lawrence Kleifges

Yes. Let me see if I have that handy. We've sliced the portfolio about 90 ways. I hope I have that with me. John, do you have that?

John G. Murray

That might be the 91st way.

Jeffrey J. Donnelly - Wells Fargo Securities, LLC, Research Division

It's all right. I can follow-up with you afterwards on it.

Mark Lawrence Kleifges

Yes. We have that. We can talk later.

Jeffrey J. Donnelly - Wells Fargo Securities, LLC, Research Division

And maybe you could just talk in some broad strokes about how the renovations from -- that were completed in 2013 are faring versus your, I guess, internal budgets? Are things sort of on track or where are they varying?

John G. Murray

I'd say that we're more or less on track, which is why the forecasts that were done, the budgets that were done for 2014, compared to the reforecasts that were done at the end of the quarter, are not materially different. I think we're tracking where we were expecting to. There's pluses and minuses built into those numbers, things that weren't expected. We didn't expect as harsh a winter. We had a fair amount of expenses as a result of utility increases and snow removal costs that probably detracted about 90 basis points from our margins. But we also got stronger RevPAR performance from the hotels renovated in 2012 than I think we were expecting. So all in all, I think we're about where we expected we would be.

Jeffrey J. Donnelly - Wells Fargo Securities, LLC, Research Division

And just to switch topics, I don't know if you'd seen this, but Susser Holdings had recently been, I guess, acquired its -- gas stations were going to be acquired by an entity that I think is going to place them into an MLP-type structure. Do you guys ever give any consideration to monetizing the gas stations maybe while they're performing well: Because I think some investors out there think that it's been sort of a source of pressure on your multiple over the years. That, I don't know, do you look at that transaction, I think it was like 10x to 11x EBITDA, and think that's appealing to you guys?

John G. Murray

I guess the short answer is we have not looked at that. TA is -- our strongest rent coverage is in TA and, frankly they've, all through the third quarter, which we can talk about, their revenue management has been at least as good as any of the hotel managers we have. Their cents per gallon increases have been pretty impressive since the recession. So I know that there are some investors who have trouble with both the TravelCenters and the hotels in the REIT. But we're not currently looking at separating them.

Operator

And we'll move along to the line of Ryan Meliker with MLV Company.

Ryan Meliker - MLV & Co LLC, Research Division

A couple things. First of all, with regards to TA, do you guys have any concern about their ability to fund rents, either going forward or currently, given the fact that it sounds like they've got some accounting issues that have precluded them from filing their K. I'm just wondering if there's going to be implications with regards to their lending covenants? Obviously, they're -- it's not going to be easy for them to raise equity if they need to over the next 12 months. Like how do you balance the fact that they are your best coverage coupled with 35% of your EBITDA with the fact that now they've got some material challenges with regards to their funding?

Mark Lawrence Kleifges

Yes. Well, first off, we don't have any concerns with TA's ability to pay the rent. The principal issues that they're dealing with and, obviously, we have to limit our comments to what they've disclosed publicly. But they have some very, very complex income tax accounting that they're working through. TA is in a net operating loss position as a company and they've historically put a valuation reserve up against that NOL, that because of their improved operating performance over the last couple years, they're required to reverse that valuation reserve under GAAP. And in working through that, there's some very, very complex tax regulations that may limit how much NOL they get to record and over what periods they can utilize that NOL. So that's the primary thing they're working through, Ryan. It's nothing to -- the delay in financial statements isn't due to some other more troubling issue. And the core business remains solid and we have absolutely no concerns with respect to rent. In terms of their liquidity, they did disclose that they've received waivers, I believe it's for the 10-K through the end of May from other banks. And with respect to the first quarter, I believe it's through the end of June, but you can double check those with the filing, I think, they made last week.

Ryan Meliker - MLV & Co LLC, Research Division

Okay. And then, I guess, would there be concerns on your part if they went through those deadlines and still hadn't filed the required SEC filings?

Mark Lawrence Kleifges

Well, I think given the nature of the accounting issues, I would think even if they met -- if they were unable to meet those deadlines, I would think that the banks would provide additional waivers. Obviously, I can't -- I haven't had any discussions with the banks, I can't confirm that. But given the nature of the issue, the fact that it's non-cash, it's a future benefit to TA, the NOLs, I just don't know. I don't think that would cause me a whole lot of concerns. I'm also optimistic they're going to be able to meet those deadlines.

Ryan Meliker - MLV & Co LLC, Research Division

Okay. That's helpful. Then with regards to Orlando and Fort Lauderdale, can you just give us a little more color on why you walked away from Orlando? What it is you found you didn't like? And then with Fort Lauderdale, a 6%, 7% cap rate seems relatively low given your capital structure and cost of equity. What made you get comfortable with that? How high do you really think that could be on a more stabilized basis once you get Sonesta in there?

John G. Murray

On the Orlando property, there was the seller on the couple hotels that were adjacent to one another and there are some systems that were shared by the 2 buildings. And the cost to separate them was prohibitive and time-consuming, and we just couldn't wait any longer. So we decided to pass. The hotel in Fort Lauderdale, I agree that's a lower cap rate than we've seen on some other acquisitions that we've done. It's an unusual property in that it, first of all, was recently, effectively in 2010, gutted and rebuilt. So all the systems are new, the design is fresh and attractive. So we don't expect to need to put any capital into that property for a long time. It's also right on the ocean, it's right across the street from the beach. The Fort Lauderdale market is improving significantly. The airport in Fort Lauderdale is being expanded. They're adding a runway partially to accommodate flights that are being -- that are going to over time be diverted from Miami into Fort Lauderdale because Miami, frankly, is too busy with international flights. So the Fort Lauderdale market is perhaps not as strong as Miami's, but it's a 4-season market and there's a lot of businesses and demand generated there, and so we expect that we'll be north of an 8% cash return out of that property possibly in '15, but assuredly in '16, I think.

Ryan Meliker - MLV & Co LLC, Research Division

And was that an unlevered or a levered cash return?

John G. Murray

Sorry?

Ryan Meliker - MLV & Co LLC, Research Division

Was that an unlevered or a levered cash return?

John G. Murray

Unlevered.

Operator

And we'll go to the line of Wes Golladay with RBC Capital Markets.

Wes Golladay - RBC Capital Markets, LLC, Research Division

Looking at the Wyndham portfolio, you had pretty strong RevPAR at 18.3% RevPAR growth. The coverage is still a little light there. Is there onetime expenses flowing through that, the strong RevPAR is not flowing through to the bottom line? Can you comment on that?

John G. Murray

There are a lot of different things that went on in that portfolio. There are a number of properties that were under renovation during part of the first quarter. There's an unusual weighting of properties in that Wyndham portfolio that are in the northern parts of the United States, including in Illinois and Michigan. And so -- they were some of the hotels that beared (sic) [bore] the brunt of the unusually harsh winter besides the renovation activity. I don't have the numbers exactly for the Wyndham portfolio, but I think we had -- across that portfolio, we had something like 16% increase in utilities because of the harsh winter, and we had about a 22% or 23% increase in cost for snow removal. And so that had a negative impact across the portfolio, but certainly had, I think, an outsized impact on Wyndham.

Wes Golladay - RBC Capital Markets, LLC, Research Division

Okay. So going forward, Wyndham looks like it's going to be relatively one of your better performers on the RevPAR front and we should expect a little bit better bottom line performance going forward?

Mark Lawrence Kleifges

Yes. I think, Wes, you'll see a significant -- you should see a significant improvement starting in the second quarter from a coverage perspective.

Wes Golladay - RBC Capital Markets, LLC, Research Division

Okay. And then looking at the Sonesta, I know you have some more renovations. When do you think that bottoms out? I mean, you'll be lapping against some renovations as well. So I mean, is that enough to get it going in the right direction or do we have to wait until probably 2015 to really accelerate that one?

Mark Lawrence Kleifges

I think it's more a 2015 story. I mean, we had 7 hotels under renovation in the first quarter and coverage was relatively flat quarter versus the prior year quarter. We're going to have 16 hotels under renovation for all the part of the second quarter, and 13 for all the part of the third quarter and then it winds down to just 2 in the fourth quarter. So I think Q2 and Q3, there's going to be a lot of renovation disruption. We are seeing positive results in growth and cash flow at the non-renovation hotels, so that's going to offset some of that renovation disruption. But I don't think it's unreasonable to assume kind of flattish coverage year-over-year for the Sonesta portfolio, and then see coverage start to improve in 2015.

Wes Golladay - RBC Capital Markets, LLC, Research Division

Okay. And then looking at the IHG portfolio, it looks like at the beginning of the year, they added more to the deposit. Can you walk us through what's going on there and is it always like a soft guarantee of around $30 million for you? Or can you give some color on that?

Mark Lawrence Kleifges

On the security deposit?

Wes Golladay - RBC Capital Markets, LLC, Research Division

Yes. It looks like they funded additional money -- gave you additional money, I think, on January 6.

Mark Lawrence Kleifges

Yes.

John G. Murray

So it was a minimum deposit maintenance requirement in the -- that was in our agreements. And while IHG expected to easily hit those levels, maintenance levels, at year end in this year and next year because of seasonality, there was concern that possibly in the first quarter of this year and possibly in the fourth quarter, they might dip below those maintenance levels. So as an abundance of caution, they asked if we would give them some relief. And we said that we would do so if they put up additional deposit amounts, we would reduce the threshold on a 2 for 1 basis. As it turns out, this quarter, they had coverage so.

Wes Golladay - RBC Capital Markets, LLC, Research Division

Yes. I mean, it appears that this is the seasonally soft quarter, so it looks like they're going to be okay this year.

John G. Murray

Yes. Not an indication of a problem, it's everybody just being cautious.

Operator

[Operator Instructions] We'll go to the line of Bryan Maher with Craig-Hallum Capital Group.

Bryan A. Maher - Craig-Hallum Capital Group LLC, Research Division

Quick question. Maybe taking a different tack with TA, since I covered TA and I agree with the comments that you made earlier. As it relates to the now over 30 properties that they, over the past couple years, have acquired on their own balance sheet, renovated, repositioned and are ramping EBITDA nicely, would you consider, or do you think about at all, building upon your portfolio once they have new TravelCenters that have reached the stabilized EBITDA?

John G. Murray

We have certain rights of first receivable when they acquire properties, and most of the properties that they've been acquiring needed to be -- were sort of turnaround stories, and that's why we didn't -- we haven't taken advantage of the rights that we had. But we are, as I mentioned earlier, we don't have any issues with our TA investments. And if TA were to come to us and ask us to acquire additional sites, I don't see any reason why we wouldn't consider that.

Bryan A. Maher - Craig-Hallum Capital Group LLC, Research Division

Okay, that's interesting to know. And then also, what would you be your appetite for other non-hotel investments, kind of excluding TA, excluding hotels? Do you look at other non-hotel investments, and what categories might those be in?

John G. Murray

We are not looking at and I don't anticipate us looking at other non-lodging-related property types.

Operator

[Operator Instructions] We have no further questions in queue. I'll turn the conference back over to John Murray for closing remarks.

John G. Murray

Thank you very much for joining us on our call today. We hope to see you at the upcoming NYU hotel conference and NAREIT in June. Thanks again.

Operator

Thank you. And ladies and gentlemen, that does conclude our conference for today. Thank you for your participation and for using AT&T teleconference. You may now disconnect.

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