American Hotel Income Properties REIT LP's (AHOTF) CEO Rob O'Neill on Q1 2016 Results - Earnings Call Transcript

| About: American Hotel (AHOTF)

American Hotel Income Properties REIT LP (OTC:AHOTF) Q1 2016 Results Earnings Conference Call May 13, 2016 4:00 PM ET

Executives

Rob O'Neill - CEO

Azim Lalani - CFO

Ian McAuley - EVP of Asset Management

Anne Yu - Director of Finance

Analysts

Brad Sturges - Industrial Alliance

Trevor Johnson - National Bank

Mark Rothschild - Canaccord

Operator

Good afternoon, ladies and gentlemen, welcome to American Hotel Income Properties REIT LP's First Quarter 2016 Financial Results Conference Call. [Operator Instructions]

Before beginning its formal remarks, AHIP would like to remind listeners that today's discussion may contain forward-looking statements that reflect current views with respect to future events. Any such statements are subject to risks and uncertainties that could cause actual results to differ materially from those projected in these forward-looking statements.

AHIP does not undertake to update or revise any forward-looking statements to reflect how new events or circumstances, except as required by law. Listeners are urged to review the full discussion of Risk Factors in AHIP's annual information form, dated March 17, 2016, which has been filed on SEDAR at www.sedar.com.

I would like to remind everyone that this call is being recorded today, May 13, 2016. A replay of this call will be available on AHIP's website at www.ahipreit.com.

I would now like to turn the call over to Rob O'Neill, CEO of AHIP. Please go ahead, Mr. O'Neill.

Rob O'Neill

Thank you, operator, and a good Friday afternoon, welcome to everyone for our discussion of American Hotel Income Properties first quarter 2016 results. I'm Rob O'Neill and with me this afternoon is Azim Lalani, our CFO; Ian McAuley, our EVP of Asset Management and Anne Yu, Director of Finance.

We’ll keep our opening remarks brief on this call, trusting that you had a chance to review our management discussion and analysis and related financial statements for the three months ending March 31 which were released yesterday after the market close.

And there is always for more information you can go to our filings on SEDAR or our website at ahipreit.com. And please note otherwise that all the amounts that I’m talking about are U.S. dollars unless I indicate otherwise.

The first quarter of 2016 was a record breaking for AHIP as we generated some of the best first quarter numbers in our short history. Azim will provide the detailed numbers later on during our call.

Our current geographically diversified portfolio is located in 27 U.S. States and is made up of 80 hotel properties totaling 7,072 guestrooms with 45 hotels and 3,742 guestrooms in the Rail portfolio and 35 hotels and 3,330 guestrooms in the Branded Hotel portfolio.

Our branded portfolio continued to perform well during the seasonally weaker first quarter. We saw very strong performance from our branded hotels with same property RevPAR growth of 6.7% led by Virginia, North Carolina and Florida as they all experienced robust RevPAR growth.

This was offset by weaker performance in our Pittsburgh and Oklahoma hotels caused by continued volatility in the oil and gas business and the impacts of new supply. Overall the U.S. economy is expected to grow by 2.1% in 2016, an election year. We believe the U.S. economy will continue growing in the near term and given the strong correlation between the U.S. economy and the U.S. lodging sector, we continue to expect U.S. hotel industry to grow over the next 24 months.

We also expect lower gasoline prices to have positive impacts on disposable income like a tax-cut and should encourage highway travel to our branded hotels in secondary and tertiary markets during the busier second and third quarters.

The U.S. hotel industry continued to grow as RevPAR has increased for the 72 consecutive month in the current cycle. STR reported positive operating metrics for the first quarter of 2016 with occupancy down slightly due to the shift of Easter from April last year into March which resulted in lower business demand.

Average daily rate was up though by 3.2% and the resulting RevPAR increased by 2.7%. For 2016, STR expects RevPAR to grow in total by 5% nationally and a further 4.5% in 2017 driven primarily by growth in average daily rate. We expect the current U.S. hotel cycle currently in year six to last longer than pervious cycles led by rising room demand and a modest new room supply growth.

On the other hand we continue to see the U.S. rail industry facing headwinds from lower call and commodity shipments, a strong U.S. dollar and tepid growth in intermodal carloads. This reflects the cyclical nature of this industry. Lower rail volumes coupled with reduced non-rail hotel traffic has reduced occupancies at AHIP’s rail hotels.

We are fortunate to be able to lock into long term contracts with our rail partners to ride these various cycles of the business. The benefit of these contracts is that during the down cycles as we are currently experience, is the stability to the revenues and cash flows. We continue to experience support from these contracts and expect this to continue.

The hotel manager is actively pursuing though commercial travelers to absorb some of these excess rooms available at Oak Tree Inns and we have seen considerable growth in the year-over-year statistics from 2015 to 2016.

Despite the weakness in rail volumes, our rail customers continue to pursue their large multi-year capital expenditure programs, including track and engine replacement. This along with maintenance of weight crews are expected to generate room demand and further support the contractual room revenues.

Overall our hotel manager has been successful in bringing expertise in yield management and strong cost discipline to the hotels. And this is translated into higher income and better operating margins.

During 2016, we are planning to invest $0.5 million in the property management systems and point of sale systems at the rail hotels to capture non-commercial rail customer during periods of excess vacancy. This is part of our multimillion dollar capital expenditure program to refurbish both rail and branded hotels and provide our hotel manager with the best-in-class product to effectively meet new markets.

Our development partner, SunOne is also planning to deliver two more completed hotel expansions, totaling 48 rooms at existing very high occupancy Oak Tree Inns in Oregon, and Nebraska in June and July of this year. We also continue to evaluate new build and conversion opportunities with our rail partners and potential new rail customers as we look to grow our industry-leading Oak Tree Inn portfolio across the country.

In addition, AHIP continues to review a number of potential accretive branded hotel transactions as well, with an emphasis on hotels that have strong demand generators and are priced below replacement cost. We have seen the public U.S. hotel REITs, along with private REITs, head for the sidelines for a variety of reasons. With a smaller pool of potential buyers, along with the tightening of available credit, we are now seeing cap rates move up.

As you may know, we are also paying our distributions today in U.S. dollars. This means our annual distribution of $0.648 U.S. is expected to translate into a payout ratio of approximately 75% based on analyst current consensus for 2016 AFFO. This aligns our distributions with our income and avoids entering into extensive hedging programs to reduce currency risk.

We continue to implement our strategy of building a solid and reliable income stream for our investors, with our conservative balance sheet and a modest payout ratio.

I'll now pass the discussion to our CFO, Azim Lalani to provide a summary of the record financial and operating results for the first quarter.

Azim Lalani

Thanks Rob. Before I begin, I just wanted to highlight the seasonality of the hotel business. The hotel industry is seasonal in nature with operating results weaker in the first and fourth quarters and stronger in the second and third quarters of the calendar year. As a result, there is variability in various operating metrics between the quarters.

Here's a summary of some of our key financial results for the quarter ended March 31, 2016 compared to the same periods in 2015. Since March 31, 2015 we have acquired 19 hotels adding almost 1,800 guestrooms to the total AHIP portfolio. The increase in RevPAR, revenues and net operating income can be attributed to the portfolio changes that have occurred over the past 12 months.

For the quarter, our occupancy was 68.7% down from the same period last year. This was due primarily to lower occupancy in our rail portfolio caused by lower coal and commodity shipments and fewer non-rail occupancies compared to 2015. This was offset by higher occupancies in our branded hotels as same-store occupancies jumped by 4.8% to 73.3% led by strong performance in Virginia, North Carolina and Florida.

ADR for the quarter was up approximately 10% to $82.80 and our revenue per available room or RevPAR was $56.88 up approximately 2% from last year. This was due to a combination of rail crew contract revenues coupled with higher ADR from the branded hotels.

Total same-store RevPAR remain unchanged year-over-year at $55.82. This was due to RevPAR declines at the rail hotels offset by RevPAR increases at the branded hotels. The big performers this quarter included the Virginia hotels up by 17%, North Carolina hotels up by 14% and the Florida hotels up by 12%.

In addition during 2015 the Residence Inn Cranberry Pittsburg, Hampton Inn Harrisonburg University, Virginia and Hampton Inn Harrisburg, North Carolina all had significant renovations and had some guest displacement. After the renovations were completed during 2015, we have seen significant year-over-year RevPAR increases at these properties averaging 24%.

The hotel manager has also made great strides in managing hotels in the weaker markets of Oklahoma and Pittsburg by implementing dynamic pricing and yield management such that in both markets AHIPs hotels have outperformed their comparative set.

For the quarter total revenues were up 36% to $40 million compared to last year. This coupled with good cost controls drove EBITDA up by 57% to $10.7 million and EBITDA margin improved by 350 basis points to 26.6%.

For the quarter FFO was up 65% to $7.2 million and AFFO was up 72% to $6.1 million. Diluted FFO per unit for the quarter was up 17% at $0.21 and diluted AFFO per unit was up 20% to $0.18.

Our AFFO calculation reflects the full FF&E capital expenditure reserve and excludes the impact of any FF&E reserve waivers provided by our lenders. Our current AFFO payout ratio improved to 93.5% for the quarter compared to 125% last year.

I will now review our liquidity and financial condition. Our debt to gross book value was at 50%, our weighted average interest rate was 4.58% down by 13 basis points from last year. Our weighted average loan term to maturity improved to 8 years compared to 7.4 years last year. Our available cash balance at March 31, 2016 was approximately $9 million and our restricted cash balance was $16 million and as available to fully fund, all brand mandated capital expenditures over the next 12 to 18 months.

We continue to fund our CapEx reserve of 3% of room revenues for the Oak Tree Inn hotels and 4% of gross revenues for branded hotels.

Thank you and now back to Rob.

Rob O'Neill

Thanks Azim.

I'd like to close the formal portion of this call with a few key points. Looking over the statistics in our short life since our IPO in February of 2013, I really I'm pleased that the growth in our sales and EBITDA which are an amazing 8 times since that IPO have also grown our FFO by over 30% that to me is material and good growth.

We expect though that rail headwinds will continue for the balance of 2016 as the rail industry tries to recover from its cyclical lows. We expect this to continue to put pressure on real occupancies. However the benefit of the contracted rail revenues are being realized as our revenue in cash flow stream has stayed on target. The stability from contractual revenues differentiates us from all other hotels companies in Canada and the U.S.

But I can't go on without saying that our hotel manager has done an excellent job of pushing revenue growth and cost controls and has delivered meaningful growth in income and operating margins.

We continue to actively evaluate development and renovation opportunities, secured by long term rail crew contracts to deliver our industry leading high quality hotels that really need the needs of employee accommodation of our rail customers.

We are as we said before expecting higher cap rates in 2016 and we continue to identify quality accretive branded hotel acquisition opportunities at or below replacement cost. With the movements and exchange rates over the past 3 years, I also continue to note that we have locked in significant FX gains for our unitholders.

Regarding the expected merger of Marriott and Starwood Hotels in late 2016, making it the world’s largest hotel company with over a million rooms and the effect on our 12 Marriott branded hotels, I would expect this to be a long-term positive as our hotels will receive wider distribution and participate in the world's strongest guest loyalty program.

We're highly focused on executing our stated growth strategy of building AHIP with the conservative balance sheet, diversified with high quality properties in secondary and tertiary markets that create long-term value for our unitholders.

Remembering that our stock is currency for the equity has been undervalued in our opinion in the last two or three quarters and that our pace of acquisition growth is slowing as we are reticent to use bought deals and their inherent pricing discounts to fuel that growth. As we have shown this quarter our focus on internal growth is paying dividends.

Given the events of the last few days in the Canadian Hotel REIT space, I feel compelled to add my $0.02 worth to the unsolicited tender of invest by Blue Sky from Hong Kong currently unknown in the hotel space. Invest is our only true comparable in the Canadian market today.

I too was put in that situation 28 years ago when the Okabe Steel Company from Japan unknown at that time made an unsolicited offer for our family company Coast Hotels. The eventual sale was I believe great for business in the community space served. New capital and fresh ideas have contributed to the Canadian hospitality landscape and brought closer connection between the two great companies.

I also learned a lot working as CEO for a First Division Japanese Public Company. I would also see that for AHIP this potential sale of Invest re-establishes a value proposition that bankers and analysts have forgotten about. Too often they just look at the cap rates of the individual hotels and add them together to get a company's value. They forget the value of a platform and that it takes time, money, and tons of intellectual capital to create a company and a platform.

So going out and buying 80 hotels over 4 years and building an organization to run complex assets, that's really worth a lot. Today when people are saying that Blue Sky overpaid, I’m saying that they didn’t pay enough, and I believe that - but remember that if they didn’t pay enough, they paid 16 times AFFO and we at AHIP are trading around nine times AFFO, certainly a valuation disconnect and to me a strong signal that our strong diversified platform built on U.S. assets is undervalued.

Finally and as always, I would like to thank our investors, board members, our management team and all of our employees for their hard work during the quarter. I would like to now open up the lines for questions. Operator?

Question-and-Answer Session

Operator

[Operator Instructions] Your first question comes from the line of Brad Sturges of Industrial Alliance. Your line is open.

Brad Sturges

Hi good afternoon. I'm just wondering if you could start on the cost control strategies that you implemented in the quarter, just wondering if you could expand on what those strategies were? And whether that's something that, given the low rail volumes that you're expecting for the remainder of the year, is something that we would see going forward for 2016?

Azim Lalani

Yes, they're both cost and revenue strategies, I'll just take one cost strategy that was implemented last - late last year and the rails was our purchasing program with a vendor and it’s relatively complicated but bringing 45 hotels on that sector and actually we also brought them in on the branded - brings pricing benefits and that will be continuing based on the current volume, so, we’ll see that.

On the revenue benefits clearly we - on the rail side hired yield management personnel to go into the Wichita division offices and work. This is the first time that's ever been done, as well as new sales person looking at the transient business and the opportunity, now there are more guestrooms available on the rail side in this term.

And there is approximately half of the hotels that have been identified as having real good ability to attract the transient rooms which as you know we sell for 50% more at least than our existing rooms.

There have also been some labor planning programs put into place and those will continue. The information is now in the last few months flowing very well out of the field. It’s a dynamic scheduling program that allows for managers to work and see do some forecasting on their business volumes and adjust their staffing accordingly.

So, stuff that we have been working on for long time and just as - I know I’m going on this question but it’s appropriate. The board yesterday approved significant purchase of the property management systems for the rail which we believe will considerably help on the revenue as we’ll be able to tie directly the available transient hotel rooms that are available to the OTAs other than travel agents like Expedia directly into their system.

So, that will be rolling out immediately and we expect full implementation by the end of the year.

Brad Sturges

And a little bit more on the transient. Q1 typically would be a little bit more quiet, I guess, from that type of travel, so would you expect to be able to capture a little bit more of the transient travel in the busier summer months, Q2, Q3, let's say?

Rob O'Neill

Yes, I think so and we expect so we budget so, and why I think Azim spent just a moment to alert everybody that our second and third quarters should be stronger. The seasonally they are and we will pick up especially on the branded hotels in the North and the West as the summer travel season starts and its started now and we’re very pleased with the business levels as they exist today.

Brad Sturges

I guess, I mean more specifically on the rail side, if the rail volume's a little bit lighter and you have that excess capacity, is that something that you could capture within the Oak Tree Inn portfolio?

Rob O'Neill

Yes, that’s a real target as I indicated. There's a good 20 hotels in the group that have good access to the transient traveler.

Brad Sturges

Then, in terms of renovations, did that have any impact in the quarter at all in terms of room displacement or impact on your rate?

Rob O'Neill

None whatsoever.

Brad Sturges

Okay, great. Thank you.

Operator

And your next question comes from the line of Trevor Johnson of National Bank. Your line is open.

Trevor Johnson

Good afternoon, gentlemen. Just wondering, with the depressed occupancy and lower railcar volumes are you having to change your behavior at the diners at all in terms of staffing or just the overall variable costs that you might be able to be exposed there? Are you seeing any of that yet?

Rob O'Neill

I'm sorry I didn’t get the question, are we happy to what?

Trevor Johnson

At the diners, for your food and beverage, with the depressed occupancy, are you happy to change any of the behavior there from a variable cost model? Is there an opportunity there from a staffing or is it pretty much what you see is what you get because you have to have full staffing at all times?

Rob O'Neill

Well, full staffing at the diners in some of the smaller hotels is one person. So, it's one person especially on the night shifts. We do some planning, we've got some menu engineering going on, if your volume is impacted and don't forget, it's not all the lines, the co lines are more effected then the main lines, they are down in the single digit and in some cases that's not noticed terribly by the amount of volume we’re doing.

So intermodal itself which makes up the vast majority of the U.S. rail transport is flat slightly up in some cases and you might have noticed that the three major rails who reported earnings in the last week or so have all been very, very strong, exceeded analyst expectations as their earnings still remains strong in light of some significant reductions in the core volume which as you probably know, that coal's a commodity for them and it was always under great cost pressure against natural gas.

So didn’t generate huge profits I think for the rails but the last issue relative to pennies is that, it’s still a significant process center for us, while we are seeing some volume reductions we’re not seeing major volume reductions.

Trevor Johnson

Okay. And just looking at the contracts on the rail side, how should we think about occupancy going forward? I know it's going to be challenging. You guys have articulated that both on this call and in the past. But with the guaranteed minimum occupancy being 70% for a lot of the contracts, could we just think about maybe what the floor could look like if things do kind of stabilize around here?

Rob O'Neill

Well the issue is that you’re seeing the effect of the reductions in the first quarter. I don’t believe that they’re going to continue to increase and essentially we’re trading occupancy for rate and that’s how we have recorded ourselves. So we don’t see a big impact in our rail bottom lines going forward for the balance of the year.

Trevor Johnson

And just thinking about 2016, is ideally the blueprint, given obviously your payout ratio showed that it was sustainable in a seasonally weak Q1, you're going to have lower payout Q2, Q3 improve up? Probably payouts in the, whatever, mid-70s to say 80s, firm up share price and then look to probably grow a little bit more externally, given that have you a lot of your internal capital initiatives already funded. Just curious if that's a blueprint makes sense you think for the next 6 to 12 months?

Rob O'Neill

It sounds like you are the guy that's writing our strategic plan. Yes, it does, but we have other opportunities. Our shares are great currency for us as the issue of the discount involved with the bought deal is significant but there can be a currency for us even at these levels, if some of the vendors of hotels decide to join and become partners with us in the REIT in smaller ways and we’re exploring some of those opportunities right now.

And so we will see some growth we hope certainly not at the pace that we were looking at doing bought deals in the years prior. So we're more careful. We're consistent with what we said in the last couple of quarters, so we got a strong quarter, sure looks like second quarter is going to be a strong quarter.

So if that continues we hope the markets going to start to feel more comfortable with our numbers and we go forward from there. So, we'll just see - we’re very acute to the commitments we’ve made.

Trevor Johnson

Thanks Rob.

Operator

[Operator Instructions] Your next question comes from the line of Mark Rothschild of Canaccord. Your line is open.

Mark Rothschild

Thanks and good afternoon guys. Maybe you could just do me a favor - reconcile the comments about, you mentioned the strength of the rail companies and earlier in the call the prospect for good results over the next couple of quarters, but obviously, there's been some softening in certain areas of the rail business, which you acknowledged a minute or two ago. I'm trying to understand how to tie that all together.

Rob O'Neill

Well I think the softening in the rail business has been offset by the kick-in of our guarantees so that overall we're pretty net neutral. So one could report only RevPAR and which is the factor of it and obviously we’re making some contributions from our transient, so the rail division has been as I say net neutral in contribution to us at some point.

Mark Rothschild

Okay. And has, what's gone on the past little while, the softening, has it changed your view on certain markets or certain types of hotels or do you view this as more just short-term fluctuation?

Rob O'Neill

I think coal is a real issue for the United States. Not that I'm a politician but it sure was interesting seeing Trump in West Virginia saying I love coal and I’m going to put you guys back to work. So who knows what that’s going to do but I think the long-term trend for coal is negative but the rail have - were operating at almost full capacity a year ago and part of that capacity was tied up in low rated coal.

Now they have the free - lot of free engines and some fair load staff, I think what the rails were saying in some of the conference calls that we've listened to, was that they want to put everybody back to work and they’re going to compete against truckers to move product off trucks and back onto the rails again.

So, and all the while the intermodal transport has been sort of flat ticking down a bit, ticking up a bit. But that's flat at pretty significant volumes. So I just think there is going to be a transfer over time and a readjustment out of some of the coal regions.

Mark Rothschild

Okay, great. And then just lastly, you made some interesting comments about the InnVest transaction. I was wondering if you would expand on maybe what's your view of the current value of your units and maybe how do you look at that? Do you look at it on a by cap rate basis or by room basis? What do you think is the most important metric and with the difference in the multiple that it seems to be something that you think is appropriate to look at. Is this something you intend to do or is there a strategy to narrow that gap?

Rob O'Neill

Well, it’s essentially the portfolio premium, it's do you have a platform that one can grow and utilize and what type of premium do you put towards that and I guess my comment is that, there is a pretty wide disparity between their cap rate and our cap rates and I think we should be better.

I really don’t know what the proper cap rate for us is as a platform, all I know is it should be a heck lot better and I think the platform that - the comments I heard about investing way overvalued in this and that, and I thought to myself that's taken them 12 years, 14 years to build this platform of a large company in Canada with some iconic assets and some assets not so good.

But any company that wants to acquire that and all the quality people that are around that should be paying this substantial premium. So, I’m not very helpful to you I think in terms of exact numbers but I think you’re getting the sense of what I believe.

Mark Rothschild

Got it. Thanks a lot.

Operator

And there are no further questions in the queue at this time. I’ll turn the call back to the presenter.

Rob O'Neill

Thank you, Operator. On behalf of Azim and the entire AHIP management team, we would like to thank you all for sharing your time with us today especially on a Friday afternoon. Azim and I and Ian and Ann are available any time to answer your questions. And we'd like to thank you for your supports. We strive to continue to grow AHIP in a prudent and profitable manner. Thank you.

Operator

And this concludes today's conference call. You may now disconnect.

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