Chatham: Public Vs. Private Market Valuation

| About: Chatham Lodging (CLDT)

Summary

A stab at going in NOI.

Public market implied cap rates.

Private market cap rates.

Stock market prices for lodging REITs have been quite volatile in the past 12 months. After several years of consistent increases in occupancy levels and average daily rates, there is (justified) concern that the lodging business cycle is at its peak. Part of the concern is that an uptick in rooms in development will surely pressure occupancy as well as rates when they hit the market (for instance, see this and this). Combined with the inevitable demand shock (recession, less travel for whatever short term reason, etc.) the lodging sector could be in for a double whammy.

Chatham Lodging Trust (NYSE:CLDT) is an internally managed REIT specializing in premium branded select-service and upscale extended stay hotels.

Even given all the aforementioned concerns, at first glance, one might argue that Mr. Market is undervaluing CLDT - a monthly dividend yielding over 7% (based on the closing price as of writing), a payout ratio (as a percentage of FFO) of under 60%, reasonable capital structure, reasonable geographic diversification, steady historical dividend growth, a seasoned management team with a good track record, etc.

The purpose of this note is to compare the valuation ascribed to Chatham's properties by Mr Market (i.e., the public equity market) with the value being ascribed by private markets. Private markets are often more rational than Mr Market and such a comparison can be a useful sanity check.

This essentially boils down to a calculation of net asset value (NAV for short) and (implied) capitalization rates (cap rates).

Net Operating Income

Our first order of business is to determine yearly/going in NOI (net operating income) for the hotels in Chatham's portfolio. That is, roughly, cash income from operations before interest expense and other corporate level expenses.

Here is the relevant data for CLDT ($ amounts in thousands):

Operating income

$59,122

Add back depreciation and amortization $49,512
Add back corporate level G&A $12,168
NOI $120,802
Click to enlarge

The above data has been obtained by annualizing the data from the past six months, extracted from Chatham's most recent SEC filings. Let me emphasize that the reader should exercise some judgment in annualizing data in this way (one has the intuitively obvious fact that lodging is a seasonal business).

For comparison, for the first six months of 2016, Chatham produced about $40 million in cash from operations after paying about $14 million in interest expense and $6 million in corporate level G&A (which yields an annualized estimate of $120 million in NOI).

Note that this is merely an estimate for NOI (chosen primarily for its ease of extraction). A more nuanced approach might involve drilling down into Chatham's portfolio and using location specific industry (as well as Chatham's own historical) statistics on occupancy levels, average daily rates, margins, etc.

Public Market Implied Cap Rate

At the most recent close, CLDT traded at a market capitalization of about $690 million. Further, according to the latest 10-Q, total debt outstanding (most of which is property level, non-recourse fixed rate mortgage) was about $598 million.

The company also held about $38 million in cash (including restricted cash) on its balance sheet. Hence, Mr. Market is valuing Chatham's portfolio of properties at $1.25 billion. An alternative, but equivalent perspective, is that Chatham is trading in the public equity market at a cap rate of about 10%.

Private Market Cap Rates

All that remains to be done is to bring the viewpoint of the private market into the picture.

According to JLL's Select Service Hotel Investor Survey conducted in May of 2016, average cap rates for select service hotels were 9.1%. This is in line with slightly dated data from CBRE from the first half of last year.

Based on our estimated NOI of $120.8 million, this values Chatham's portfolio at about $1.3 billion.

The obvious caveat here is that the above cited cap rates are nationwide averages which can vary significantly depending on geographic location. As with estimating NOI, a more nuanced approach would involving drilling deeper into Chatham's portfolio and using location specific cap rates. The reader should view the current note as merely a starting point.

Conclusion

To sum up, although Mr Market often exhibits manic depressive behavior, in the case of pricing CLDT, Mr Market's pricing is more or less in line with valuations being ascribed by, presumably more even keeled, private market buyers.

Thus, although CLDT might standout based purely on conventional REIT metrics, upon closer inspection it would appear to be priced in a zone of reasonableness.

Disclosure: I am/we are long CLDT.

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.