In the face of a REIT market approaching historical highs, many investors are considering short plays. Presently, the shorts seem to be heavily weighted into the hotel sector, particularly Ashford Hospitality Trust (AHT) which currently has 5.75mm shares short. With so many overpriced REITs, why is the market shorting a stock that trades below book and has a 5.7 FFO multiple? I believe it is due to a misinterpretation of the uncertainty in the future of the hotel sector as a bad thing. Yes, there are many unknowns here, and it does translate to increased risk, but let us examine these potential events more closely to glean a proper valuation.
· Fiscal Cliff - in a worst case scenario, companies and individuals will be forced to minimize travel expenses. This would adversely affect both ADR and occupancy. However, the anticipation of the fiscal cliff has caused many to already begin reducing travel expenditures. In the event it is resolved cleanly with minimal damage, it may even create a boom as the saved up money can once again be spent. Companies will perform their delayed business travel and individuals who had foregone vacation will finally be able to indulge. Of course, the fiscal cliff is a legitimate concern for hotels as travel spending is among the first areas to get cut during crisis, but there is also an upside.
· Online travel agencies (OTAs), such as Expedia or Travelocity, have had an intimate relationship with hotel bookings over the years. Recently, hoteliers have shown increasing interest in developing mobile websites and apps as an alternate source for bookings. The new supply of travel sites would create competition amongst OTAs and lower margins. Thus, hotels would have access to the same services at a lower cost or free for those who use their own. Conversely, if the mobile sites and apps do not pan out, the capital that many hotel companies are investing in development would be mostly lost. In my opinion, there is no way to predict which way this will play out so we can simply evaluate the future of OTAs as it relates to the hotel industry as a bi-directional risk factor. To clarify, I simply mean that it increases the risk without being necessarily positive or negative.
· Per-Diem changes/government regulations: Government spending on hotel rooms has been about 20% lower so far in 2012 as compared to the previous year. The decline is expected to continue with programs such as FedRooms, which is essentially a list of approved hotels at which government employees are allowed to stay. It contains rooms with rates slightly lower that the current per-diem and is a discount to what the contracted hotels would typically charge. While FedRooms has been in existence for a while, it was largely unused, but now GSA employees are mandated to use it and other portions of the government may follow this initiative. Government travel expense reduction is nearly certain to continue hurting hotels, but the effect is rather small. Despite the 20% decrease that has already occurred in 2012, Smith Travel Research reports a YOY RevPAR increase of 8.3% driven by gains in both occupancy and ADR for the week ended 09/07/12.
All this uncertainty combined with the inherently inconsistent revenue streams of hotels has created a fear of hotel stocks. In fact, at an estimated FFO multiple of 12.4 the hotels trade the lowest among all major REIT sectors. However, the actual performance of the hotel industry has been strong, and since much of the risk has been priced into the stocks, there is a large upside potential.
With this in mind, I am predicting a short squeeze in the near future on Ashford Hospitality. The upcoming dividend at the end of September creates a significant cost for any who remain short. While a 5.15% annual dividend is not huge, it means the stock would have to drop incrementally further for short investors to profit. Given its already low FFO multiple and a strong 2Q, how much lower can it really go? A drop large enough to make a short profitable is mostly counting on poor Q3 results. Let us explore the probability of this occurrence.
So far in 3Q12 national RevPAR has been very strong, and some particular locations of AHT's hotels have received very large boosts. In reference to the Republican and Democratic conventions, the 8/29/12 Wall Street Journal reports "Hotel owner Ashford Hospitality Trust which owns 4 hotels in the Tampa area and one in Charlotte, is reaping nightly rates of $400 to $600 for last-minute bookings in the convention cities. Ashford's average rate for August at its four Tampa-area properties increased 60% from a year ago. Its average for this September in Charlotte is up 120% from last September".
As more of AHT's Highland portfolio properties are done being renovated, it will begin to see increased cash flows. A majority of these properties were under renovation during the first quarter and a smaller portion during Q2. While some will remain down throughout Q3, the upgrade of these hotels to upper-upscale will pay-off in the long run. Unless we see some bad news soon, it seems unlikely that Q3 will underperform expectations.
Considering there are 5.75mm shares short and a 3 month average daily trading volume of 396,881, it would take approximately 14.49 days to cover. So, it is possible for those shorting to get out before the dividend hits. If AHT's 3Q report is strong and the short investors are still positioned, we may see a short squeeze give AHT a nice price bump.
Disclosure: 2nd Market Capital and its affiliated accounts are long AHT, AHT-A, AHT-D and AHT-E. 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 author.
Disclosure: I am long AHT.