In the report, I argue that this operator of travel centres and convenience stores (c-stores) around the US interstate highway system is really only a proxy to the interests of Hospitality Properties Trust (NYSE:HPT), a REIT that owns many of TA operated travel centres and of RMR, a management company directed by Mr. Portnoy, who is also a director of HPT. These two firms and Mr. Portnoy have created an enormous web of conflict of interests which burden TA's operating cash flow.
HPT's/RMR's position is also well entrenched by the fact that TA is an LLC and thus can operate under a shareholder agreement that primarily benefits the insiders. For example, any single shareholder can't own more than 9.8% of the company and majority of potential lawsuits would have to end in arbitration, therefore discouraging anyone to try to do something about this situation. A simplified representation of the situation is given below.
The situation continues to be detrimental for TA's shareholders.
On 15th of March, TravelCenters of America filed its 10-K annual report for FY 2015. The company reported $5,850 mil. in revenue vs. $7,778 mil. in FY 2014, operating income of $78.3 mil. vs. $113.6 mil. in FY 2014, and net income of $27.7 mil. vs. $60.9 mil. in FY 2014.
As you can see, the market reacted negatively. This is most likely due to that fact that the company posted a loss for the Q4 of FY 2015, despite posting a profit for the fiscal year. The loss mainly occurred due to thinner margins on the fuel revenue.
The management had the following to say with regards to this point.
Our fuel gross margin cents per gallon declined approximately $0.09 year-over-year to $0.19 per gallon in the fourth quarter of 2015 compared to $0.28 per gallon in the prior year period. The year-over-year fuel gross margin decline was attributable to a favorable purchasing environment in the 2014 fourth quarter that did not recur in the 2015 fourth quarter. Both years' quarters benefited from declining fuel costs, but the 2015 quarter did not provide the same opportunities for advantaged purchasing that we enjoyed in the 2014 quarter.'
Taken from the Q4 conference call on 15th of March, 2016
The whole situation was not helped by the fact that the operating expenses grew by 12.2%. This was mainly driven by acquisitions of convenience stores, which totaled $700 million in spending since the management started to pursue the strategy in 2011. The operating expenses were also lifted by the ever-present rent increases, which are going to continue in the upcoming year as the company has announced $150 million in capital expenditures for improvements of the travel centres. This will translate into roughly a $13 million rent increase. This rent increase benefits RMR, HPT and ultimately Mr. Portnoy and his group of insiders, but, in my view, do not make economic sense for TravelCenters of America.
Due to the aforementioned points, the stock continues to be untradeable as the company's management continued to exploit their extremely entrenched position and the conflict of interests that it created as was laid out in my initiating article.
When we look at the income statement, we can see that the fuel revenue ended up lower by almost 25%, but this is not an issue as this is just a reflection of the lower gas price due to the lower oil price. The important top line factor is the volume of fuel sold, which was actually up by 0.7% on same-site basis. Although, as mentioned, due to the tighter margins, the gross profit from fuel revenue ended up being lower by about 4% for the whole year, but 33% for Q4.
The non-fuel revenue did improve by around 5.4% on same-site basis, which could be possibly due to the lower gas price environment which could encourage consumers to spend more on non-essentials.
As a whole, the non-fuel revenue was up mostly due to the acquisition strategy of TA's management.
The operational income was then also squeezed by the increase in site level operating expense due to the new acquisitions and the rent expense. The latter will also continue to increase at an increasingly rapid pace due to the nature of the dubious rent agreement that TA has with Portnoy's HPT, which acts a landlord. HPT essentially buys any improvement that TA purchases for the travel centres and subsequently raises TA's rent as can be seen below.
If we complete our capital improvements program as currently planned, we expect to sell approximately $150 million of improvements at sites we lease from HPT in 2016. Our rent expense will increase by 8.5% of the proceeds of these sales to HPT.'
Taken from the corresponding 10-K report.
This is over 50% increase from the previous year. We can see the expenses connected in the previous years below.
During 2015, 2014 and 2013, pursuant to the terms of the HPT Leases, we sold to HPT $99,896, $66,133 and $83,912, respectively, of improvements we previously made to properties leased from HPT, and, as a result, our minimum annual rent payable to HPT increased by $8,491, $5,621 and $7,133, respectively.'
Taken from the corresponding 10-K report.
This is something that should be investigated further as it means that TA is spending increasing amounts on improvements on the same sites. I do not have specific information about each site's improvement plan, but one could speculate that the rate of spending on improvements, in the span of three years, should go from high to low rather than inversely.
I do have only a sparse information from the annual report about the nature of the improvements, which state that typical improvements are revolving around adding truck repair facilities, parking lots, rebranding gasoline offerings, replacing fuel dispensers, IT systems etc.
I wanted to question the management on the conference call on the day of the release of the update, but I was not able to ask any questions due to the fact that the Q&A line was crowded. I did, however, reach out to the investor relation department of TA via email (on the 25th of March) about the 50% increase in the improvement spending. I have yet to receive an answer.
Whatever the reason, all this means more burden onto the company's operations and more fees earned by RMR and Mr. Portnoy and his insider group through their 'management' agreements with TA.
Cash Flow Side
As you can see, the operating cash flow remains positive and is likely to do as the whole industry is not likely to sustain any shock anytime soon.
In this year's cash flow from investing activities, we can see exactly how the dubious HPT/RMR relationship with TA is sustained, i.e., how TA is able to finance it. The increase in proceeds from assets sales mainly comes from the sale and subsequent leaseback of TA's properties to HPT. This helped TA to build up a cash base for the year in order to continue spending an exorbitant amount on capital expenditures, which increased 73% compared to the previous year and to continue its acquisition strategy, which also recorded significant increase compared to previous years.
TA also raised debt for the third year in a row. This whole situation then translated into a loss of $52 million in cash and cash equivalents.
When looking at the balance sheet, there is not much that has changed since last year.
There are only two points here that I would like to mention.
Firstly, the management was asked during the conference call what they are planning to do with the spare cash sitting on their balance sheet. The analyst asking the question specifically aimed at stock buybacks, but the management had the following to say.
… In the current state of play here with the company growing and in fact not just through acquisitions, a few of which we still have on the docket going forward, but also the integration.
While I believe that is going to work out as planned, that's not the same thing as saying there's absolutely no risk that it won't. So the prospect in the near term of allocating capital to making the company smaller, which is in fact one of the impacts of a share repurchase, there's very little prospect of that.
The cash that we have, I think is best utilized--its highest use is in fact what we've been doing.'
Taken from the conference call on 15th of March.
It is understandable that the management will most likely never agree to a different capital allocation strategy as the insiders around Mr. Portnoy benefit from spending TA's money on capital expenditures and acquisitions as explained in my initiating report.
Secondly, we need to bear in mind that the balance sheet is not accounting for the contractual obligations, which include the HPT leases. This is not something new as you can read about the balance sheet adjustments in my previous report. I am specifically talking about the non-current HPT lease liabilities, which increased by around $50 million from last year on the balance sheet, but actually the lease liabilities as a whole increased by about $1.3 billion.
You can see the breakdown of the total contractual obligations below.
This means that even though the stock trades at a discount to its book value, it does not seem to be undervalued from an asset point of view, because of this significant adjustment.
The fact that I am adjusting the balance sheet this way is actually supported by the IASB (International Accounting Standards Board), which released this recent update. The ruling in the update makes showcasing leases on the balance sheet mandatory from early 2019.
Absolute & Relative Valuation
The valuation of this stock continues to be irrelevant as the management is exerting significant influence over the company and thus renders the fundamentals irrelevant.
Other Company Specifics
As previously stated almost any action by the shareholders is futile. There are only few ways to actually remove the board and these are subjected to many unlikely circumstances. One way to try to remove the board would be to sue them for breach of fiduciary duty as the whole structure is built for self-dealing and exploitation of conflict of interests, but even if one is successful, the board will still evade any potential fees payable, and who will cover those fees? The company itself.
What I have not covered extensively in the initiating report was the fact that the board of directors is well prepared for potential legal liability as they have the following in the LLC agreement and in any other agreement with HPT and RMR.
'Nonliability of Trustees
…BUT NOT INDIVIDUALLY OR PERSONALLY, AND THAT NO TRUSTEE, OFFICER, SHAREHOLDER, EMPLOYEE OR AGENT OF SUCH ENTITY SHALL BE HELD TO ANY PERSONAL LIABILITY, JOINTLY OR SEVERALLY, FOR ANY OBLIGATION OF, OR CLAIM AGAINST, SUCH ENTITY. ALL PERSONS DEALING WITH SUCH ENTITY, IN ANY WAY, SHALL LOOK ONLY TO THE ASSETS OF SUCH ENTITY FOR THE PAYMENT OF ANY SUM OR THE PERFORMANCE OF ANY OBLIGATION.'
Taken from this lease agreement with HPT and TA.
And TA's management is covered by this clause in the LLC agreement with shareholders.
Section 10.1 INDEMNIFICATION.
To the fullest extent permitted by law but subject to the limitations expressly provided in this Agreement or in any Bylaws of the Company, all Indemnitees shall be indemnified and held harmless by the Company from and against any and all losses, claims, damages, liabilities, joint or several, expenses (including legal fees and expenses), judgments, fines, penalties, interest, settlements or other amounts arising from any and all claims, demands, actions, suits or proceedings, whether civil, criminal, administrative or investigative, whether or not by or in the right of the Company, in which any Indemnitee may be involved, or is threatened to be involved, as a party…'
Taken from this LLC agreement of TA.
One way to think about this is that the management of HPT and TA in a way waives their fiduciary duty. Even though they are still bound by it, the ramifications if they broke such obligation seems to be completely irrelevant. Unless the plaintiff calls for a criminal lawsuit, whereby the defendant, or HPT and TA, would be under the threat of serving jail time, they literally don't have much incentive to worry about any lawsuit as they know that whatever fine will be declared at the end of it, it won't be them who will pay, it will be the shareholders.
New HPT leases from July 2015
Now, as mentioned in my initiating report, TA also did a leaseback with HPT in the middle of last year, which raised the rent on average by $100,000 per site or by around $50 million as a whole, which again pointed out to the inherent conflict of interests, where HPT and RMR stand to benefit from increased fees due to the increase in rent.
Additionally, the company decided to split the leases in four separate agreement. I reached out to the investor relations via email as to why exactly did the company split the agreements in this manner, but I am still waiting for an answer. What I did on my own, however, was to compare the agreements for any divergence in content.
The only differences were the facts that each lease has a different expiry date and that the fourth lease has an extra section aimed at a specific travel centre in Willington, Connecticut. TA has to pay additional 'fixed component' of rent that comprises of almost $1.2 million per annum. This fixed component than increases every year on October 1 by the percentage change of the 'Consumer Price Index for Urban Wage Earners and Clerical Workers'. Other than that the contracts are identical.
My TA's thesis still holds. The stock is untradeable due to the fact that the management render the fundamentals worthless. In fact, the management's strategy is likely to continue to push the company into further losses. The capital expenditures and acquisition strategy are likely to continue or even accelerate as we saw in the case of the improvements. On the other hand, as pointed out in the initiating report, this can also go the other way round. The investors can't really be certain about the prospects as the management can decide that it will help the company and ease the aforementioned burden.
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.