Investment Thesis
Real Estate Investment Trusts (REITs) have been struggling across the board which has created some attractive discounts. In the last month, no drop has been more apparent than Chatham Lodging Trust (NYSE:CLDT) has this name normally sells for a premium when compared to other lodging REITs like Apple Hospitality (APLE).
LXP data by YCharts
CLDT's drop comes after a small Q4-2017 earnings miss but what was more concerning was the year-over-year change drop in Funds From Operations (FFO) from $.44/share in Q4-2016 to $.36/share in Q4-2017. Although these results were still within suggested guidance, it was notable that expenses increased faster than revenue during 2017.
The goal of this article is to dig in two CLDT's Q4-2017 earnings and 2017 10-K and determine if the current drop in share price is warranted before initiating a long-term position for my clients.
Background
CLDT is comprised of 40 hotels and an aggregate of 6,018 rooms which are spread throughout 15 states in the top 25 metropolitan markets in the United States (as of December 31, 2017). In addition to these holdings, CLDT also holds a non-controlling interest in two joint ventures, including:
- NewINK Joint Venture - This joint venture was established in Q2-2014 and consists of 47 hotels with a total of 6,097 rooms. CLDT's ownership represents 10.3% of the joint venture.
- Inland Joint Venture - this joint venture was established in Q4-2014 and consists of 48 hotels and 6,401 rooms. CLDT's ownership represents 10.0% of the joint venture.
CLDT's portfolio primarily focuses on "upscale extended-stay hotels such as Homewood Suites by Hilton and Residence Inn by Marriott" (2017 10-K). Additionally, CLDT invests "in upscale or upper upscale all suite hotels such as SpringHill Suites by Marriott or Embassy Suites" (2017 10-K). According to the 2017 10-K, CLDT invests in extended-stay and all suite hotels because they come with the following three characteristics:
- Customer base focused on business travelers (including short-term and those on extended assignments).
- High-quality services and amenities such as complimentary breakfast, evening hospitality hour, and other amenities desired by its high-end customer base.
- High-end construction including large suites, full separate kitchens, pool and exercise facilities.
Management Fees
It is important to understand that in order for CLDT to qualify as a REIT the company cannot operate its hotels. CLDT lease the company's wholly owned hotels to taxable REIT subsidiary lessees also referred to as "TRS Lessees".
TRS Lessees have contracted management services through Island Hospitality Management, Inc. (IHM) for all 40 of its wholly-owned hotels. The contract with IHM is fairly straightforward as it is paid a 3% base management fee, a monthly accounting fee, and a monthly revenue management fee. There is also an incentive program for IHM if certain financial thresholds are met/exceeded. This fee is calculated "as 10% of the hotel's net operating income less fixed costs, base management fees, and a specified return threshold. The incentive management fee is capped at 1% of gross hotel revenues for the applicable calculation" (2017 10-K).
Management fees have grown in-line with CLDT's operations as management fees and incentive bonuses were $9.9 million, $9.4 million, and $8.7 million in 2017, 2016, and 2015, respectively. The incentive fees during these periods were $.2 million, $.3 million, $.3 million.
IHM's has a strong relationship with CLDT as it manages all 40 of its wholly-owned hotels. IHM is also responsible for managing all 47 of the hotels owned by the NewINK Joint Venture and 34 of the 48 hotels owned by the Inland Joint Venture. The heavy emphasis on IHM for management services is beneficial because it creates consistency across all locations but is negative in the sense that it makes CLDT more economically exposed to any adverse developments in IHM's business/affairs.
It is worth noting that CLDT's CEO, Mr. Fisher, owns 51% of IHM. I would normally consider this to be a conflict of interest with the exception that management fees and incentives paid to IHM all appear to be reasonable and in line with going market. Any renewal of contracts with IHM should be watched closely to ensure that this remains the standard.
Revenues
Revenues increased by $5 million (approximately 1.7%) between 2016 and 2017. Of the $5 million increase, roughly $3.5 million came from three hotels that were acquired during 2017. Therefore organic revenue growth was only $1.5 million year-over-year.
Source: 2017 10-K
Another important revenue metric for the lodging industry is RevPAR, which stands for revenue per available room. CLDT's growth of 1.0% from 2016 to 2017 comes in well below the industry average of 3.0% according to Smith Travel Research. Management notes that they believe their growth was lower due to new supply in the markets they operate in.
Expenses
Expenses appear to be one of the biggest problems with CLDT's reported results because they exceeded revenue growth which is a major concern I have going forward. Expenses increased by $6.9 million or 4.6% year-over-year which far exceeds revenue growth of approximately $5.0 million or 1.7% year-over-year.
Source: 2017 10-K
The fields highlighted above represent the most concerning increases in CLDT's expenses from 2016 to 2017.
- Room Expenses - this category represents an increase of nearly $2 million, of which $.6 million can be attributed to the additional expenses of the three hotels acquired in 2017. In other words, room expenses organically increased by roughly $1.4 million year-over-year. This increase was primarily driven by increased wages.
- All Other Expenses - remaining expenses increased by $4.9 million year-over-year, of which, $1.5 million can be attributed to the three hotels acquired in 2017. Therefore all other expenses organically increased by $3.4 million year-over-year.
I will be looking for CLDT's next quarterly report to show that they are keeping other expenses, general and administrative, and repairs and maintenance in check going forward. While the increase in expenses relative to the limited increase in revenue is concerning, I do not feel it is significant enough to stop me from considering an investment in CLDT.
Impairment Loss
One of the most significant items that caught my eye was the impairment loss of $6.7 million on CLDT's Washington SHS, PA hotel. This was a significant contribution to CLDT's total operating expenses and if we exclude this one-time item operating income would've been approximately $59.7 million in 2017 versus $58.9 million in 2016.
Funds From Operations
If we exclude the impact of the one-time impairment charge on CLDT's funds from operations we find that CLDT's operating results are significantly better than their current report shows.
Source: Consistent Dividend Investor, LLC.
Don't get me wrong, I'm not trying to say that CLDT is running a perfect operation but it is worth noting that when we exclude these impairment charges that adjusted funds from operations is level year-over-year.
Dividend
Using the same figures from the funds from operation section we can see that CLDT maintains a fairly conservative payout ratio. Although some investors are quick to bash on CLDT for their lack of dividend growth, I personally prefer to see the maintenance of a conservative dividend payout especially when the stock currently yields 6.8%.
Source: Consistent Dividend Investor, LLC.
It is important to consider these items as it shows CLDT's dividend is extremely safe even with their less than desirable results for the FY-2017.
Great Entry Point With Support
I believe that the current drop in price as a result of poor Q4-2017 results has created a strong buying opportunity for investors looking to maximize yield on this long-term income stock. Some investors might be convinced that CLDT has yet to reach its bottom, but it isn't far off what looks like a strong support level of approximately $16.30-$16.50/share.
Source: Charles Schwab
If we use $2.14/share AFFO this represents a current price to AFFO (P/AFFO) of 8.56 compared to P/AFFO that is normally above 10. While CLDT may not be growing AFFO currently a P/AFFO of $8.56 for this high-quality name is absolutely dirt cheap.
Conclusion
I am optimistic that CLDT's focused business model is primed for continued success going forward and that Q4-2017's poor results should largely be ignored especially when we consider that Q1/Q4 represent its two weakest earnings quarters. Additionally, the one-time impairment charge created a lot of noise in the Q4-2017 earnings. I believe that CLDT will return to a P/AFFO of 10 or 11 in the next few months which means that I expect a price target between $21.40 and $23.50. This represents an upside somewhere between 15 and 22%. I rate CLDT as a buy for investors seeking income with the potential for modest capital appreciation.
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