Pick Up Park For Peanuts

Summary

• The value investor’s purpose is to capitalize upon “a favorable difference between price on the one hand and indicated or appraised value on the other.”.
• While Park lacks diversified brand affiliations, the company mitigates the risk by owning such a diversified portfolio.
• Park is trading at almost the same multiple as Chatham (8.6x), suggesting that Park is getting absolutely no credit for its diversified platform and premium brand flags.
• I am upgrading Park from a Buy to Strong Buy.

Last week, Chinese conglomerate HNA Group, a 25% shareholder of Park Hotels & Resorts (NYSE:PK), announced that it was seeking to sell all or part of its ownership (more than 53 million shares). As Floris van Dijkum, equity analyst with Boenning & Scattergood, wrote in a research report,

The HNA situation should continue to depress PK’s stock performance until the overhang is lifted. New of the pending sale helped to send PK’s share price down 5.8% on Friday.”

HNA was founded in 2000 and is involved in a variety of industries such as aviation, real estate, financial services, tourism, logistics, and more. In addition to PK, HNA also has substantial stakes in Grand China Air and Hilton Worldwide (HLT). In July 2017, HNA was ranked #170 in Fortune Global 500 companies with more than $53.335 billion. (Source: Wikipedia)

According to Bloomberg, HNA is selling assets because of a “liquidity squeeze” in which more than $9 billion in HNA asset sales have emerged:

Reuters cites “HNA’s leverage” and “aggressive financing policy” for the aggressive actions and said that “in recent weeks (HNA has) also has raised additional financing by selling expensive short-term debt and pledging more of its shares for loans.”

Since the HNA news on Friday (March 2^nd), PK shares have declined ~5%:

In my last PK article (on Seeking Alpha) I wrote that “when you invest in Park you are essentially investing in the premium Hilton brand. Conrad Hilton knew a thing or two about branding and the value proposition for owning shares in Park today is that you are essentially getting a slice of one of the best hotel brands in the world, at a discount.”

Conrad Hilton said,

The buyer is entitled to a bargain. The seller is entitled to a profit. So there is a fine margin in between where the price is right. I have found this to be true to this day whether dealing in paper hats, winter underwear or hotels.”

Well, that “fine line” is not as “fine” now, thanks to HNA Group’s announcement that it is unloading shares in Park Hotels. As Benjamin Graham wrote in The Intelligent Investor, the value investor’s purpose is to capitalize upon “a favorable difference between price on the one hand and indicated or appraised value on the other” and that is why I am “picking up Park for peanuts.”

Photo Credit

Why Park?

Based in McLean, Virginia, Park Hotels & Resorts was formed when Hilton Worldwide spun off most of its owned real estate into a separate public REIT. Park is the latest entrant in the Lodging REIT sector long dominated by Host (HST), which still dwarfs all other stock exchange-listed hotel REITs in terms of size. Park is the second-largest publicly traded Lodging REIT:

Park is among the Top 25 largest REITs out of 130 REITs based on TTM Adjusted EBITDA and Park ranks among the Top 25 Largest REITs in the US:

Park Hotels owns a $9 billion portfolio of 67 large-scale, high-end hotels, including iconic properties stretching from coast to coast. Its trophy properties include the New York Hilton, which spans an entire city block in Midtown Manhattan; the landmark, 1,544-room Hilton Chicago Downtown, boasting nearly 200,000 square feet of meeting space; and the oceanfront, 2,860-room Hilton Hawaiian Village in Honolulu.

There is strong potential in the 35,000-room portfolio of upper-upscale and luxury hotels, and Park Hotels, through acquisitions of like properties in leading hotel and resort markets, already has holdings in 14 of the top 25 U.S. hotel markets.

Park is one-brand concentrated right now, but the company says it "seeks brand and operator diversity over time." This is similar to what happened in 1993, after Marriott International (NYSE:MAR) spun off what is now Host Hotels.

The pictures below illustrate Park's diversified exposure to attractive markets:

Around 74% of Hotel EBITDA comes from coastal markets, and 91% of Hotel EBITDA is from Top 25 Markets and resort destinations:

While Park lacks diversified brand affiliations, the company mitigates the risk by owning such a diversified portfolio:

Its portfolio's strong group positioning increases visibility into forward bookings and reduces operating volatility by enhancing the stability and predictability of revenue throughout the lodging cycle.

Top 25 Hotels: Group/Transient Mix: 31%/63%. Park's strategy will be to "Group Up" and drive that mix up another 400 bps to 35% Group demand. The portfolio contains 26 properties with over 25,000 sq. ft. of meeting space and 6 properties with over 125,000 sq. ft. of meeting space in top convention markets, generating robust corporate meeting and group business. Supply and demand trends favor large, group-oriented hotels for the foreseeable future.

Iconic Assets Valued at Well Below Replacement Cost

The REIT's focus is on building a portfolio of Upper Upscale and Luxury branded assets in Top 25 markets and premium resort destinations. It pursues larger-scale deals (assets and portfolios) that offer significant value-add opportunities.

The company seeks to diversify its brand (beyond Hilton) and operator mix to include other global manager/franchisors. Park will opportunistically recycle capital, selling out of slower-growth, non-core assets and reinvesting in higher-growth markets.

Less competition exists on larger transactions, as only a limited number of investors have access to the equity needed to pursue $250+ million single assets.

Consequently, the share of deals pre-empted and executed off-market increases in conjunction with deal size, thereby enhancing the price negotiation leverage for an eligible buyer. Park's balance sheet and operating platform are well positioned to execute these larger transactions.

Park focuses on owning hotels and resorts in the Luxury and Upper Upscale segments. The company focuses on recognizable products compared to independent hotels struggling to differentiate their offerings. Loyalty programs help to drive recurring sales, while lowering new customer acquisition costs. Hilton (~60 million members) and Marriott, including Starwood (NYSE:STWD) (~100 million members), have ~50% of sales stemming from customers within their loyalty programs.

Park has the ability to achieve increased direct-to-consumer sales, minimizing OTA/wholesale commissions and increasing revenue to the company. This means significantly lower distribution costs for the OTA business, given the negotiating power of brands.

Park can more effectively compete against Airbnb (Private:AIRB), particularly with respect to frequent travelers who appreciate the reliability and security of branded hotels.

Active Asset Management: Hands-on Approach

Hilton continues to manage the vast majority of Park's properties it spun off. Oversight of operations under Park creates a system of checks and balances that should eventually translate into higher profits.

Hilton, like most brand owners, doesn't have corporate oversight of property-level management to make sure they are maximizing profits for the owner.

Park is able to maximize each asset's full potential through a focused approach on revenue management and cost containment initiatives, while purposefully addressing capital needs, including ROI opportunities.

CapEx: Over $1.3 Billion Has Been Reinvested in Park's Hotels

Park has invested heavily to drive market share and ensure strong competitive positioning of its portfolio. The company continues to consistently renovate to adapt to evolving customer preferences and the latest technology.

Renovations have been focused on guestroom design, open and activated lobby areas, food and beverage and public spaces, and modernized meeting spaces. Park creates value through repositioning select hotels across brands or chain scale segments, and exploring adaptive reuse opportunities for highest and best use. (No major deferred maintenance.)

The Balance Sheet & Fundamentals

In December, PK repaid $55 million in maturing high-yield bonds, which carried a 7.5% coupon, leaving the company with a forward debt maturity schedule that is well-balanced and very manageable with no major maturities until 2021.

As of Q4-17, net leverage stood at just 3.7x with ample liquidity to execute on PK’s strategic plan. At year-end PK had $2.8 billion of net debt outstanding:

On the recent earnings call PK’s management team said that it would be able to buy back shares with disposition proceeds. Since the last quarterly call, PK has sold a total of 12 noncore hotels in 4 separate transactions, including 9 international assets accounting for approximately $379 million of gross proceeds at an average cap rate of 5.5%.

The Latest Earnings Results

For Q4-17, PK reported total revenues of $686 million and adjusted EBITDA of $180 million, and adjusted FFO was $145 million (or $0.68 per diluted share). On a full-year basis, PK reported total revenues of approximately $2.8 billion, adjusted EBITDA of $757 million and adjusted FFO of $596 million (or $2.78 per diluted share).

For the full year 2017, PK’s comparable portfolio produced a RevPAR of $163 or an increase of 0.7%. The company’s occupancy for the year was 81.1% or a slight decrease of 20 basis points.

PK’s average daily rate was $202 or an increase of 0.9% versus the prior year. These top-line trends resulted in hotel-adjusted EBITDA of $709 million for the comparable portfolio, while the hotel-adjusted EBITDA margin was 28.1% or a 20 basis point decrease from the prior year.

For Q4-17, PK reported comparable RevPAR of $160 or an increase of 1.7% versus the prior year. The company’s occupancy for the quarter was 78.7% or 40 basis points higher, while the average daily rate ended the quarter at $203 or an increase of 1.1% year-over-year. These top-line trends resulted in comparable hotel-adjusted EBITDA of $175 million, while margins increased 70 basis points to 27.8%.

The Bottom Line: PK beat consensus quarterly FFO by $.06 per share.

It is PK’s intention to pay out an annualized 65% to 70% of adjusted FFO for the year. With Q4 earnings coming in line with expectations, the company paid out a Q4-17 step-up dividend of $0.55 per share in January.

Also, PK paid out its first-quarter dividend of $0.43 per share (to be paid on April 16 to stockholders of record as of March 30). Similar to 2017, PK is targeting a full-year payout ratio of 65% to 70% of adjusted FFO, with a potential top-up dividend to be paid in the fourth quarter (That may explain the reason that F.A.S.T. Graphs illustrates PK’s dividend yield at 9%+).

PK has established RevPAR guidance of 0 to plus 2% for full-year 2018, with a comparable hotel-adjusted EBITDA margin range of -80 basis points to a +20 basis points, which will take into account many of the asset management initiatives.

For the full year 2018, PK anticipates adjusted EBITDA to be in the range of $705 million to $745 million, while adjusted FFO per share will be in the range of $2.59 to $2.75. Note that our earnings guidance does not include redeployment of proceeds from asset sales.

Here is a snapshot of the FFO per share forecaster (using F.A.S.T. Graphs data):

Pick Up Park For Peanuts

As noted, PK shares have declined by over 5% as a result of the recent HNA news, and as illustrated below, PK has returned -14% YTD:

The last time I wrote on PK (December 2017) shares were yielding 6.1% and now they are yielding 7.4%:

Given PK’s high-quality portfolio, it’s surprising to see such a high yield (with a sound payout ratio) and as you can see below, PK is trading at a discount to the closest peers – LHO (10.4x) and PEB (13.4x).

In fact, Park is trading at almost the same multiple as Chatham (CLDT) (8.6x), suggesting that Park is getting absolutely no credit for its diversified platform and premium brand flags.

Park has continued to report solid earnings momentum and the dividend true-up in 2017 suggests that this Lodging REIT is aligned with investors. Recognizing that HNA Group is in a “forced sell” mode, I plan to take advantage of the overhang and pick up a few more shares for peanuts. Clearly, Mr. Market does not recognize the value of this premium hotel REIT, but I know I am buying shares in Park Place not Pennsylvania Avenue.

I am upgrading Park from a Buy to Strong Buy (as noted: I am forecasting annual returns of at least 25%).

Note: Brad Thomas is a Wall Street writer, and that means he is not always right with his predictions or recommendations. That also applies to his grammar. Please excuse any typos, and be assured that he will do his best to correct any errors if they are overlooked.

Finally, this article is free, and the sole purpose for writing it is to assist with research, while also providing a forum for second-level thinking. If you have not followed him, please take five seconds and click his name above (top of the page).

Source: F.A.S.T. Graphs and PK Investor Presentation.

REITs mentioned: CDOR, PEB, RHP, SHO, HST, DRH, LHO, INN, APLE, XHR, CLDT, RLJ, HT, HPT, AHP, and AHT.

Analyst’s Disclosure: I am/we are long ACC, AHP, APTS, ARI, BRX, BXMT, CCI, CHCT, CIO, CLDT, CONE, CORR, CUBE, DDR, DEA, DLR, DOC, EPR, EXR, FPI, FRT, GEO, GMRE, GPT, HASI, HTA, INN, IRET, IRM, JCAP, KIM, LADR, LAND, LMRK, LTC, MNR, NXRT, O, OFC, OHI, OUT, PEB, PEI, PK, PSB, QTS, REG, RHP, ROIC, SBRA, SKT, SPG, STAG, STOR, TCO, UBA, UMH, UNIT, VER, VTR, WPC. 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.

Comments

[Brooksy1]

Thx for your screaming buy Brad. Got in for 400 @ $26. Currently trying to sell an Oct $30 call for $2.50. That would allow me 2 more divs plus the special one they announced. Tidy profit especially that I'm Canadian and your dollar is 1.28 times ours... Keep writing

[Brad Thomas]

Been traveling....please message me...also, who can beat me in BRACKETOLOGY?

http://on.ncaa.com/2Gp...

[Larvelsk]

Brad,
Sill waiting for a response to my March 8 post.
Thanks,
Larsvelsk

[douglass.list.31moorgate]

Yes, see comments about mid-way through the discussion board above. Management said nothing at the time about the dividend increase in December being special. But then they decided to go back to the old dividend rate in March, retroactively declaring that the December increase was a one-off deal.

As best as I can tell, all of the dividend tracking community viewed the December increase as just that, an increase. And published that conclusion. And the company never issued a press release to state that the dividend increase had been misinterpreted.

In my view, calls into question the integrity of management communications.

[hafen]

Uh, I just received notice from Simply Safe that the PK dividend was reduced by 22%. What’s that about?

[Larvelsk]

Please explain why in the March 2018 Forbes Real Estate Investor you list PK as a HOLD (which implies sell) in the Durable Income Portfolio, a HOLD in the KISS Reit Portfolio, and a SALSA and TRIM in your lab, and today you say you are upgrading it from a
BUY to A STRONG BUY.

Something smells rotten in Denmark. I am very disappointed in your Opinion Quality Control. People are looking to you for sound investment advice.

[NewToThis2015]

What is the current quarterly dividend for PK? SA shows it to be $.55 per quarter, but according to PK's website, the last dividend declared on 2/23 was $.43 to be paid on 4/16/18. SA has no mention of the dividend declared on 2/23.

What gives?

[Vandooman]

Brad, I think PK just was run up too far last year and has come back down. I am still above water with a slight gain since I bought it last year. Good performance considering the rest of the REIT sector. I like the capex numbers but would like to see what portion was maintenance and renovations. A good hotel group should be spending 4% of revenues to maintain the brand.

In terms of quality of assets we shouldn't confuse luxury with quality for an investor. The 30 hotels at the lower end are probably less sensitive to recession than the top end. In recession business travel gets cut back substantially. In a recession 85% of the population are as well off as they ever were and still need to travel. Sales personnel still need to travel and many receive fixed hotel allowances rather than just having the costs covered. They are motivated to not stay in luxury hotels.

[wildpitcher]

Long PK and PEB in sort of a barbell hotel REIT investment.

Dave

[Guy at Work reading SA]

Been following the sector and this stock in particular for awhile now but I don't know if the bottom is in

[Mike,]

Don’t buy a5 bottom it unpredictable buy a5 good value

[NecessityMadeMeDividendInvestor]

Thank you Brad for great article. But as I own CLDT already I will stick with that. They are almost same in DY and FFO, I do not monitor price to much.

[labman106]

IMO, the hospitality sector is a big AVOID.
HT has promise, perhaps.

[ckarabin]

Why is hospitality an "avoid.?"

[Vandooman]

Opinions are great but would like to know the logic behind it. Otherwise meaningless.

[AlieGee]

Dividend history too short. I see they raised then lowered. Wondering why.

[Kenny_G]

@AlieGee Check out the other prior comments, the "apparent" dividend issue you speak of is well explained by other commenters.

[AlieGee]

Yes, thanks Kenny.

Al

[PSPnomore60]

Anyone have thoughts of PK vs HT???

[ckarabin]

HT is much smaller but very profitable. They also seem to be willing to trade in hotels more too. Lately because book is so much higher than the stock, they have been selling off a few hotels at the higher market value and then buying back shares at well below book. That really increases shareholders equity per share as probably FFO/share too. It really is a no brainer of an investment.

[Edward Kennedy]

My wife and I stay at Hilton Hotels a lot, including NY Hilton. They consistently are good in all respects. We have lots of Hilton points (because HGV timeshare salesman is smarter than me. :-)

[PSPnomore60]

They almost got us too-- but we were able to get out before really getting stuck.

[SchlarbD]

Unfortunately I held on to my Park after the spin-off from Hilton. It has been disappointing investment as though the company has repeatedly talked about acquisitions so far as pointed out in this article it has disposed of 12 properties. The stock price has underperformed. No acquisitions yet but hopefully they will move up to more luxury properties as management has promised.

I would take issue with PK being a purely luxury and high end properties holding company. PK certainly owns some amazing properties. Breaking down the properties that are not premium PK owns 21 airport properties which 9 are Double Tree, 2 Embassy Suites and 2 Hilton Garden Inn Hotels. PK owns a total of 11 Double Tree, two it calls resort properties, one resort property in Durango, Co and one resort property in California. 7 Embassy Suites and 2 Hilton Garden Inn Suites and 1 Hampton Inn in Memphis, Tn. certainly not high end luxury hotels.

This article does not really make it clear that PK only owns 55 properties not 67 though it does point out 12 were disposed. An uninformed reader might have thought PK previously owned 79 properties. The article would further lead you to believe that all hotels are high end when they own 30 properties that are certainly not leaving just 25 that are really high end properties. The article does not address the one property in Puerto Rico the Caribe was heavily damaged during the Hurricane and will be out of service for 2018.

The author states when you invest in Park you are essentially investing in the premium Hilton brand. Certainly PK does own some but the majority are not.

Just wanted to give some insight as a investor who has been following PK. I am close to selling PK as even the website of PK misleads investors to believe all properties are high end. Hampton Inn in Memphis definitely not. Double Trees are not either. I have stayed in many!! Further the disposal of 12 properties is going to lower the bottom line plus the Caribe is an added liability for 2018. After reading my article I will sell.

[Orphan Brigade]

Thanks for the information. I agree that not all their properties are "high end" however if they perform well then that is a plus and ok with me. Hampton Inns, Embassy Suites and Hilton Garden properties are focused on a particular customer base and business travelers who looking for a clean place to stay with quick access and maybe a decent breakfast. I have stayed in the Hampton Inn in Memphis, it was fine. I have also stayed in three of four of their high end properties and everything was spot on..

As long as PK remembers that the quality of service and value for a nights stay remain in their crosshairs they will do fine. JMHO..

[Arimnestos]

Agreed on the luxury hyperbole, but SA writers in general and Brad in particular use a lot of language they pull right off the company website. IIRC, he said the same thing about CLDT's portfolio and they are all limited service hotels, not even close to "luxury" as far as I am concerned. I would go a step further on PK and say, none of their assets are luxury quality. Doesn't mean they are not good assets though. I like that they are selling off the lesser quality assets and those with limited service flags. They were saddled with the entire portfolio and need to cull the garbage and add some better assets with the proceeds. Long PK

[SchlarbD]

I hope you are wrong about authors simply copying off the website. Certainly it is better to interpret the information. Disappointed how this article would have you believe the fluff of the companies website of being a only high end luxury hotel when it owns about 30 properties that are clearly not. The article also really does not make it clear that PK has 55 hotels now and only 32,000 rooms since the disposal of 12 properties. Pretty significant reduction bound to hit the bottom line. Also no mention of Caribe Puerto Rico property out for all of 2018 because of being virtually destroyed by the Hurricane. Really do not see how the author can see this a strong buy. Hope PK will start making acquisitions that more fit the billing from it website “Our portfolio consists of 55 premium-branded hotels and resorts with over 32,000 rooms located in prime U.S. and international markets with high barriers to entry” Certainly some are but many are not!!

[troon55]

If HNA is selling their shares at $25.75, why is it a buy at $26.74 ?

[Choosh]

The commoners never get to buy any of the secondary offerings at the stated prices, that lovely discount is scooped up by the usual privileged suspects...board members, banks.

If you have an idea when the next recession is coming, plan to get out of PK safely before then as this it will be one of the worst types of stocks to hold and there is no room for timing errors.

[Orphan Brigade]

Hard to predict that one...

[Vandooman]

Not sure that makes sense. If dividend coverage has excess room you will still get a good dividend. Interest rates fall in a recession which makes the dividend more valuable. In any case the last recession was not normal so it means very little. We do not have a huge asset bubble with enormous housing projects in the desert. I made money out of the last recession, lots of it. When blood is in the streets you back up the truck.

[2bears]

Article is a day late and dollar short.

[pscalare]

doug:

Not a cut. $0.55 was a special event, normal dividend has been $0.43 since the beginning.

[northgoingzax]

quarterly

[Orphan Brigade]

Thanks, much appreciated