American Hotel: Why We Think This 12.9%-Yielding REIT Will Have A Total Return Of 40%

|
About: American Hotel Income Properties REIT LP (AHOTF)
by: Ploutos Investing
Summary

American Hotel REIT owns a portfolio of branded hotels in the United States.

Most of American Hotel’s PIP projects will reach completion by end of 2019.

American Hotel is trading at a significant discount to its peers and pays an attractive 12.9%-yielding dividend.

Investment Thesis

American Hotel REIT (OTC:AHOTF) (TSX:HOT.U) (TSX:HOT.UN) posted an in-line Q1 2019 result. We believe its growth outlook has improved considerably as it is about midway through its project improvement plan projects. In addition, the company’s rebranding of its economy lodges to Wyndham brands is also reaping fruits. We are also seeing signs of improving net operating income margin thanks to its cost containment efforts. The company is currently trading at a significant discount to its peers. It also pays an attractive 12.9%-yielding dividend. We believe there is significant upside and that investors are well-compensated to wait for its business to rebound in 2020.

Chart Data by YCharts

Recent Developments: Q1 2019 Highlights

American Hotel posted an in-line quarter. The company posted adjusted funds from operations of US$0.13 per share. This was the same as last year. While its occupancy rate declined by 110 basis points to 72.4% in Q1 2019, the REIT saw its revenue per available room increased to US$70.46 in Q1 2019 from US$70.23 in Q1 2018. The decline in occupancy ratio was primarily due to room displacement from its PIP projects. However, we are seeing signs of improvement in NOI margin. This suggests its switching of external management team to Aimbridge has started to produce positive impacts. One operating metric we need to pay attention to is the elevated AFFO payout ratio. As can be seen from the table below, American Hotel’s payout ratio (based on past 12-months AFFO) has increased to 98.7% in Q1 2019 from 93.9% in Q1 2018.

US$

Q1 2019

Q1 2018

Occupancy Rate

72.4%

73.5%

Revenue per available room

$70.46

$70.23

NOI Margin %

32.1%

31.6%

Adjusted funds from operations

$0.13

$0.13

AFFO Payout Ratio (TTM)

98.7%

93.9%

Source: Created by author; Q1 2019 MD&A

Growth and Earnings Analysis

Despite elevated payout ratio, we think the worst is about to be over. We expect significant growth to happen in the second half of 2019 for the following reasons:

PIP projects are about half done

One of the main reasons why American Hotel underperformed last year and Q1 2019 was due to its PIP projects. Under the terms of the applicable franchise agreement, American Hotel is required to complete various property improvement plans within 18 to 24 months of the acquisition date. Unfortunately, these PIP projects have created guest displacement and operation interruptions in the past year. In addition, labor shortages have caused some delays in the construction. Together, these have resulted in bumpy top and bottom lines in the past year. The good news is that American Hotel is about halfway completed in its PIP projects. As can be seen from the table below, the company has completed 6 PIP projects with a total of 1,202 guestrooms renovated. There are still 1,485 guestrooms to be renovated.

Hotel Name and Guestrooms

Q1 2018

Q2 2018

Q3 2018

Q4 2018

Q1 2019

Embassy Suites Cincinnati (KY) (227 guestrooms)

Ongoing

Ongoing

Completed

Embassy Suites DFW South (TX) (305 guestrooms)

Ongoing

Ongoing

Completed

Hilton Garden Inn White Marsh (MD) (155 guestrooms)

Completed

Embassy Suites Columbus (OH) (284 guestrooms)

Ongoing

Ongoing

Completed

Staybridge Suites Tampa (FL) (100 guestrooms)

Ongoing

Completed

Residence Inn White Marsh (MD) (131 guestrooms)

Ongoing

Completed

Source: Created by author; Q1 2019 MD&A

The chart below shows the remaining guest rooms to be renovated in 2019. Renovation projects will usually take about 23 quarters to reach completion. As can be seen from the table below, two additional renovation projects (198 guest rooms in total) should reach completion by the end of Q2 2019. In addition, 3 renovation projects (329 guest rooms in total) will reach completion by the end of Q3 2019. This means that only 794 guest rooms out of 2,768 guest rooms will have to go through PIP after Q3 2019. We like the fact that management noted an increase in its average daily rates even at its hotels under renovation. We expect its ADR to improve strongly after these hotels completed the renovations. This should translate into higher revenue in H2 2019 and 2020.

Source: Q1 2019 MD&A

Wyndham rebranding should continue to drive growth in traffic and average daily rates

American Hotel’s rebranding of its Economy Lodging Hotels (mostly rail hotels) under Wyndham brands (Travelodge, Days Inn, and Super 8) has resulted in positive benefits. The company’s Wyndham rebranding initiative continues to drive more non-rail crew customers. In fact, its RevPAR grew by 6.7% year over year thanks to higher occupancy. This is much better than STR’s forecast of RevPAR growth rates of 2.3%. American Hotel’s Economy Lodging Hotel’s ADR also grew by 4.3% year over year.

Operating costs containment

In 2018, American Hotel officially switched hotel management responsibilities for all of its hotels to Aimbridge Hospitality from One Lodging Management. Aimbridge's experience to implement new technologies and improve its operating efficiencies should result in margin expansion. After nearly 1 year of switching we are seeing positive signs such as operating cost containment and NOI margin expansion. As can be seen from the table below, American Hotel’s total expenses declined to US$54.7 million in Q1 2019. This was a decline of 1.3% from Q1 2018’s US$55.4 million. Not only has American Hotel reduced its total expenses, but its NOI margin also expanded by 50 basis points to 32.1% in Q1 2019.

Source: Q1 2019 MD&A

Valuation at a deep discount

We estimate American Hotel to generate about US$0.63 per share of AFFO in 2019. This means that it is currently trading at a price to 2019 AFFO ratio of 7.98x. On the other hand, its U.S. hotel REIT peers are trading at average price to 2019 AFFO ratio north of 10x. Therefore, we think American Hotel deserves higher valuation especially given the growth potential after the completion of its PIP projects. If its valuation improves to 10x of its price to 2019 AFFO ratio, its shares would trade at US$6.3 per share. If American Hotel can execute its PIP projects according to the time schedule it laid out, its valuation may improve towards the end of 2019. Together with its dividend yield of nearly 13% (dividend of US$0.65 per share annually), its total return would be nearly 40%.

Chart Data by YCharts

Risks and Challenges

Shortage of labors and rising wages can result in higher operating expenses

Shortage of labor was one of the reasons why some of American Hotel’s PIP renovations got delayed. In addition, rising wage expenses may cause a significant increase in the company’s operating expenses especially given the fact that U.S. unemployment rate of 3.6% is at its lowest since 1969.

Hotel industry is highly cyclical

Investors should keep in mind that the hotel industry is highly cyclical. This means that in an economic recession, American Hotel’s revenue may be impacted negatively. This is because business activities will be reduced and consumers will cut their leisure spending. In such condition, its bottom line will be impacted negatively. As a result, its payout ratio will spike over 100%. If a recession prolongs, management may be forced to cut its dividend.

Investor Takeaway

American Hotel currently pays an attractive 12.9%-yielding dividend. Its shares are also trading at a significant discount. We believe investors are well compensated to wait for the share price to appreciate in the next year. Even if its shares slid for another 10% in the next 12 months, the company’s 12.9%-yielding dividend will be able to help offset this downside risk. We like its current risk/reward and believe it is a good buy. However, if you believe an economic recession is imminent, you may want to take a wait and see approach.

Additional Disclosure: This is not financial advice and that all financial investments carry risks. Investors are expected to seek financial advice from professionals before making any investment.

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 (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.