Pebblebrook Hotel: Synergies Expected, But Still Faces Elevated Supply In Several Markets

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About: Pebblebrook Hotel Trust (PEB)
by: Ploutos Investing
Summary

Pebblebrook Hotel operates upper-upscale hotels in several key coastal markets in the United States.

The company has a list of redevelopment projects to grow its EBITDA in future years.

Pebblebrook Hotel pays a 5.4%-yielding dividend.

Investment Thesis

Pebblebrook Hotel Trust (PEB) delivered positive revenue per available room growth in Q1 2019. The REIT has several redevelopment projects that should help it to grow its EBITDA in subsequent years. Pebblebrook Hotel currently pays a 5.4%-yielding dividend. However, the REIT faces elevated supply in several markets. Since hotel industry is cyclical and given the fact that we are now in the latter stage of the economic cycle, investors may want to stay on the sideline.

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Data by YCharts

Recent Developments: Q1 2019 Highlights

Pebblebrook Hotel reported a mixed quarter as it saw its same-property RevPAR increase by 4.3% to $187.76. The increase was driven by a healthy growth of 5.3% of its average daily rate despite a decline of 100 basis points of its occupancy rate. The decline in its same-property EBITDA margin of 40 basis points was primarily due to the increase in real estate taxes related to the California hotels acquired last year. Its decline in adjusted funds from operations per diluted share was primarily due to increase in diluted shares from 69.4 million shares to 131 million shares.

Source: Q1 2019 Earnings Release

What we like about Pebblebrook Hotel and its business

A geographically diversified portfolio in key coastal markets

Pebblebrook Hotel has a portfolio of 60 upper-upscale hotels with over 14,500 rooms located in the key coastal and urban markets of the U.S. As can be seen from the map below, West Coast and East Coast markets represent about 58% and 36% of its portfolio respectively.

Source: June 2019 Investor Presentation

As can be seen from the map, many of Pebblebrook's major markets are important business hubs (e.g. San Francisco, San Diego, Washington DC, Boston, LA, etc.). As such, these markets tend to have higher lodging demand than the national average. In addition, its focus in high tech markets such as San Francisco (20% of its EBITDA) and Seattle (2% of its EBITDA) is advantageous as economic activities in these markets are generally stronger than other regions. This should help support lodging demands.

Merger with LaSalle Hotel should result in synergies

Pebblebrook merged with LaSalle Hotel in December 2018. We view this merger favorably as this transaction doubled the company's size. This should result in significant operating efficiency improvements such as a reduction in G&A expenses as well as increase its purchasing power. In fact, management reported that they expect annualized savings of about $18 million.

Redevelopment and operational efficiency value creation should help grow its EBITDA

Pebblebrook Hotel has an aggressive redevelopment pipeline in 2019. As can be seen from the table below, there are 13 hotels that are under renovation or will begin renovation in 2019. While management expects hotel EBITDA displacement of $8.3 million in 2019, these projects should help grow its EBITDA favorably in future years. Pebblebrook Hotel has done an excellent job redeveloping its properties in the past. As can be seen from the table below, its 2018 development projects are expected to increase its EBITDA by $12.5 million in 2019.

Source: June 2019 Investor Presentation

Strong balance sheet

Pebblebrook Hotel has a strong balance sheet with a well-laddered maturity schedule. The REIT has no significant debt maturities before 2020. It also has a net debt to EBITDA ratio of 4.7x. This ratio is comparable to its peers. About 60% of its debts have fixed interest rates with an average of 3.4%. Its solid balance sheet should provide support to fund its redevelopment projects.

Source: June 2019 Investor Presentation

Valuation

Pebblebrook Hotel expects to generate AFFO of $2.60 to $2.67 per share in 2019. Using the midpoint of its guidance range ($2.635 per share), we have a price to 2019 AFFO ratio of 10.6x. This ratio is comparable to its peer Host Hotels & Resorts' (HST) 10.0x. Given the fact that we are already in the latter stage of the current economic cycle, we do not see much upside on its share price.

A 5.4%-yielding dividend

Pebblebrook currently pays a quarterly dividend of $0.38 per share. This is equivalent to a dividend yield of 5.4%.

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Data by YCharts

Risks and Challenges

Deceleration of Economic growth rate

Hotel industry is cyclical and the prosperity depends on the strength of the economy. Unfortunately, the strength of the U.S. economy is expected to weaken towards the second half of 2019. As can be seen from the chart below, business confidence in the U.S. has declined considerably and dropped by 13.2% in May 2019. This deceleration is not good news for the hotel industry as businesses may cut travel expenses in order to preserve cash.

Source: CEIC Data

Fortunately, U.S. consumer confidence remains at an elevated level. As can be seen from the chart below, U.S. consumer sentiment index of 98.2 in June 2019 remains healthy and well above the average of 86.6 between 1952 to 2019. This elevated consumer confidence level is likely due to the record low unemployment rate in the States. We think the summer travel season will likely stay healthy thanks to the good consumer sentiment. However, if U.S. economy falls into a recession, we suspect consumer confidence index will decline quickly and this may result in poor hotel bookings and lower daily rates.

U.S. Consumer Confidence Index (Source: Trading Economics)

New supply to the market

Pebblebrook Hotel is exposed to supply risk. This is because hotel operators tend to invest and build more hotels during the peak of the economic cycle. By the time these developments reach completion, the economy may reach a downturn. In fact, the REIT continues to face oversupply in several of its markets. In its past conference call, management indicated that its Chicago and west LA markets are currently experiencing higher supplies. This has resulted in declining RevPAR. In west LA, its RevPAR was done 5.1% year over year. In addition to elevated supplies in its Chicago market, a tough winter coupled with a weak convention calendar have resulted in a RevPAR decline of 16.5%.

Investor Takeaway

Pebblebrook Hotel has a quality portfolio of properties in key locations. However, hotel industry is highly dependent on the strength and weakness of the economy. In addition, the company continues to face elevated supplies in some of its markets. Given the fact that we are already in the latter stage of the current economic cycle, we feel investors can continue to wait on the sideline.

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.

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.