The extraordinary conditions we've seen in the equity markets in the past three months have produced some truly jaw-dropping moves in certain stocks. Investors feared the worst back in March for many companies, but those fears have subsided as there is an indication that we've got a path back to a new normal from COVID-19. However, I think some stocks traded lower quite justifiably, and have rebounded too quickly. One such stock is hotel and resort owner Pebblebrook Hotel Trust (NYSE:PEB), which has seen its shares triple from the March panic bottom. While I think Pebblebrook will survive, what exactly it will look like when this is over remains to be seen, and the stock is pricing in too much.
First, some good news
To be clear, I like Pebblebrook's approach to lodging. It buys desirable properties, reimages them, and then reaps the rewards. Pebblebrook built an impressive slate of hotels and resorts over the years, with a unique mix of different types of lodging.
Source: Investor presentation
The trust gets about two-thirds of its EBITDA from its portfolio of 40 urban hotels that are generally in desirable travel locations. These are "soft-branded" hotels, meaning they appear to the consumer as a boutique, bespoke hotel and can generally charge quite favorable rates.
The remaining third of EBITDA comes from a combination of luxury resorts that are in coastal settings in the US, as well as six major brand hotels that would seem more like a traditional, mainstream branded hotel to the consumer.
Overall, Pebblebrook has built a strong upscale portfolio of accommodations that have worked well over the years. Its properties are very valuable, and generate strong levels of returns under normal conditions.
Speaking of strong returns, the below slide details what I'm on about.
Source: Investor presentation
Pebblebrook's portfolio was built to be upscale and therefore, to charge more per room and generate strong profits. It has done just that as the entire portfolio generated average daily rate of $258 in 2019, with revenue per available room at $212, and EBITDA per room of 32%, or $36k. All of those numbers are well in excess of peers because Pebblebrook has been a superior operator in the past, controlling costs while maximizing the combination of occupancy and room rates.
Pebblebrook is also somewhat diversified geographically, although it does have a significant reliance upon the California market.
Source: Investor presentation
Three of the trust's largest markets by EBITDA generation are in California, with Boston being the only market that isn't on the West Coast to crack the top-4. While I'd hope for a bit less reliance upon a relatively small area, Pebblebrook has proven this can work over time.
Now, some not-so-good news
While I respect the portfolio Pebblebrook has built, and its ability to operate that portfolio at its peak, I'm pretty concerned about the trust's future given the way the stock is priced today. Obviously, the COVID-19 crisis has upended the trust's business model, as it has for every other travel-related entity, so Pebblebrook isn't alone. However, with it being a pure-play on luxury lodging, I cannot help but wonder how long it will take to get back to prior levels, if it will happen at all.
The trust has taken many actions in the wake of COVID-19 to preserve cash, including cutting the dividend to a token payout of one penny per quarter per share, as well as reducing G&A costs.
Source: Investor presentation
You can read the list but essentially, Pebblebrook went into crisis management mode back in March, closing hotels and resorts and slashing costs and cash expenses wherever possible. Given these actions, the trust will survive COVID-19, so the question of whether or not it will survive has been taken care of.
The problem is that the economic situation we're in is far from ideal for an operator of luxury travel destinations. First, airline travel is still a small fraction of what it was as people aren't traveling as they used to for obvious reasons. In addition, even when we return to normal, whatever that ends up being, we have no idea if planes will be allowed to be full, or what other precautions we may be forced to take as consumers.
Second, nearly 40 million people have become newly unemployed since the crisis began, and I have to think traveling to a luxury hotel isn't high on the list for people that are simply trying to make rent payments and keep food on the table. While many of these unemployed wouldn't have necessarily been Pebblebrook customers anyway, I have to think some people that were on the margins are now firmly in the camp of not being able to travel as they would have otherwise wanted.
This becomes more of an issue because Pebblebrook's per-key profitability began declining years ago and hasn't recovered.
Source: Investor presentation
EBITDA per key was nearly $39k in 2016, and has been lower for each of the past three years, with 2020 certainly set to be another year of decline. I'm sure we'll see a rebound in 2021 as some sort of normalcy returns, but to what level? Pebblebrook was struggling to even maintain per-key profitability in recent years, let alone increase it, and COVID-19's aftermath will only make this more difficult. Pricing power will become more challenging as fewer people travel, occupancy will be more difficult to maintain, and I have to believe that additional cleaning procedures will need to be in place to maintain a safe environment. All of this adds up to reduced profitability per room, which is something Pebblebrook simply isn't pricing in today.
The bottom line
Without COVID-19, Pebblebrook was struggling to maintain its profitability, which resulted in essentially flat FFO-per-share for the past few years. However, with the impact of COVID-19, Pebblebrook is slated to have a very long road to recovery, and I see the stock as pricing in far too much optimism today.
Source: Seeking Alpha
Analysts have the trust posting a small loss this year, which certainly sounds reasonable given its hotels and resorts were operating at very limited capacity, or not at all for months. However, the recovery is what I find very interesting, as even if we look out to 2024, FFO is just barely cresting $2 per share. That's lower than what the trust produced last year, and it is years from now.
The reasons I've laid out above are why I believe Pebblebrook will struggle to achieve $2 in FFO-per-share again, and why the dividend may take some time to return.
Pebblebrook made $2.63 in FFO-per-share last year, and traded for about $26 before the crash. We can therefore deduce that ~10 times FFO is a fair price for Pebblebrook, so it stands to reason that the current share price of $17 is pricing in ~$1.70 of FFO-per-share. Pebblebrook isn't expected to earn that much until 2022 or 2023, meaning shares are already pricing in two years of profits or more that may or may not occur. That's not a chance I'm willing to take for all the reasons I laid out above.
With essentially no dividend, and the stock pricing in a very quick recovery in FFO that I simply don't believe is reasonable, Pebblebrook is a sell.
