RLJ Is Pricing In A Recovery That May Not Materialize
Summary
- RLJ shares are well off their recent high, but not enough.
- The dividend has been essentially eliminated, and the valuation is pricing in a speedy recovery.
- With the stock at or above fair value, and so much uncertainty in lodging's recovery, RLJ is a sell.
The recent action that has taken place in the lodging REIT market has left me a bit puzzled, if I'm honest. Stocks of trusts that have seen demand collapse to essentially nothing in recent months have recovered strongly in a lot of cases, although I have to admit I don't understand why.
One such stock is RLJ Lodging Trust (NYSE:RLJ), a hotel REIT that has been suffering along with its peers for the past three months. Shares reached $15 just a couple of weeks ago, or less than $3 from their pre-crash high, indicating that investors think the worst has come and gone. While shares have traded back down to $10, even at that price, I fail to see how RLJ represents value today. At best, it is fairly valued. However, I can see how things could deteriorate more longer-term for lodging, so I think investors should take what they can get and sell RLJ.
Assessing the damage
The first thing to do when looking at a REIT today is to assess the damage from COVID-19. Depending upon the specific type of real estate a REIT owns, damage could be anywhere between minimal and devastating. One sector I'd put firmly toward the latter end is lodging, as travel collapsed in March and hasn't recovered. In addition, we don't know when people will be able to travel as they once did, if they'll be willing to, or if the 40+ million recently unemployed Americans will even be able to afford to travel even if they are allowed. These are huge variables for lodging, and none of them look particularly favorable at the moment. In my view, therefore, RLJ is leveraged to exactly the wrong type of real estate for this year, and potentially beyond.
Source: Investor presentation
The good news is that the trust has taken the necessary action to ensure it survives this crisis and lives to fight another day. The trust suspended operations early on in the crisis at 57 of its hotels, while the others operated with reduced capacity and amenities to conserve costs. It has also postponed substantially all of its capex that was planned for this year, implemented cost savings initiatives, suspended share repurchases, and nearly eliminated the dividend. Finally, it drew down $400 million of additional liquidity from its line of credit. All of these actions add up a trust that has done what is necessary to ensure its survival, which is a good thing. However, just because RLJ will survive, that doesn't make it a buy at this price.
Source: Investor presentation
The trust believes it is burning through ~$30 million in cash every month it is operating in crisis mode, so it has ample liquidity to survive a very prolonged shutdown from COVID-19. I don't see any reasonable scenario where RLJ would run out of cash, but keep in mind that this crisis is damaging the balance sheet. Surviving is one thing; being in strong operating condition afterwards is something entirely different. After all, "liquidity" in this case just means additional debt, which needs to be serviced and then paid back at some point, or refinanced. This isn't free money, and its costs will be long-term, not a short-term event.
On the plus side, RLJ's busy 2019 positioned it quite well for the long-term, before the COVID-19 outbreak in the US.
Source: Investor presentation
The trust sold significant assets, generating $720 million in proceeds, and simultaneously improving its balance sheet and its portfolio metrics. This turned out to be exactly what the trust needed to do given a crisis was coming, so the timing on these divestitures was extremely fortunate. What RLJ is left with is a stronger, smaller portfolio, and a lot more cash than it otherwise would have had.
Source: Investor presentation
With no debt maturities until 2022, and a below-peer leverage profile, RLJ positioned itself well with its 2019 class of asset divestitures. This will not only help RLJ survive the crisis, but potentially rebound more quickly as well. However, it appears to me that the stock, even after declining by nearly a third in recent weeks, is pricing all of this in, and then some.
The bottom line
We know that 2020 is going to be a disaster for profitability in the lodging sector among others. When all is said and done, we will have had at least three months of reduced or no capacity in the industry, and likely reduced demand for months after reopenings are allowed. With at least some social distancing protocols likely to become semi-permanent, like reduced seating capacity on airplanes as an example, I have to imagine travel-related entities like hotels will continue to suffer long after the reopenings are in place. As I see it, however, RLJ shares are pricing in what looks like a return to normal fairly quickly, and I simply don't agree that this stance is reasonable.
Source: Seeking Alpha
Shares trade at 12 times next year's FFO-per-share estimate of 85 cents, and 9 times 2022 estimates. While those aren't sky-high valuations by any means, coming into 2020, estimates were for $1.84 in FFO-per-share on a share price of ~$18 at the beginning of 2020. That suggests the market - under normal conditions - would pay ~10 times FFO for this stock. That's below today's valuation on 2021 earnings, and only slightly above 2022 estimates.
With the stock already pricing in a return to normal as far as I can tell, and the immense uncertainty lodging stocks are facing post-COVID-19, RLJ would need to be a lot cheaper than $10 per share for me to be bullish. With essentially no dividend being paid and a valuation that is pricing in a speedy recovery, RLJ is a sell.
This article was written by
I've been covering financial markets for ten years, using a combination of technical and fundamental analysis to identify potential winners (and losers) early, particularly when it comes to growth stocks.
Analyst’s 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.
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