- Service Properties Trust has seen a lot of pain as a result of the COVID-19 pandemic.
- Even so, the company is holding up fairly well, and it should eventually recover.
- A return to normalcy would imply a nice amount of upside for investors from current pricing, but that could take some time still.
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While many REITs may focus on one type of core asset to invest in, some are more diversified. One example of this is Service Properties Trust (NASDAQ:SVC). Service Properties, in a sense, is really two businesses in one. On the one hand, the firm generates the bulk of its revenue from the hotel properties in its portfolio. However, it also owns several hundred net-lease retail properties that tenants fill up. In the years leading up to its 2020 fiscal year, the business fared quite well. However, the COVID-19 pandemic really hurt it, and as a result, there might be an interesting opportunity here for long-term investors. While shares look to be priced toward the cheap end today, if business does return to what it was like in 2019, upside for investors could be quite attractive.
A look at Service Properties
As I mentioned already, Service Properties is kind of like two businesses rolled up into one. On the one hand, you have the 310 hotel properties that it owns and operates. Collectively, these hotels have 49,014 rooms and 13.46 million square feet of space. By investment, these hotels account for 57.4% of the company's portfolio. In addition, it owns 799 net lease retail properties. These comprise the remaining 42.6% of its portfolio by investment. At present, the company has assets located in 47 US states, plus Washington DC, Puerto Rico, and Ontario, Canada. However, 11% of its investments are concentrated in California. 9% are concentrated in Texas. And 6% are located in both Georgia and Illinois.
*Taken from Service Properties Trust
On the hotel side of the equation, 168 of the firm's properties are branded as Sonesta hotels. This works out to 15.1% of their properties, but to 37.1% of their value by investment. On the retail side, the company's largest tenant is TravelCenters of America. Properties under this name makeup 12.1% to the company's overall properties, but 18.8% of its investments. Outside of hotels and travel centers, the business is fairly diversified. Its next largest category are quick service restaurants, which accounted for just 2.6% of its investments.
There's no denying that 2020 was a painful year for Service Properties. Revenue at the business came in at just $1.27 billion. This represents a decline of 45.4% compared to the $2.32 billion that the company generated a year earlier. To put this in perspective, the business had been seeing an uptrend in its revenue, as demonstrated by the fact that revenue in 2018 was $2.29 billion. Essentially all of this pain though, came on the hotel side of the business. Revenue there tanked by 56%. But on the retail side, revenue actually managed to grow 21%.
Just as revenue dropped during 2020, so too did operating cash flow. According to management, this metric came in at $37.60 million in 2020. This compares to $617.72 million in 2019, and $596.95 million the year before that. The company's normalized FFO, or normalized funds from operations, also took a beating. Between 2018 and 2019, this figure grew from $605.71 million to $620.66 million. However, in 2020, it plummeted to $201.96 million. This was driven in large part by the fact that the hotel's occupancy rate dropped from 73% in 2019 to 42% in 2020. Such asset intensive properties will see cash flows contract much more rapidly than revenue during tough times like this. It is important to note that we can see a similar trend, though far less severe, when looking at the company’s EBITDA. In 2018, this figure was $805.30 million. And this grew to $851.43 million in 2019. However, in 2020, this figure declined to $515.87 million.
When it comes to valuing the firm, these significant disparities create the question of what is the right period of time to compare the company’s metrics over. A case could be made that once the business recovers that it should look a lot like it did in 2019. In short, 2020 would be considered a one-time event. I feel like this is the most appropriate approach in valuing the firm. Sticking with this, I calculated that the company is currently trading at a market capitalization to operating cash flow multiple of 3.4. If, instead, we were to use its 2020 figure, the metric would be an astronomical 56.4. Its market capitalization to FFO multiple is also 3.4, while if we used the 2020 figure, it would be 10.5. These 3.4 readings are incredibly low no matter how you stack them, and it goes to underscore just how scared of this space investors are. Meanwhile, the company’s EV to EBITDA multiple is 9.7, which is far lower than the 16 it would be if we used its figures from 2020.
To see how shares of Service Properties stack up, I decided to compare the company to the top five highest ranked REITs that are similar to it as laid out by Seeking Alpha’s Quant platform. What I found is that on a price to operating cash flow basis, only one of the five was priced lower than what Service Properties is trading for today. On an EV to EBITDA basis, meanwhile, the lowest firm’s multiple was 19.18. This is nearly double what Service Properties is trading for at this moment. Some of this disparity may be chalked up to the fact that the company’s net leverage ratio is a lofty 7.2 as of this writing. To help address this debt picture, management is not only focusing on cutting costs but also been willing to sell some assets as well. For instance, in the fourth quarter last year, the company sold 24 properties for a combined $104.3 million. It's a small amount in the grand scheme of things, but every little bit helps.
Based on all of the data provided, it seems clear to me that Service Properties represents a compelling prospect for investors. There's no doubt that the company was hit hard by the COVID-19 pandemic. And it would be surprising if the company fully recovers this year. More likely than not, a 2022 recovery is more probable, and even that is up for debate. What does seem likely though, is that as the business does eventually recover, shares should rise to reflect just how underpriced they appear. It would make me feel a lot better if net leverage were lower, but with that being my only qualm, it's not an awful play for very long-term, value-oriented investors to consider.
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This article was written by
Daniel is an avid and active professional investor.He runs Crude Value Insights, a value-oriented newsletter aimed at analyzing the cash flows and assessing the value of companies in the oil and gas space. His primary focus is on finding businesses that are trading at a significant discount to their intrinsic value by employing a combination of Benjamin Graham's investment philosophy and a contrarian approach to the market and the securities therein. Learn more.
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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