cibc analyst : target US$ 0.75The Second Time Isn’t Always The Charm
Our Conclusion
HOT reported Q3 results that likely provided more questions than answers, as waning operating fundamentals and an overstretched balance sheet forced the REIT to embark on a plethora of strategic initiatives. In light of the current economic environment, the REIT has decided to suspend the distribution for the second time since the onset of COVID, citing higher operating expenses, a decline in occupancy (which we expected), and elevated inflation and interest rates as factors increasing the risk of business and consumer demand. While the immediate steps taken to de-lever and bolster the balance sheet may appear to be steps in the right direction, the solutions will likely result in a long and arduous path before we see the REIT in a position to comfortably re-institute its distribution. We expect investor sentiment surrounding HOT to be tempered for the foreseeable future, and when coupled with declining operations (and potential for a higher-for-longer rate environment), we maintain our Neutral rating and decrease our NAV estimate to US$2.50 (from US$3.50) and our price target to US$0.75 (from US$2.25) on a 50 bps increase in our utilized cap rate, implying a discount to NAV consistent with the one last observed at the time of HOT’s distribution cut during the pandemic.
Key Points
Earnings Update: While headline diluted FFO per unit was an impressive $0.17, this figure included non-recurring insurance proceeds of $5.4MM; adjusting for this puts FFO/unit at a more modest and in-line $0.11.
Balance Sheet And Liquidity: Liquidity for the quarter was ~$32.4MM. We note, however, that as of November 7, 2023, the available borrowing under HOT’s revolving credit facility was decreased to zero in accordance with the Sixth Amendment until new appraisals on the REIT’s hotel properties are available later in the month. D/GBV was 51.1% (-150 bps) and, in our opinion, likely to increase upon the receipt of updated hotel property values.
Debt Rolls: HOT has ~$289MM of debt maturing through 2024 (~45% of its total debt stack) with a portfolio weighted average intern rate of ~4.56%. Additionally, while the REIT may currently have ~91.7% of its debt fixed, effective November 30, 2023 two interest rate swaps are set to expire, resulting in the percentage of HOT’s fixed rate debt decreasing to 71%, with expected incremental annual interest expenses increasing by ~$5.2MM (based on a 5.3% SOFR). The REIT plans to address near-term maturing debt by divesting non-core properties, in addition to refinancing hotels within its Virginia portfolio.
Distribution Update: HOT announced the temporary suspension of its distribution, which is expected to provide an additional $14.2MM of cash annually to strengthen its balance sheet and to provide liquidity to address part of its near-term debt obligations.
Q3 Update: Addressing A Plethora Of Challenges
Operating Results: HOT reported mixed operating results; rising costs continue to place downward pressure on operating margins. While SP-ADR increased 3.1% to $133 during the quarter, the REIT reported a ~220 bps decline in SP-occupancy (71.5%) as a result of lower demand at its extended stay and select service properties. Preliminary results for October also indicate that occupancy is ~130 bps below Q3/22 levels, with current demand expected to continue through Q4/23. On the cost front, SP-NOI margins continue to be hampered by rising operating costs as a result of inflation and labor shortages, in addition to the use of an external labor force. Management expects to focus on continuing to reduce its labor costs, expected to remain elevated in 2024, by focusing on hiring in-house staff. SP-NOI margins as a result compressed to 30.6% (-270 bps) when compared to Q3/22.
Amendment Of The Master Hotel Agreement: HOT entered into an amendment agreement with One Lodging Management LLC to defer or reduce the management fee collected on certain hotel properties for an approximate annual savings of ~$3.7MM through June 30, 2026. We note, however, that fees incurred from 2027 through 2032 will be higher, to offset the fee deferrals received in the first three years of the agreement.
Amendment To Credit Facility: On November 7, 2023, HOT entered into an amendment of its revolving credit facility (RVF), extending the maturity to December 3, 2024, with an option to further extend the maturity to 2025 subject to a reduction of the maximum facility size to $148.2MM. Pursuant to the Sixth Amendment, the RCF will be limited by revised calculations on its DSCR and LTV tests, requiring new hotel appraisals in determining its borrowing base. The borrowing base has since been reduced to a maximum LTV of 67.5%, with time permitted to reduce any outstanding amounts should the current borrowings exceed 67.5% LTV. Additionally, further covenants have been imposed and revised to the satisfaction of more restrictive FFO payout ratios and sliding coverage ratios (a DSCR floor of 1.3x increasing to 1.45x by 2025, and fixed charge coverage floor of 1.1x increasing to 1.25x by 2025). HOT is also required to maintain a Tangible Net Worth of no less than $500MM, and a max variable rate indebtedness ratio of 0.3x. FFO payout ratio restrictions for restricted payments are capped at 20% if the fixed charge ratio is <1.25x, and 50% if >1.5x.
Valuation – Where Do We Go From Here? Upon the announcement of the suspension of its distribution, HOT units are down ~40% for the day (~70% YTD), as the REIT focuses on shoring up its balance sheet and handling near-term debt obligations. With all the restrictions in place, we do not see a situation in the foreseeable future where the REIT can re-introduce its distribution comfortably, and with an investor base composed of largely income-oriented investors, we believe the units may continue to trade at depressed levels for the near term. In the absence of a strong valuation argument, and in light of the pre-existing conditions, we derive our price target by applying a discount to NAV last seen at the time of HOT’s last distribution cut (~70% discount to NAV).