Service Properties Trust (SVC) 2017 Q2 法說會逐字稿

Good morning, and welcome to the Hospitality Properties Trust Second Quarter 2017 Financial Results Conference Call. (Operator Instructions) Please note, this event is being recorded.

I would now like to turn the conference over to Katie Strohacker, Senior Director of Investor Relations. Please go ahead.

Thank you, Gary, and good morning. On today's call, John Murray, President; and Mark Kleifges, Chief Financial Officer, will make a short presentation, which will be followed by a question-and-answer session with analysts. Please note that the recording, retransmission and transcription of today's conference call is prohibited without the prior written consent of HPT.

I would like to point out that today's conference call contains forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995 and other securities laws. These forward-looking statements are based on HPT's present beliefs and expectations as of today, August 9, 2017. The company undertakes no obligation to revise or publicly release the results of any revision to the forward-looking statements made in today's conference call other than through filings with the Securities and Exchange Commission, or SEC.

In addition, this call may contain non-GAAP financial measures, including normalized funds from operations, or normalized FFO. A reconciliation of normalized FFO and adjusted EBITDA to net income, as well as components to calculate AFFO, are available in our supplemental package found in the Investor Relations section of the company's website. Actual results may differ materially from those projected in these forward-looking statements.

Additional information concerning factors that could cause those differences is contained in our Form 10-Q to be filed later today with the SEC and, once again, in our supplemental operating and financial data found on our website at www.hptreit.com. Investors are cautioned not to place undue reliance upon any forward-looking statements.

And with that, I'll turn the call over to John.

Thank you, Katie. Good morning, and welcome to our second quarter 2017 earnings call. Earlier this morning, we reported second quarter normalized FFO of $173.6 million, an increase of 4.8% compared to $165.7 million reported in the second quarter of 2016.

On a per share basis, normalized FFO of $1.06 per share represents a 2.8% decrease compared to the $1.09 per share in the 2016 quarter due to a higher outstanding share count, a result of our August 2016 common share offering.

Second quarter results for HPT's 199 travel centers reflected a $2.2 million or 2.7% increase in fuel margin as increased cents per gallon diesel fuel margins offset slightly weaker diesel gallons sold compared to the 2016 quarter. Nonfuel gross margin increased $4.7 million or 2.1%, led by improvements in the stores, quick service restaurants and repair shops.

Property level rent coverage for the quarter was 1.62x, approximately flat with the 2016 quarter. A strong result considering HPT's rent increased 5.2% compared to the 2016 quarter due to increased investments.

Turning to hotel investments. HPT's second quarter 2017 comparable RevPAR declined by 0.3% as various factors, including increased supply and market weakness negatively impacted results. Comparable GOP margins declined by 112 basis points versus the 2016 quarter to 43.8%, reflecting lower group business and increased wages and travel agent commission.

Aggregate coverage of annual minimum returns and rents at all of our hotels declined to 1.26x this quarter from 1.34x in 2016. Our primarily upscale and mid-priced hotel portfolios' performance this quarter fell short of industry RevPAR improvement due to room supply growth, market-specific factors negatively impacting demand, particularly in Houston and San Francisco, and renovation.

Our comparable Sonesta portfolio had the strongest revenue growth this quarter with RevPAR increasing by 5.4%, a comparable hotel GOP margin improvement of 79 basis points versus the second quarter of 2016. Growth was led by our ES Suites' portfolio and the continued postrenovation ramp-up at the 11 most recently acquired hotels. The 14 original ES Suite hotels also grew RevPAR at above the industry levels.

Full-service performance was impacted by weakness in our Houston, Atlanta and New Orleans hotels.

Our Carlson portfolio reported above industry revenue growth this quarter with RevPAR increasing by 2.8%, led by rate growth of 7.1%, offset by occupancy declines of 3 percentage points. Once again, Carlson was successful in replacing low-rated accounts with higher-rated business and this drove the portfolio results. GOP margin percentage increased by 74 basis points and cash flow available to pay a minimum return increased by 3.3% versus the 2016 quarter.

Our Marriott No. 1 Courtyard portfolio had the weakest revenue performance this quarter with RevPAR decreasing by 4.4%, driven by rate and occupancy declines of 1.4% and 2.3 percentage points, respectively. GOP margin percentage declined 271 basis points. Headwinds associated with increased supply, renovations and declines in corporate negotiated business continued to negatively impact results. Nonetheless, this portfolio is among our best-performing hotel portfolios with coverage of 1.28x for the last 12 months.

Our Wyndham portfolio second quarter RevPAR declined 3.9% as a 3.8 percentage point decline in occupancy more than offset 1% growth in rate. Full-service results led to the decline as renovations and supply growth impacted hotels in New Jersey, Houston, Dallas and Irvine. The Hamilton Park Hotel completed renovations in April and began improving in May and June. We expect this hotel's performance will continue to improve for the remainder of this year as group sales grow. Wyndham's GOP margin percentage declined by 108 basis points.

IHG's comparable hotel RevPAR increased 0.4% this quarter with a 1% increase in rate, offset by a 0.5 percentage point decrease in occupancy versus the year ago quarter. IHG's full-service hotels outperformed the extended-stay hotels due to occupancy and rate gains due to growth in the transient segment. For the extended-stay portfolio, increased supply impacted certain hotels this quarter, particularly in Houston, Austin and Chicago. Tough comps related to last year's Porter Ranch gas leak also negatively impacted results.

On a positive note, our Crowne Plaza Denver completed renovations in the second quarter and performance is ramping up well.

Across property types, performance was best at our 168 comparable extended-stay hotels, where RevPAR increased 1.1% with a 0.9% increase in rate and a 10 basis point increase in occupancy. RevPAR at our 42 comparable full-service hotels increased 0.4% with a 2.2% gain in rate, offset by a 1.4 percentage point decline in occupancy. Full-service performance reflects the market conditions in Houston and San Francisco and renovations at the Wyndham Hamilton Park Hotel. RevPAR at our 95 comparable select-service hotels was down 2.8% and margins decreased by 214 basis points, due primarily to our Marriott Courtyard hotels, which I already discussed.

Turning to transaction activity. In May, as previously reported, we acquired a newly developed travel center located in Columbia, South Carolina for $27.6 million. We added this Petro branded travel center to our TA No. 4 lease.

In June, we acquired the 389-room Chase Park Plaza Hotel in St. Louis, Missouri for $87.6 million. We rebranded this hotel to a Royal Sonesta and added it to our management agreement with Sonesta. The Royal Sonesta Chase Park Plaza is located in St. Louis' west end across from Forest Park and next to the Barnes-Jewish Hospital complex. It is arguably the nicest hotel in St. Louis.

Also in June, we acquired the 495-room Crowne Plaza Ravinia Hotel in Atlanta, Georgia for $88.6 million. We added this hotel to our management agreement with InterContinental and we obtained a security deposit of $7.1 million in connection with this purchase. This Crowne Plaza Hotel is across the driveway from IHG's Americas headquarters and will become 1 of the brand's flagship locations.

Lastly, we acquired the 419-room Crowne Plaza & Lofts Hotel in Columbus, Ohio for $49 million. We added this hotel to our management agreement with InterContinental. And in connection with the planned renovation for this hotel, we plan to brand the Lofts as an Indigo.

In July, we entered into an agreement to acquire the 300-room Crowne Plaza Charlotte Executive Park Hotel in North Carolina for $44 million. We expect to complete this acquisition during the third quarter and add this hotel to our management agreement with InterContinental. Also in July, we entered into an agreement to acquire 14 extended-stay hotels with 1,653 suites located in 12 states for $138 million. We currently expect to complete this acquisition during the third quarter of 2017 and plan to convert these hotels to the Sonesta ES Suites brand and add them to our Sonesta management agreement.

Turning to disposition. HPT and Carlson have agreed to sell 3 hotels that as of June 30 had an aggregate carrying value of $14.1 million. In July, we entered into an agreement to sell the 143-room Country Inn & Suites located in Naperville, Illinois for $6.6 million. We currently expect to complete this sale during the third quarter.

Last week, we sold the 159-room Radisson Hotel in Chandler, Arizona for $9.5 million. We are currently negotiating an agreement to sell the Park Plaza Hotel located in Bloomington, Minnesota. The sale proceeds from these transactions will be deposited in the FF&E reserve to fund renovations planned for the other hotels in this portfolio.

In addition, we've agreed to provide up to $35 million of owner funding for renovations if requested.

HPT's minimum returns will not be reduced in connection with these sales and our returns will increase as the new $35 million of renovation funding takes place.

Looking ahead, we and our hotel operators are hopeful the cautious optimism we had at the start of 2017 may yet prove warranted. However, the weaker-than-expected first half results, coupled with continued supply growth and isolated market weakness, appear likely to continue to impact occupancy levels and ADR growth in certain portfolios. As a result, our managers have adjusted their forecasts, resulting in expectations for hotel occupancy to remain relatively flat, with modest increases to rate such that RevPAR growth may be closer to 0.5% to 1% compared to the 1.5% to 2.5% projected at the start of the year. GOP margins are now forecasted to be in the flat to down 50 basis points range, reflecting slower revenue growth and continued cost pressures, especially from wages and travel agent commissions.

I'll now turn the call over to Mark.

Thanks, John. Starting with the performance of our travel center investments. An improved fuel pricing environment and continued growth in nonfuel revenues in the 2017 second quarter resulted in an increase in property level operating results from the 2016 quarter. For the quarter, fuel gross margin for our travel centers increased $2.2 million or 2.7% versus the prior year quarter as a result of a 4.7% increase in per gallon fuel margin, offset somewhat by a 1.9% decrease in fuel gallons sold. Nonfuel revenues increased 1.4% versus the prior year due primarily to higher truck repair and convenience store sales. Our travel centers grew nonfuel gross margin 2.1% versus the prior year at $230.1 million which accounted for approximately 73% of the total gross margin dollars of our travel centers in the quarter.

Site-level operating expenses increased 1.4% versus the prior year due to an additional $2.8 million in fuel card transaction fees, which are the subject of pending litigation between TA and the fuel card provider. Excluding these additional fees, site-level operating expenses were approximately flat versus the prior year. As a result of these changes, the second quarter property level EBITDA of our travel centers increased by $4.2 million or 3.9% compared to the second quarter of 2016. The annual minimum rent under our travel center leases remains well covered at 1.62x for the second quarter and 1.52x for the 12 months ended June 30.

Operating results at our comparable hotels were generally soft this quarter, with RevPAR down 0.3%, a 112 basis point decrease in GOP margin percentage and the decline in cash flow available to pay HPT's minimum returns and rents of 3.5%. The 0.3% decline in RevPAR this quarter resulted from ADR growth of 0.8%, offset by a 0.9% decline in occupancy.

The portfolios with the highest RevPAR growth this quarter were our comparable Sonesta, Carlson and Hyatt hotels, with increases of 5.4%, 2.8% and 0.6%, respectively, versus the prior year quarter. In regards to our comparable Sonesta hotels, RevPAR was up 31% at the 11 ES hotels that completed renovations during 2016. RevPAR increased 3.9% at the remaining 21 comparable Sonesta hotels.

Our Marriott No. 1 and Wyndham portfolios experienced RevPAR declines of 4.4% and 3.9%, respectively, versus the prior year quarter due to a combination of increased supply, corporate demand softness in certain markets as well as the impact of renovations.

GOP margin percentage for our comparable hotels decreased 112 basis points from the 2016 quarter to 43.8%. Of our portfolios, Carlson and our comparable Sonesta hotels had the highest increases in GOP margin percentage in the quarter, up 74 and 79 basis points, respectively, versus the 2016 quarter, while Marriott No. 1 and Hyatt had the weakest margin performance in the quarter with gross operating profit margin percentage down 271 and 161 basis points, respectively, versus the 2016 quarter.

Gross operating profit for our comparable hotels decreased approximately $7.2 million or 3.2% from the 2016 second quarter. The decline in gross operating profit was partially offset by a 2.4% decrease in below the GOP line deductions, resulting in a $5.8 million or a 3.5% decrease from the 2016 quarter in cash flow available to pay our minimum returns and rents for our comparable hotels.

The 2 portfolios with the largest percentage increases in cash flow were our comparable Sonesta and Carlson portfolios with increases of 3.7% and 3.3%, respectively. The 2 portfolios with the largest percentage declines in cash flow were our Wyndham and Marriott No. 1 portfolios with decreases of 11.6% and 11.3%, respectively.

Cash flow coverage of our minimum rents and returns declined for 7 of our 9 hotel agreements versus the prior year quarter, and hotel -- and portfolio-wide coverage declined to 1.26x for the quarter and 1.07x for the last 12 months. On the positive side, security deposit and guarantee balances were increased $16.8 million in the second quarter from a share of hotel cash flows in excess of our minimum returns.

Turning to HPT's consolidated operating results. Normalized FFO was $173.6 million in the 2017 second quarter, a $7.9 million or a 4.8% increase from the 2016 quarter. The increase was due primarily to the net effect of higher minimum returns and rents, lower preferred dividends and an increase in interest expense.

On a per share basis, second quarter 2017 normalized FFO was $1.06, a 2.8% decrease from the 2016 second quarter. This decline was a result of the 8.4% increase in HPT's weighted average share count versus the 2016 quarter due to our August 2016 common share offering.

Adjusted EBITDA was $220.3 million in the 2017 second quarter, a 2.2% increase from the 2016 quarter. Our adjusted EBITDA to total fixed charges coverage ratio for the quarter was 4.9x, and debt to annualized adjusted EBITDA was 4.4x at quarter end. Our normalized FFO payout ratio was approximately 49% in the 2017 second quarter.

Turning to our capital improvement fundings and commitments. We funded $5.1 million of hotel improvements and $25.5 million of travel center improvements in the second quarter. We currently expect to fund $39.3 million of hotel improvements and $32.9 million of travel center improvements for the remainder of 2017. We expect to have 9 hotels under renovation for all or part of the third quarter.

Turning to our balance sheet and liquidity. As of quarter end, debt was 39.9% of total gross assets, and we had significant liquidity with $50 million of cash and $722 million of borrowing capacity under our revolving credit facility.

Operator, that concludes our prepared remarks. We're ready to open up the call for questions.

(Operator Instructions) The first question comes from Ryan Meliker with Canaccord.

I had 2 questions for you. The first one is pertaining to the Crowne Plaza acquisitions. You guys have obviously been busy. I'm just curious what the take is here. The Ravinia transaction, I think Ashford Trust sold that. They said it was a trailing 5.6 cap rate, which obviously seems expensive. I know you guys have the IHG guarantee. I'm wondering, is IHG contributing a substantial amount? Or is underwriting aggressive for IHG to give these guarantees and then support the acquisitions at these prices? And is that what IHG is trying to do, go forward with Crowne Plaza given Marriott and Hilton is launching to a kind of full-service conversion brands?

Ryan, the Crowne Plaza Ravinia is right across the driveway from IHG's headquarters. The hotel was most conservatively described as poorly maintained by the prior owner and a substantial amount of capital is going to go into the hotel to renovate it. So if we expect it to continue to generate the kind of cash flow that the prior owner had, then it would be a very aggressive acquisition. But we're expecting to fix the hotel up and make it one of the flagship Crowne Plazas in the U.S., if not around the world. And as a result, and in large part because of business that IHG currently sends to other hotels out of embarrassment over the current condition of that hotel, that will now be able to stay right across the street from where their meetings are, we expect cash flow to increase dramatically. So we don't think it's an aggressive transaction at all. We think it's a very sensible, good long-term investment.

Got you. It sounds like you -- just to put it another way. You are building an upside to cash flows postrenovation that we wouldn't have seen in trailing 12-month NOI? Is it fair?

Yes.

Okay, great. That's helpful and that makes some sense. The second question I had, Mark, it's maybe more for you. If I recall correctly, you guys have historically targeted 40% total debt to gross book value of real estate assets. You have 42% at the end of the quarter. You just talked about $230 million of acquisitions that you are in contracts for, plus another roughly $80 million of CapEx coming. How should we think about that leverage level? And how high are you willing to take it?

Well I don't think, even with what we have under contract, we're going to be -- we should be right around that 40% number at the end of the year when you consider cash we had on hand at the quarter end as well as free cash flow we expect to generate from operations during the second half of the year. So we won't be outside of that 35% to 40% range. Assuming nothing else changes, we'll be right up against the 40%. As we've shown in the past, we're willing to operate above 40% for a period of time, if necessary, and that gives us the flexibility to access the capital markets, in particular the equity capital markets when we like where the share price is.

The next question comes from Jeff Donnelly with Wells Fargo.

Maybe just building off Ryan's question. Some of the full-service REITs have said that pricing in the market was maybe 10% to 15% above what they were able to pay for deals. Can you talk about the tenure of the market for full service versus maybe select-service product? Do you find them equally competitive now or are there tangible differences? And maybe the depth of competition you face or financing availability?

Yes. I would say that we feel like there is a little bit -- there has been more competition for transactions over the last 6 months than what we'd seen, say, last year. I think there was -- particularly after the election, there was some euphoria that there was going to be some changes that were going to drive an acceleration in economic growth in the United States and that it would be a good time to continue to invest. And so we saw a pickup in activity and more business at the table. So we felt like that there's still competition. Whether that will continue, I don't know. What has changed is that I think some of the expectations have been tempered as the expected pickup in economic growth and changes in taxes and the like have not materialized and it seems like they probably won't any time soon. And so, I think that we expect to temper our acquisition pace because of that. But most of the transactions that we completed this past quarter or that we announced were strategic relationship-based transactions and to maintain those types of relationships, you have to be ready to step up when the transactions present themselves. So we'll continue to be there for our relationship clients. And so we'll still do some acquisitions, but we expect to dial it back some, given the state of the economy today.

So this wasn't like necessarily the beginning of like a concerted or programmatic effort, I guess it's fair to say?

That's fair to say, yes.

I guess where I was going is that if the market is maybe a little bit better than where it was 6 or 12 months ago and as Mark explained, I think leverage is manageable, but it's maybe towards the higher end of maybe where you guys typically go. Do you guys give consideration to selling assets into this type of market, maybe in a larger basis -- larger scale effort than you have in the past? Or is it just not something really on the radar screen?

Well, I think we did sell 1 asset, which already puts us at a higher pace than we've done in the past. We have another one coming up this quarter and another one after that. So -- and we continue to look at our portfolios to try to identify some of the weaker -- regularly weaker-performing properties that we could prune out and enable our operators and ourselves to show better results. And we'll continue to do that. But I don't think you should expect us to make any sort of wholesale portfolio of sales or something like that if that's what you need.

Okay. And just 1 last one, just concerning the Morgans and the Clift. I'm just curious, how interested are you guys in ultimately expelling or terminating that relationship? I don't know if you can speak to that. And maybe I was just thinking of either finding a new manager or finding an opportunity to rebrand that property, perhaps as Sonesta or another brand. I'm just kind of curious what you kind of think your ultimate interest is there. Are you generally kind of pleased with the management just there as sort of a deal point you're negotiating?

Well, we're currently in litigation over the status of the Clift and also in negotiation, so I don't want to say too much there. But we wouldn't be litigating for the removal of the tenant if we didn't feel like they were better alternatives. The property -- it's been the management company's obligation to renovate that hotel. Because of capital constraints and other issues they have not done so. And we don't feel like it's fair to our shareholders to let the Clift -- it's not fair to the people in San Francisco to let the Clift remain in the condition that it's in. So we do expect to see change there.

The next question comes from Michael Bellisario with Baird.

On the Carlson dispositions. Are we thinking about this correctly that coverage is going to go down initially, given the unchanged rent? But cash flows will go down because of the 3 sold hotels? Is that fair?

I think the hotels that we're selling had fairly weak performance. So I don't expect to see a big change. They'll continue to cover -- I believe they'll continue to cover their returns and so you won't see a dip in our payments there.

Yes. I agree. Coverage on those 3 hotels is pretty low. I don't think removing them from the agreement will have a material impact on coverage at all going forward.

Yes, that was my next question. The 135 coverage trailing is probably not materially impacted then?

No.

And then just on that same topic. I think we maybe discussed before, when you announced that you were going to acquire another Carlson hotel in November. But any corporate level changes there affecting the way you think about investing in that portfolio? Or does that impact the negotiation that you had with being able to pull these 3 hotels out?

The change for the hotel that we were looking to acquire that was in Dallas a few quarters ago, that was a diligence pricing-related termination that had nothing to do with corporate changes at Carlson. And there was some minor impact from this. In the negotiations of this decision to sell a few hotels and for HPT to invest additional funds maybe was slowed down slightly by the need to get more layers of approval, some of which were outside of the United States. But in the end, those parties were onboard just like the local management team. So...

Fair enough. And then just following up on, I think it was Ryan's question, on the acquisitions on the hotel side. Can you provide either forward or trailing return expectations for all those deals?

We bought the Chase Park Plaza at approximately 9% cap rate. We're going to be investing in a rooms renovation. When that renovation is done and the properties ramp up, we expect to have at least an 8% minimum return generated there. The IHG branded properties are all -- have an 8% minimum return requirement associated with them. So as I mentioned earlier, trailing cap rates aren't necessarily the best way to look at some of those, particularly Ravinia. On the extended-stay portfolio, the cap rate was a little bit north of 10%. Again, we're going to be investing -- these are early-generation Residence Inns. We're going to be investing a substantial amount of money to convert them to ES Suites and when that's completed, we expect to be able to generate an 8% or better return from those hotels as well.

And then all the renovations associated with these deals. Is that 2018 spend, not 2017?

Very little on these deals is 2017. It's mostly going to be 2018 or some even into 2019.

(Operator Instructions) The next question comes from Bryan Maher with FBR Capital Markets.

And most of my questions have already been asked and answered. But just to kind of drill a little bit deeper, John, when you do acquire properties, can you tell us what it is that you're seeing with IHG and Sonesta? What they're doing maybe differently than some of your other operators, Marriott, Hyatt, Wyndham, which compels you to put them under those flags as opposed to the others?

Well, I guess, probably the best way to say it is that we've good partnerships with -- we think, with all of our operators, but because of where we are in the cycle, certain operators are focused on franchising or other means of growing their portfolios and aren't necessarily as focused on both branding and management of hotels. And in the case of the Crowne Plaza brands and the previously Kimpton branded hotels, IHG came to us and said, we want to keep this hotel in the portfolio of Ravinia. They negotiated the purchase and sale agreement because they wanted to regain control of that property across their driveway. And then they asked us if we would take assignment of the purchase and sale agreement. So a lot of the activity is mutual conversations that are regularly ongoing or just inbound inquiries as to whether we will assist them with transactions. And so Marriott has indicated that over the near term, they're not planning on continuing to offer long-term extensions to franchise agreements for older-generation Residence Inns. The Sonesta team has been very successful in rebranding some of those older-generation Residence Inns and generating decent returns and they've -- they identified this portfolio and asked if we would evaluate it together with them and we did so. And that was -- that transaction has been worked on for over a year. So it's gotten a lot of focus and analysis before we pulled the trigger. So I don't know if that answers your question, hopefully.

Yes, that's good. And then kind of shifting gears to TA for a minute. It seems like from their call yesterday that they're kind of in a holding pattern it seems on new development and acquisitions until: a, they figure out what's going on with this litigation; and b, they kind of get their house in order with respect to costs, which they're making good progress on. In light of that, do you anticipate that your travel center investments, not improvements, but investments in new properties will also slow for the next couple of quarters?

Yes. We haven't entered into any new arrangements to buy, other than this, the agreement we entered into a couple of years ago now to buy the 5 newly developed properties. But TA does own a bunch of travel centers, and from time to time, opportunities arise unexpectedly. So I wouldn't say we're not going to buy any travel centers, but we're currently not evaluating any. And so I'd say, the answer to your question is yes, our pace should slow.

This concludes our question-and-answer session. I would like to turn the conference back over to John Murray for any closing remarks.

Thank you for joining us on the call today. Have a nice day.

The conference has now concluded. Thank you for attending today's presentation. You may now disconnect.