Q3 2022 Service Properties Trust Earnings Call
Okay.
Good morning, and welcome to the service properties Trust third quarter 2022 earnings Conference call.
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I would like to turn the computer Stephen Colbert Director of Investor Relations. Please go ahead.
Good morning.
Joining me on today's call are card Hargreaves, President and Chief investment Officer, and Brian Donnelly Treasurer, and Chief Financial Officer. Today's call includes a presentation by management followed by a question and answer session with analysts. Please note that the recording retransmission and transcription.
Today's conference call is prohibited without prior written consent of that said I'd.
I'd 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 SEC's present beliefs and expectations as of today November four.
2022, 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 as required by law.
In addition, this call may contain non-GAAP financial measures, including normalized funds from operations or normalized <unk> and adjusted EBITDA Ari reconciliations of these non-GAAP financial measures to net income as well as components to calculate a S F.
<unk> 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 on file with the SEC and in our supplemental operating and financial data found on our website at Www Dot F. D. C. R E T Dot com.
And with that I'd like to turn the call over to Todd.
Thank you Steven and good morning.
Our third quarter results are highlighted by the ongoing improvement in our hotel portfolio as comparable Revpar was 86% in 2019 for the third quarter compared with 83% of 2019 in Q2.
The continued recovery of Spc's urban full service in suburban select service hotels contributed to the improvement as travel patterns normalize and workplace expectations for our employees slowly shift toward prior standards.
Combined with the solid performance of our leisure and extended stay hotels room rates have surpassed 2019 figures for the third quarter a trend that has continued into the fourth quarter with preliminary October ADR of $143, 2% above October 2019 levels.
Notably our full service portfolio Revpar for the quarter increased to 91% of 2019 levels highlighted by the strong year over year performance of our hotels in Hawaii, Boston, Toronto, San Francisco, and Chicago, which benefited from elevated leisure travel improve group demand and the continued ramp of business travel.
Revpar growth continues to be driven through ADR increases that many of our leisure and urban hotels.
<unk> and our hotels in Fort Lauderdale in Hilton Head, Chicago, Miami Airport, and Hawaii, all reporting ADR during the quarter in excess of 125% of 2019 third quarter levels.
While the recovery of our select service portfolio is trailing our other service levels. It continues to be a primary focus of ours and the gap relative to industry is tightening.
Compared to Q3 2021, Revpar for our select service hotels improved 28% outpacing industry Revpar growth by two four times.
Specifically revpar at our Sonesta select portfolio increased by 40% year over year for the quarter.
In terms of segmentation group mix was 16% in the third quarter up from 12% during the previous year quarter, and now above 2019 levels of 15%.
This increase was largely driven by elevated leisure group demand as well as the return of corporate group and markets, including Boston, Chicago and Philadelphia.
We get occupancy in the portfolio is approximately five percentage points higher than weekday occupancy a GAAP, we expect to shrink in the next year as corporate group and transient travel returns.
Group pace across our operators as positive led by leisure group demand, but also due to notable corporate group and citywide increased demand.
Sbcs hotels did not experience a material impact from hurricane Fiona or hurricane Irma during the third quarter. There's any losses were offset by incremental revenue. We received from guests displays to our sonesta Fort Lauderdale Hotel, which was not directly impacted by the storms.
Yeah.
Inflationary pressures are impacting hotel level operating expenses related to labor utilities, and insurance, leading to compressed GOP and EBITDA margins. We are working with our operators to reduce the reliance on more costly contract labor and are encouraged by the improvement in permanent staffing levels and hope to see a deceleration of labor related cost increases or not.
Coming quarters.
Also during the third quarter, we entered into an agreement to sell our remaining 16 Marriott branded hotels for $137 million, excluding closing costs, which we expect will close in Q1 2023.
And we continue to wind down the disposition process of the previously announced sonesta branded hotels with only five of the original 68 still to be closed.
To reiterate what we've said on past calls the hotels, which we have sold or plan to sell our relative underperformers and we're retaining the hotels with superior revpar margin and growth prospects.
As of September 32022, we owned 769 service oriented retail net lease properties, including our travel centers with $13 4 million square feet.
Representing 45% of our overall portfolio based on investment are net leased assets, where 98% leased by 178 tenants with a weighted average lease term of nine eight years and operating under a 136 brands in 'twenty, one distinct industries as of quarter end.
The aggregate coverage of our net lease portfolio is minimum rents was two eight times on a trailing 12 month basis as of September 32022, and.
An increase versus last quarter and an improvement from 237 times for the same period last year.
I would like to highlight for <unk>, our largest tenant site.
Site level rent coverage on a trailing 12 month basis was 254 times up from 246 times last quarter we.
We believe the diversity of our net lease tenants and the continued strong performance of Ta is an ongoing strength of our portfolio.
In the fourth quarter, we have 205000 square feet of leases expiring representing less than 1% of our net lease rents excluding ta.
This includes six tenants across multiple properties known to be vacating and represents less than $1 million of annual revenue.
We are evaluating leasing redevelopment and sale options for these properties.
Also cineworld the parent of Regal cinemas are second largest movie theater tenants filed for chapter 11 bankruptcy during the quarter. Regal has rejected just one of the six leases that house with SBC and we are in discussions with a tenant regarding the remaining five sites.
Before handing it to Brian I would like to emphasize that while we remained focused on working with our operators to return our hotels to pre pandemic levels.
We are encouraged by the improvement that we saw this quarter across our portfolio.
We are optimistic that our operating performance, we will continue to improve into 2023 with positive trends in business travel benefiting our hotel portfolio along with the reliability of cash flows from our sizeable net lease portfolio.
In addition, the improvement across the portfolio and a positive view of our business is going forward has allowed us to return to paying a meaningful common dividend to shareholders an important milestone for the company.
I will now turn the call over to Brian to discuss our financial results in more detail.
Thanks, Todd and good morning, Scott.
Starting with our consolidated financial results for the third quarter of 2020 to normalized <unk> of $88 5 million or <unk> 54 per share a 100% increase over the prior year quarter.
Adjusted EBITDA was $173 $5 million for this quarter of 26, 3% increase over the prior year quarter.
Major drivers impacting normalized <unk> over the prior year quarter was the improving performance of our hotel portfolio with hotel EBITDA, increasing 54% over the prior year to $78 9 billion.
Rental income declined approximately $900000 compared to the prior year quarter as a result of a positive impact of reducing reserves for uncollectible revenues in the prior year period, partially offset by an increase in percentage rent recognized a $1 7 million relating to our travel center leases in the current year quarter.
Net operating income from our lease portfolio for the third quarter of 2022 was flat compared with the prior year quarter.
Interest expense decreased by $10 $7 million over the prior year quarter, primarily as a result of the repayment of $500 million of senior notes in the second quarter and repaying $705 million of the outstanding balance on our revolving credit facility this quarter.
G&A expense decreased by $2 9 million or 20% to $11 $3 million in the current year quarter, primarily as a result of a decline in business management fees.
Lastly, our share of normalized <unk> recognized from our 34% ownership interest in sonesta increased by $1 $2 million over the prior year quarter.
Turning to our hotel portfolio results for our 240 comparable hotels. This quarter Revpar increased increased 29, 6% gross operating profit margin percentage increased by three two percentage points to 33% and gross operating profit increased by approximately $43 2 million from the prior year period.
Below the GOP line costs at our comparable hotels increased $7 $9 million from the prior year as a result of increased management fees driven by higher revenues at our hotels and an increase in insurance costs.
Overall, revpar increased 29% over the prior year quarter to $92 15, due to strong occupancy gains in our urban full service hotels and an ongoing recovery in our suburban select service hotels.
Our consolidated portfolio of 242 hotels generated hotel EBITDA of $78 9 million.
<unk> and a net margin of 19, 7%.
By service level, the increase was driven primarily by an improvement in our 49 full service hotels, which generated $39 million in hotel EBITDA during the quarter of 186% increase over the prior year period.
Our 114 extended stay hotels continued to deliver solid performance during $2007 $2 million of hotel EBITDA during the quarter of 14, 6% increase over the prior year period.
Our 79 select service hotels also improved generating hotel EBITDA of $14 4 million in the third quarter, an increase of 81% compared to the prior year period.
Sequentially net margins declined 100, 180 basis points due to higher expenses, although top line results exceeded our internal estimates inflationary pressures weighed on the bottom line as the cost of labor energy supplies and materials continue to rise.
On a cost per occupied room basis labor costs increased 13, 9% compared with the second quarter.
The use of expensive contract labor continues to be a challenge and we continue to work with our operators to find ways to control costs and improve productivity.
So talking about hotels that are expected to be sold which includes a 60 Marriott hotels under agreement for sale generated hotel EBITDA of $3 million in the third quarter compared to $78 million for the non exit hotels.
Preliminary October Revpar was $95 37.
As we look to the rest of the fourth quarter. We're currently projecting full quarter Q4, revpar of 77 to $80.
Hotel EBITDA is projected to be in the $50 million to $60 million range with net margins in the 14% to 17% range.
The second and third quarters and through the month of October are typically <unk> strongest periods, but we do expect to see seasonal declines in hotel activity as we move into the latter half of the fourth quarter.
Turning to the balance sheet as of today, our total liquidity is over $800 million, including over $100 million of cash and $705 million of undrawn amounts on our revolving credit facility.
Our outstanding debt includes $95 million outstanding on our revolver and $5 $7 billion of fixed rate unsecured senior notes with a weighted average interest rate of just over 5%.
And we have over $9 billion of unencumbered assets.
In October we entered into an additional amendment to the credit facility and extended the maturity date to July 2023.
The amendment removed restrictions on paying common dividends issuing secured debt, which allows us greater flexibility to navigate the debt markets.
We also continue to agree to maintain minimum liquidity levels as we prepare to address our next maturity, which is $500 million of four 5% senior notes maturing in June 2023.
We continue to monitor market conditions to evaluate strategies on our debt maturities, but we remain patient and we will look to execute on the most cost efficient options that maybe available to us.
Turning to investing activity during the third quarter, we sold five hotels for an aggregate sales price of $29 7 million.
And six net lease properties for an aggregate sales price of $1 1 billion.
We sold one hotel in October for proceeds of $6 million and we are currently under agreement to sell 16, Marriott branded hotels and four sonesta branded hotels for a combined sales price of $162 5 million.
Which we expect to close by early first quarter.
Additionally, we made $24 4 million of capital improvements at our properties during the third quarter. We currently expect our fourth quarter capital spend to be approximately 40% to $45 million.
We will provide guidance on our 2023 capital expenditures during our fourth quarter earnings call.
Finally regarding our common dividend announcement, we are pleased to increase our dividend of <unk> 20 per share this quarter, representing a normalized <unk> payout ratio of 37% based on our Q3's results with.
The decision to reinstate the dividend was based on our outlook for the company and we believe it will remain well covered at the lodging portfolio continues to recover operator that concludes our prepared remarks, we're ready to open up the line for questions.
We will now begin the question and answer session.
To ask a question you May press Star then one on your telephone keypad, it's using a speakerphone. Please pick up your handset before pressing the keys.
To withdraw your question. Please press Star then two.
At this time, we will pause momentarily to assemble our roster.
Our first question will come from Brian <unk> with B Riley Securities You May now go ahead.
Thank you and good morning, Todd and Brian .
Just a couple of questions for me on this and that.
Hotels, I mean, there was a lot.
Talk N and activity regarding moving us in the Marriott and Intercontinental brands to the Sonesta brand over the past two years.
Can you give us a little bit of color as to.
How you think of the Rev. Par those properties ends up progressing against what you would consider you would have gotten if they do.
<unk> Marriott and Intercontinental brands, and maybe offsetting that the benefits of having them in this master brand versus under those two big brands.
Sure Hey, Brian Good morning, Thanks for the thanks for the question. So you're right. We now have several quarters of data post conversion of the 200 hotels that we converted to the Sonesta brand.
So I think we're starting to get every quarter, we're getting a better idea of how how close we think we can get to the previous operator's performance.
I'd say it depends on what we're learning I think it depends on on the service level and the previous brand as well as the brand we converted to <unk>.
For the most part most of the brands, we fully expect to get back to where the previous operators were at.
The Royal Sonesta, Es are performing extremely well.
They are widely recognized in the industry most of our full service Sonesta is I would say the same thing about the.
The extended stay brands as well I think.
We expect Dave will get back to the previous operators as well I think the one to.
The one area, where we may not get back to the previous operators, our sonesta select brands that we converted.
We converted those in Q1 2021 that was a new brand for Sonesta and there is a history to with with with implementing new brands at Sonesta Sonesta did the same thing with the <unk>.
<unk> suites back in 2012, and it took a couple of years to get to get ramped up to get recognized and now sonesta Es suites is widely recognized as one of the best.
Upper mid scale extended branded extended stay brands in the industry.
So.
We expect to get back close to where the previous operator was.
But.
We acknowledged that that may not occur for those specific hotels.
To the second part of your question Youre right. There is there is there's gives and takes for <unk>.
For us converting those hotels and growing our relationship with sonesta.
Number one and it wasn't necessarily related to the conversion of those hotels and our decision to.
To exit those agreements and convert those hotels to the sonesta long term.
But.
And one of the recent amendment, we did with Sonesta, we did get 34% ownership interest and we'll we'll really do try to do a good job of attempted to quantify this as we move forward, but we really see a lot of upside in that 34% ownership interest, especially on the franchising side of the business, which we really think will well.
Grow over the next few years and having the ability to benefit from that 34% of those future royalty fee streams I think.
It's really going to show it is going to more than offset any loss that we had on a long term basis converting those <unk>, but overall I think the majority of our hotels and our brands.
I'll get back to if not above the previous operators.
Okay. Thanks, and my second question relates to the full service hotels.
There's been so much discussion over the past two years with the limited service and extended stay hotels, having performed very well during COVID-19, but it seems like all of the lodging companies reporting. These days really are our centering in on their urban full service hotels and how well those are.
Recovering.
Business travel returns and so I don't think that people spend enough time kind of thinking about the fact that you have.
Hotels, how would those recovering in this market can you drill down on that a little bit.
Sure.
I'll start.
Brian can jump in but yes. This is it's a good question and you're right. It's the urban full service, especially over the last two quarters I would say half have really started to recover.
I think relative to some of our peers are full service hotels are a lot more concentrated in urban areas versus resort hotels and like to say a limited service and extended stay recovered early on but so did the resort and luxury hotels.
Really in terms of rate recovered earlier as well so now youre starting to see.
Our portfolio I think catch up to industry, especially on the urban full service side. Our total full service that was our best performer relative to 2019, we're back to 91%.
2019 levels in terms of Revpar.
And where we are really starting to see the pickup.
Citywide events business travel.
Corporate travel at those hotels, if you remember our Q1, especially early on in Q1, a lot of the hotels that we have urban hotels in markets like Chicago, San Francisco D. C. Boston, Philadelphia doses have not reopened yet the major conferences that just won't happen.
<unk> returned yet and.
Now I think when you look at Q1 2023, we expect that to be well above Q1, 2022, not a lot of thats going to be driven by those dose urban full service hotels.
Yes.
I would just add to that.
The full service of 49 full service hotels are the lion's share of the revenue on a gross basis as Todd mentioned, the revpar and from a rate standpoint, it's over 110% of.
2019, and while the bottom line, we're creeping up to closer to 100% to where in that when the <unk> as far as percentage of hotel EBITDA to 2019.
So theres still some room to run there.
Still certain markets that haven't fully ramped all the way up you look at places like San Francisco and others, but our Hawaii assets Ross asked why is another one that was under the knife for renovations room renovations last year has come back very strong and actually it was our biggest producer this quarter. So.
We feel pretty good about that portfolio as we as we move forward here.
And just lastly, I mean, we get a lot of questions related to the value of Garrett.
On a per key basis.
Done studies.
Studies, where we back out what we think the value of the Tas awards with a value of the net leased assets are worth then you get a ridiculous number of like 45% to 50000, a key for the value of your hotels when.
You're selling your noncore hotels for somewhere in the <unk> and I don't think people are focused on the fact that you own barge full service hotels in Puerto Rico in Boston, San Francisco, and Chicago that one could easily argue out where hundreds of thousands of dollars per key I mean can you give us just a little bit of color as to how you look at the valley.
Are you of what has become an increasingly important part of your portfolio.
Sure Yeah, we think the same thing and I think what we've been selling over the past 12 months as we've mentioned has really bad.
<unk>.
The lower quality portion of our portfolio from any way you look at it in terms of performance in terms of age in terms of location.
And the select service.
On average we've been selling above 50000, a key the extended stay and we're selling closer to 70000 a key.
But youre right there is.
Especially our luxury resort hotels.
Those those are value well above well in the hundreds of thousands per key.
So youre right.
We have our internal analysis on what we think valuations are that we haven't made public but.
I think I think youre on the right track if you look at each hotel by hotel on a per key basis on a stabilized cap rate basis, I think youll. It sounds like you are coming to it to a similar conclusion.
We do and we get off market offers all the time for some of our hotels.
Our hotel at Cambridge in Hawaii, we get off market first of all the time that we.
We look at everything, but we're not interested in selling those hotels now, but we get I think we have a pretty good sense of what value is for our assets and it's well above the levels that you mentioned.
Okay. Thank you very much sure. Thanks, Thanks for the question.
Again, if you have a question. Please press Star then one our next question will come from Dori Kesten with Wells Fargo. You May now go ahead.
Thanks, Good morning.
Just walk through what the options are on the table with respect to your mid 'twenty three maturities is it.
Our asset sales potentially resort.
Dancing.
Good morning, Thanks for the question.
We're going to keep looking at the debt markets and look at our different options.
<unk> markets and unsecured notes today would be pretty expensive to do.
Yes, we do have some asset sales still on the table and significant amounts of liquidity sitting there but.
I think we are going to look to refinance all if not part of those $500 $500 million notes.
Whether thats with.
Senior unsecured bonds or some sort of secured financing or bank debt remains to be seen but we feel pretty good.
Even despite the market backdrop and the issues with interest rates.
We just wanted to make sure whatever we execute we'll be.
But cost option for us to not increase our cost of capital is radically.
Okay.
Investors have been asking about the potential equity issuance.
Alaska.
And no prior management team I was just wondering if you could provide your NGL.
Yes, we're not interested in issuing equity at these levels.
We looked at the portfolio as equity issuance is around 30% $31 a share.
We don't certainly don't think the values decreased to where it is today for the portfolio.
So in that today.
Okay.
Previously you said that you expect hotel EBITDA margins to get back to prior peak in the next few years do you continue to expect that full recovery.
Yeah, we do we do we expect it.
It's hard to put.
The timeframe on it but we do expect to get back to EBITDA margins from where we were before.
Yes.
Okay. Thank you.
Sure Thanks for the questions Don.
Our next question will come from Tyler Battery with Oppenheimer. You May now go ahead.
Good morning. Thank you first question for me clarification on the Revpar guidance, how does that 77 to 80, you guided for Q4 compare with 2019 I mean in other words are you assuming that the comp with 2019 will improve in Q4 versus.
Q3 and Q2.
Yes, I think from a seasonality standpoint.
The decline compared to Q3, I think the relative measurement to 19 will sort of trend in the same way Q3 was 86%.
2019, Q3, I don't think its going to vary all that much.
In this environment is pretty tough to predict what's going to happen.
Week never mind, a couple of months, but we think generally there'll be in that same range.
Okay, Great and then just a follow up question on the margin.
Can you talk a little bit more about the call.
What's the environment out there I mean does it sound like its gotten incrementally worse and you gave some some some guidance on your margin expectation for Q4, but just kind of wondering a little bit more in detail, what you're seeing there not sure. It perhaps the pressures are more isolated too.
But full service properties comparable select service.
Yes, I think from from Labor standpoint, which is obviously the biggest expense in the company.
That continues to be a challenge I've put some metrics in the prepared remarks about on a cost per occupied room basis.
Double digit increases sequentially.
Contract labor, which is roughly 20% of wages as we look to fill positions.
No.
Great that its been tough to hire leisure and hospitality workers.
I think the jobs report came out today, saying that they were gains in that area. We're seeing the same thing we've shrunk the Oakland positioned significantly, but it's still it's still a cost drag.
We continue to try to push top line to make up for some of the difference on the cost structure, but youre seeing it elsewhere to utilities for example, energy cost was up 50% over last year.
Just the cost of everything is going up and again, that's not unique to us. It's just it's just part of reality today and do the best we can do is continue to mitigate costs and try to push rate to keep margin going.
Okay.
Okay.
In terms of the asset sales the 16 Marriott hotels, specifically, how did pricing come in versus your expectations and what's your confidence level in terms of.
We're getting that transaction closed.
By early early Q1.
Hi, Tyler good morning.
So the asset sales of the <unk> pack.
They came in.
Frankly, much higher than we expected.
We were under agreement if you remember to sell these hotels before the pandemic.
For $107 $5 million and.
Without getting too much into the details it was.
Under that under that sale scenario.
We were delivered we were required to deliver fee simple title and if we didn't price would have dropped to 93% $94 million. So now that we're at $137 million a significant increase even the guidance that we started out with at this time and the process was.
I think around $110 million so.
Much higher than we expected. It ended up we got a significant number of bids from highly qualified groups.
So we are under agreement now.
Sure.
It's.
We're expected to close these in the first quarter.
We had the benefit of having as I mentioned that those highly qualified groups. So we selected a well known buyer.
That was well capitalized.
<unk> had a history of closing transactions of this size. So at this point in time.
I am confident that we will close there is no guarantee.
It Hasnt.
We don't guarantee until it does close but we've tried to structure the deal appropriately as well so that there are protections for us if it doesn't close but now at this point in time.
I'm still confident that it will close in Q1.
Okay. Great last question for me in terms of the dividend announcements can you provide a little bit more detail in terms of why you thought this level was appropriate.
Interested your perspective on.
A potential payout ratio going forward and how did you think about reinstating the dividend vis vis some of the other avenues for capital that are that are out there like Mike capex or paying down debt or something like that.
Sure. It's a good question Tyler.
We started obviously being a REIT dividend paying a dividend is very important to us so as we really at that.
And part of the first quarter of this year coming into the second quarter. When we really started to see significant recovery in the lodging side of our portfolio.
And you combine that with.
Stable net lease cash flows for almost half of our overall portfolio, we started to have meaningful meaningful conversations with our board about.
About two things when to reinstate the dividend above the pay per share we've been paying and at what level to reinstate the dividend. So I think it's an indication of our view of the lodging portfolio going forward, what we're seeing in terms of group pace.
And business travel.
Yes, I think the goal was to set a.
Dividend level that was well covered.
A dividend that we could at a minimum maintain going forward. So.
That was the rationale we ran a variety of analyses downside analyses.
And we thought we thought we settled on this level again.
Mostly due to both the coverage today and what we think the coverage will be going forward.
Okay, Great. That's all for me thank you for the detail.
Sure Thanks, Alex for the questions.
This concludes our question and answer session.
Like to turn the conference back over to Todd Hargreaves for any closing remarks.
Thanks, everyone for joining today's call. We appreciate your continued interest in SBC and we look forward to seeing many of you in San Francisco at NAREIT later this month.
The conference has now concluded. Thank you for attending today's presentation you may now disconnect.