Disclosure: The author is long O, DLR, VTR, HTA, STAG, CSG, GPT, ROIC, HCN, OHI, LXP, KIM, WPC, DOC, UDF, EXR, MYCC, BX, TCO, ED, CTWS.
Summary
- Recently, Stifel downgraded Host Hotels & Resorts from a Buy to a Hold due to "lackluster 2015 outlook... and partly due to valuation".
- HST's modest acquisition activity sparked the company's CEO to say "we're sitting out the dance".
- While the company may be "sitting on the dance" as it relates to large-scale acquisitions, I'm not going to wait.
- The shares look attractive after the sell-off, and I'm initiating a BUY on HST at $21.00.
My article last week may have hit a nerve for a few shareholders ofHospitality Property Trust (NYSE:HPT). I unintentionally wrote that article on this externally managed Lodging REIT just a day before the company announced fourth-quarter results. In case you missed it, here's how I recapped the article:
HPT is a classic example of a REIT that has inherent conflicts of interest, and the recent letter from RDG (activist investor) is just another indication that investors are being left behind. By forcing TA to spin off its real estate holdings, both TA and HPT should benefit by removing conflicts of interest arisen from the flawed structure. I remain deeply skeptical of external management, and I have no ownership stake in any of the companies mentioned.
As I said, HPT provided Q4-14 earnings a day after my article was published, and here's how the company's president and COO responded (on the earnings call) to the activist noise (associated with the letter from the activist investor to Travel Centers of America:
... I think on each of the last couple of quarterly calls we've been asked about TravelCenters and we've indicated that we're not opposed to buying TravelCenters. So if TA was to approach us regarding a sale-lease back transaction for additional TravelCenters, I'm sure that's that something that we would seriously consider.
I really don't have a dog in the hunt, since I have no interest in owning HPT, and I have been somewhat vocal with my distrust of this externally managed REIT. In my opinion, the "smoke and mirrors" game won't last, and I'm glad to see an activist "calling out" the flaws at TA. As I view it, the best solution for HPT is not to buy more TA assets, but instead, to internalize management so shareholders are on even ground.
Remember, externally managed REITs tend to underperform from an operating perspective, because most are only interested in growing assets under management and not spending enough time on watching the bottom line. Why buy HPT when I have plenty of other trustworthy options?
Host Hotels & Resorts - A Trusted Brand to Consider
Host Hotels & Resorts (NYSE:HST) was formed in 1992, when the Marriott Corporation split into two separate entities, creating Marriott International(NASDAQ:MAR) and Host Marriott (Marriott International represented the original Marriott company prior to Marriott's 1982 acquisition of the old Host International Company founded in 1897).
After the spin-off, the original assets were consolidated as the Host Marriott Corporation, and on January 2, 1996, Host Marriott further divided the company into two separate companies: (1) Host Marriott continues to own lodging real estate; and (2) Host Marriott Services Corporation (now known as HMSHost Corporation) created to hold and operate concessions at airports, on toll roads, and at sports and entertainment attractions.
On January 1, 1999 Host Marriott emerged as a REIT, and in 2005, the company acquired 38 domestic and international hotel properties for approximately $4.1 billion from Starwood Hotels & Resorts. As part of that transaction, Host Marriott was renamed Host Hotels & Resorts to better reflect its more diversified portfolio of hotel brands. Today, HST ranks as the largest Lodging REIT, with total assets of $12.207 billion (as of Q4-14):
HST has a market capitalization of $15.907 billion, or around 31% of the market capitalization of the combined Lodging REIT sector:
It is an S&P 500 and Fortune 500 company, and in addition to being the largest Lodging REIT, the company is also one of the largest owners of luxury and upper-upscale hotels. HST currently owns 97 properties in the US and 17 properties internationally, totaling approximately 59,000 rooms. The company also holds non-controlling interests in 5 joint ventures, including one in Europe that owns 19 hotels with approximately 6,500 rooms, and one in Asia that has interests in four hotels in Australia and India.
Here's a snapshot of HST's revenues by market:
HST partners with premium brands such as Marriott®, Ritz-Carlton®, Westin®, Sheraton®, W®, St. Regis®, Le Meridien®, The Luxury Collection®, Hyatt®, Fairmont®, Hilton®, Swissotel®, ibis®, Pullman®, and Novotel®, as well as independent brands in the operation of properties in over 50 major markets worldwide. Here's a snapshot of the brand affiliates:
Here's a snapshot breaking down the company's hotels by brand:
Here's a snapshot of HST's revenue by property type:
Before digging into the financials, let's take a closer look at some of HST's irreplaceable hotels. The first snapshot is The Westin Kierland Resort & Spa in Scottsdale - HST acquired this 732-room property in 2006 for around $393 million.
Here's a snapshot of the JW Marriott Hotel that HST acquired for around $47 million in 2000 (has 245 rooms):
The next photo is the Manchester Grand Hyatt San Diego. I have stayed at this property, and I can attest to the exceptional quality. HST purchased this property in 2011 for around $572 million (has 1,628 rooms).
The next photo is The Weston Chicago River North that HST acquired in 2010 for around $165 million (has 424 rooms):
The next photo is The Ritz-Carlton in Naples, acquired in 2002 (has 295 rooms):
The next photo is of the W New York - Union Square purchased in 2006 (was built in 1927):
The last picture is of The Fairmont Kea Lani that HST acquired in 2004 for $255 million (has 450 rooms).
The Balance Sheet
HST has investment-grade ratings from Moody's (Baa3) and S&P (BB+), and the company has a very strong liquidity profile. Over the last few years (since the Great Recession), HST has lowered its leverage and ramped up liquidity. Its current Net Debt-to-EV is the lowest in the sector (19.4%) and 640 bps below the sector average. Here's a snapshot of HST's historical Total Debt-to-Total Capitalization:
Here's a snapshot comparing its total debt with that of the peer group (the lowest in the sector):
HST has just around 10% of secured debt. Here's a snapshot comparing this to that of the peer group:
Here's a snapshot illustrating the historical percentage of secured debt:
HST has about $1.2 billion of liquidity, including $684 million of unrestricted cash and $796 million of line capacity. Here's a snapshot illustrating the company's debt maturities:
Stifel Downgrade
On the latest earnings call, HST's CEO, Ed Walters, said the company's top priority was reinvesting in its own portfolio, particularly if it felt like the returns from ROI projects were greater than potential acquisitions. However, property renovations take rooms out of service, causing revenue disruption, creating a source of dilution. As evidenced by the snapshot below, HST has maintained a relatively modest growth model, favoring renovations over property expansion.
Recently, Stifel downgraded HST from a Buy to a Hold due to "lackluster 2015 outlook... and partly due to valuation". Here's how the analyst summed it up:
It was suggested on the earnings call that the underperformance may be due to the lack of acquisitions and the external growth they create. Host was "sitting out the dance." The stock did perform well early in the cycle when it was buying some big hotels such as the W Union Square, the Westin Grand Central (Helmsley), and the Manchester Grand Hyatt in San Diego. However, last year they were net sellers, disposing of $519 million of assets while buying only $133 million, which created dilution.
With limited growth forecasted in 2015, HST said its top priority was reinvesting in its own portfolio, particularly if it felt like returns from ROI projects were greater than potential acquisitions. However, Stifel offered the bearish response:
... property renovations take rooms out of service causing revenue disruption creating yet another source of dilution.
Yet, there's another argument that suggest that HST is simply preparing to strike when the time is right. The underwriting suggests that the company is playing defense, building up its fortress balance sheet (driving down leverages and reducing interest costs), watching and waiting for an opportunity to pounce.
HST believes that U.S. industry-wide fundamentals should remain strong over the next few years, and that supply growth should stay below demand over the next two years. Here's what Stifel had to say:
Host is the battleship in this sector, which may take little longer to turn and change course. The company may be starting a little earlier than others. The company does have almost 27% exposure to New York City and Washington, D.C., two markets that have experienced increased supply and expected to be underperformers in 2015.
HST's management believes that the short-term negative impact of the redevelopment projects will create long-term value in the portfolio. Meanwhile, Stifel offered the following rebuttal:
... we question whether projects of this scale make sense six years into a recovery.
The Latest Earnings
For the latest quarter, HST's Adjusted EBITDA was $351 million and was $1.402 billion for the full year, representing a 7.4% increase over the prior year. Adjusted FFO (or AFFO) per diluted share was $0.40 and $1.50 for the full year, exceeding consensus estimates and reflecting a 14.5% increase over 2013.
HST's portfolio achieved a 77% average occupancy, allowing hotels to drive rate increases of nearly 5%, resulting in an improvement in comparable hotel RevPAR of 5.7%. For the quarter, comparable hotel RevPAR increased 3.2%, due entirely to rate growth as occupancy declined by .6 points (as noted above, a large number of room and meeting space renovations began in the fourth quarter). Here's how HST's president and CEO, W. Edward Walter, summed up 2015:
Given the positive industry outlook and underlying economic fundamentals, we believe this cycle will continue to be strong throughout 2015. The capital we are investing in our hotels ensure that our portfolio is in excellent condition and has the opportunity to achieve strong NOI growth. Our industry leading balance sheet is only getting stronger, our cost of capital remains attractive.
In terms of historical performance, let's examine HST's FFO results:
Now let's compare HST's dividend history:
Let's compare the dividend growth with the peer group dividend growth:
Several of the REITs had seen monster dividend growth last year. Let's remove them to see how HST compares with the other peers:
HST's dividend yield is 3.8%, higher than the peer average of 3.24%.
Host Hotels is a BUY
As mentioned, Stifel downgraded HST a few days ago, resulting in a drop in the share price. The shares currently trade at $21.00.
As noted above, the dividend yield is now 3.81%, indicating the REIT is a good value play.
HST's P/FFO multiple is 13.1x, trading at the lowest multiple over the last 90-day period:
The pullback presents an attractive buying opportunity, as HST is one the few high-quality REITs that are trading at or below Fair Value. The recent pullback could serve as a good entry point for new money. Here's how HST's P/FFO compares with that of its peer group:
HST has the lowest Total Return performance over the last 12-month period:
Perhaps one of the biggest potential catalysts for HST is share buybacks. Here's what the company's president and CEO said on the recent earnings call:
Buying back stock is something that is clearly something we're looking at. I think we have a few things that we have in the pipeline right now that we would like to see how they play out, but we are certainly open to buying back stocks.
It seems that much of the risk for HST is now baked into the price, and with the US economy still gaining strength, I view HST as a very attractive BUY today. It seems there's no recession I sight; however, investors should be aware of the volatility associated with Lodging REITs. Here's what happened to HST over the last two recessions.
Drilling down further, you can see that HST slashed its dividend to $.04 (the share price fell to $3.70).
If anyone had the courage to pick up shares in HST, he or she would have done quite well - returning 521% (or 35.6% annually).
However, I see one of the biggest catalysts for HST is the discounted P/FFO multiple. Over recent history, HST has traded at an average of 15.8x, and the shares are trading at 13.3x today (F.A.S.T. Graphs reports 13.8x).
HST's long-term fundamentals are sound, and I believe that the company has been selectively grooming its balance sheet in preparation of market opportunities. The management team appears to be methodically managing portfolio risks in an effort to create enhanced shareholder value.
While HST may be "sitting on the dance" as it relates to large-scale acquisitions, I'm not going to wait. I'm initiating a BUY on Host Hotels & Resorts at $21.00. (Using F.A.S.T. Graphs' Forecasting chart below, I predict the company to move into normal valuation levels of 15x and produce Total Annual ROR of 18.14%.)
Sources: SNL Financial, F.A.S.T. Graphs, HST Investor Presentation and 10-K.
REITs mentioned: Strategic Hotels & Resorts (NYSE:BEE), FelCor Lodging Trust (NYSE:FCH), Ashford Hospitality Prime (NYSE:AHP), Sunstone Hotel Investors (NYSE:SHO), Pebblebrook Hotel Trust (NYSE:PEB), DiamondRock Hospitality Company (NYSE:DRH), Chesapeake Lodging Trust (NYSE:CHSP), Chatham Lodging Trust (NYSE:CLDT), RLJ Lodging Trust (NYSE:RLJ), LaSalle Hotel Properties (NYSE:LHO), Hersha Hospitality Trust (NYSE:HT), Summit Hotel Properties (NYSE:INN), Ashford Hospitality Trust (NYSE:AHT), and SoTHERLY Hotels, Inc. (NASDAQ:SOHO).
Disclaimer: This article is intended to provide information to interested parties. As I have no knowledge of individual investor circumstances, goals, and/or portfolio concentration or diversification, readers are expected to complete their own due diligence before purchasing any stocks mentioned or recommended.
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