A Way to Go About Hotel REITs

Summary

  1. Hotel REITs have been out of favor, but recent chase for yield has helped to propel share price performance.
  2. Several stocks that failed to approach their fair value present their own catalysts. FelCor Lodging Trust is a great example.
  3. FelCor management is actively engaged in selling non-core hotels and using the proceeds to repurchase stocks.
  4. Moreover, although being an activist target doesn’t necessarily lead to gains, the company has worked cooperatively with activists in an effort to improve governance.
  5. Finally, the company is actively looking to reduce its leverage level and improve its debt profile.
  6. June’s share dip was a great opportunity to buy, but new dip after softer Q2 results presents new opportunity.
Quick Profile (as of 29 July 2016)
Industry Fundamentals: Favorable, but potentially near or at peak

Hotel Portfolio: Luxury and upper upscale, balanced, diversified

Stock Volatility: High

Small Cap (Market Cap: $0.9 billion)

Dividend Yield 3.5% vs Hotel REITs 5.4%

AFFO Payout ratio: 19%

Upside: High (38% below 52-week high)

Risk: High

External catalyst: Fair

Internal catalyst: High (sale of five hotels, repurchase of stocks, decrease of leverage ratio, potential credit rating upgrade)

A Way to Go About Hotel REITs

That hotels, one of 2016’s trailing REIT performers, have been out of favor is not news. Investors have been cautious because many believe hotel REITs have either already reached or are currently reaching their peak in the real estate cycle. Nevertheless, recent chase for yield has helped to propel hotel REIT share price performance. Although share price performance was flat in the first half of the year, July demonstrated to be more promising.

Hotels overall lack a long lasting industry catalyst to convince investors. Although industry figures still demonstrate that supply has yet to surpass demand, supply has been on track to reach the historic growth rate of 2%. Also, supply has seen intensified construction in several hotel categories, especially upscale and upper midscale markets. In a highly competitive industry, this doesn’t come off very encouraging.

To top it off, economy has not helped to make the industry’s case. Rumors of recession have been on and off, the same way Fed’s Janet Yellen has demonstrated to be very sensitive to the swings of labor figures. In addition, a potential appreciation of U.S. dollar will scare international tourists away, especially to gateway locations such New York and Miami.

Weaker industry catalysts don’t imply that individual stocks cannot present their own internal catalysts. A way to go about this situation is to look for undervalued stocks (which is the large majority of hotel REITs) and find those that are creating events that could spur a share price performance. A promising hotel REIT that has failed to realize its value and fits the bill is FelCor Lodging Trust.

Among hotels, FelCor is the REIT with one of highest upsides. FelCor’s share price has been 37% below its 52 week high and 14% below its 2016 high. While hotel REIT shares are up by 9% this year, shares of FelCor are down by 6%. In June, its share dropped by 6%.

The management is focused on propping up shares. They put up for sale 5 of its 41 hotels and plan to use the proceeds to reduce debt, repurchase stocks and redevelop several hotels. Also, the sale of non-core assets will raise FelCor’s portfolio profile, improving hotel metrics, such as RevPAR, Hotel EBITDA per key, and hotel EBITDA margins. The company’s core assets have been in gateway urban markets and resort locations that can be more difficult to break into.

Maybe one of the reasons why the company has been flying under the radar is its debt profile. In April of 2015, Standard & Poor’s upgraded the company from B- to B, which is still two notches below investment grade.

The company is actively looking to reduce its leverage level and improve its debt profile. The company doesn’t have any major debt maturity in the next two years as interest expense has decreased over time and debt metrics have improved.

Diversified Portfolio Not Potentially Affected by Supply Growth

chart01FelCor owns luxury and upper upscale hotels in gateway cities and tourist locations. They own well rated hotels that are ranked very competitively to the hotels in the surroundings.

Gateway urban markets remain to generate a significant portion of revenues. Geographically, they have a balanced distribution of properties on both east and west coast, in cities such as Boston, Los Angeles and San Diego.

What is in the company’s favor is its diversified portfolio composed of suburban, airport, and resorts, which is not one of the subsectors potentially affected by supply growth.

Seasoned Leadership More in Touch with Shareholders

FelCor, although they encompass two entities, is a de facto internally managed REIT. The management is seasoned and composed of executives who worked for other companies in the industry. Key people in the senior team have been with the company for about ten years.

The board has accumulated an equivalent average tenure, although the company has taken recent measures to reduce the board term from 3 to 1 year. The desired effect is to reduce the average tenure and promote renewal that better reflects shareholders’ concerns. It is one of the actions to improve corporate governance.

Choppy Dividend Record, But Who Doesn’t?

chart02Although the company has been around since 1994, the company’s dividend record has been choppy. Notably, the REIT hasn’t distributed dividends for almost six years, between 2008 and 2014. The management interrupted dividends because they had predicted a sharp drop in FFO in the following years in function of the great recession, which actually forced the company into negative territory in 2010.

In January of 2014, the company resumed distributions, but management has clearly been cautious as they only distribute equivalent to 19% of the adjusted funds from operations. The company is concentrating its efforts on internal growth. For that reason, the dividend has been well covered, but yield is one of the lowest among hotel REITs.

The truth is that there’s nothing to be ashamed of this record. In fact, very few hotel REITs have dividend records that date back before the great recession in 2008. The sector has not produced a premier, long lasting dividend payer yet.

Activists Made Compelling Case

The company has been the target of activist Land and Buildings, which has almost doubled down on its position and now owns approximately 4% of the shares. Although being an activist target doesn’t necessarily lead to future gains, they did make the management improve its governance by including two independent directors. In the end, the company seems to be working cooperatively with the activist, something that is positive in itself.

In late January, Land and Buildings cited an upside of 60% to NAV and made a series of proposals to accomplish the target price. In February and March, FelCor shares were on a roll, rallying by more than 30%. However, weeks later, the stock lost steam and went back down.

Latest Results

chart03Following its Q2 announcement late July, the stock began trading with a significant drop. The management was treading lightly after seeing business travel getting soft in Q2. The weakening of corporate demand in transient travel forced the company to lower expectations for some of the metrics, including the full-year 2016 guidance for AFFO per share. The corporate transient segment accounts for 30% of overnight stays.

Despite the market’s negative reaction, the firm owns an overall portfolio that has the potential to deliver positive results. Also, the management has resources to partially mitigate the softness.

On Track for a Credit Rating Upgrade

chart04Highly levered, the company has been making a systematic push to reduce its debt level. By the time the company finalizes the planned sale of some hotels, the leverage ratio will be below the peer average. Moreover, the company has one of the best maturity profiles among hotel REITs and the majority of its debt is fixed rate interest (79%).

Following its corporate credit rating upgrade from B- to B by Standard&Poor’s April last year, the company improved its debt profile. Although it is two notches below becoming investment grade, the company managed to expand its borrowing capacity. Also, the company was able to replace its outstanding 6.75% senior secured notes due 2019 to 6.00% senior unsecured notes due 2025.

Valuation

The company is clearly undervalued. While hotels’ average multiple has been around 10 times AFFO, FelCor’s multiple is around 7 times.

Conclusion

If you buy FelCor, you’re buying it for long term appreciation, not for dividend.

In summary, with the recent dip, FelCor demonstrates to be a good opportunity, but I’d limit its exposure in the portfolio because FelCor performance has been conditioned to the successful hotel sales.

Source: FelCor Lodging Trust Incorporated (NYSE:FCH)

Written on 29 July 2016

Disclaimer: This is not a recommendation to buy or sell stocks. The highest-yield stocks are not necessarily the best portfolio investment choice. The purpose of this report — which is essentially a snapshot of information available on July 29, 2016 — is to reduce your stock analysis by enabling you to compare stock and sector performance. Please do your own due diligence before making any investment decision.

This report is not engaged in rendering tax, accounting, or other professional advice through this publication. No statement in this issue is to be construed as a recommendation to buy or sell any security or other investment. Some information presented in this publication has been obtained from third-party sources considered to be reliable. Sources are not required to make representations as to the accuracy of the information, however, and consequently the publisher cannot guarantee accuracy.

Disclosure: The author is long FCH, XHR, CLDT, PEB.

Yellow Flag on Hotel REITs

chart01

During the release of Q2 results last week, several lodging stocks relayed the weakening of corporate transient demand. This has led some management teams to be more cautious while several have decided to review their 2016 guidance figures. Hotel REITs are not saying how long this will take, but they have confirmed that the second half of the year will suffer from the lingering effect.

The main cause has been the macro environment. Many uncertainties have led many companies, regardless of their size, to spend less and also cut travel expenses. Plus, the geopolitical tensions and fears of terrorism have discouraged travelers. With domestic and global events such as Brexit, China economy, oil prices, and U.S. elections, companies are lacking a clear horizon.

Hilton Worldwide, which is planning to spin off to create ‘Park Hotels & Resorts REIT,’ has mentioned on their Q2 call that, because of corporate transient, they remain on the lower end of their guidance range. While the corporate transient segment is slowing down, the group business is still doing well.

FelCor Lodging Trust, which is significantly exposed to the business traveler customer base, has also reported they are expecting group business to remain solid. While the group business partially offsets the decline in business transient performance, they are still continuing to expect negative effects on hotel metrics.

The Dow Jones U.S. Hotel & Lodging index has dropped by 4% by Wednesday, in tandem with most hotel REITs, but it has quickly recovered. Regarding last week’s worst performers, FelCor went down by 8%, Pebblebrook fell by 5%, and Hersha dropped by 3%.

Although the softness was detected a couple of months ago, a stronger impact has recently thrown down a yellow flag on hotels, whose operational results have been doing well. While on the other hand, the softening has made a low to moderate impact on the results. Many management teams have reported that there are ways to mitigate the impact.

In conclusion, the softening is not all bad, but it still will require some monitoring.

Source: Dow Jones U.S. Hotel & Lodging (^DJUSHL), Hilton Worldwide Holdings Inc.(NYSE:HLT), FelCor Lodging Trust Incorporated (NYSE:FCH), Pebblebrook Hotel Trust(NYSE:PEB), Hersha Hospitality Trust(NYSE:HT)

Disclaimer: This is not a recommendation to buy or sell stocks. The highest-yield stocks are not necessarily the best portfolio investment choice. The purpose of this report — which is essentially a snapshot of information available on July 29, 2016 — is to reduce your stock analysis by enabling you to compare stock and sector performance. Please do your own due diligence before making any investment decision.

As of May 31, 2016, the equity REITs are constituent companies of the FTSE NAREIT All REITs Index. Companies whose equity market capitalization is lower than $100 million have been disregarded.

This report is not engaged in rendering tax, accounting, or other professional advice through this publication. No statement in this issue is to be construed as a recommendation to buy or sell any security or other investment. Some information presented in this publication has been obtained from third-party sources considered to be reliable. Sources are not required to make representations as to the accuracy of the information, however, and consequently the publisher cannot guarantee accuracy.

Disclosure: The author is long FCH, XHR, CLDT, PEB.

This Hotel REIT For Long Term Appreciation

chart01

  1. Although hotel REITs have been out of favor, several stocks failed to approach their real share value. FelCor Lodging Trust is a great example.
  2. FelCor management is actively engaged in selling non-core hotels and using the proceeds to repurchase stocks.
  3. Moreover, although being an activist target doesn’t necessarily lead to gains, the company has worked cooperatively with activists in an effort to improve governance.
  4. Finally, the company is actively looking to reduce its leverage level and improve its debt profile.
  5. May and June’s share dip was a great opportunity to buy.

That hotels, one of 2016’s poorest REIT performers, are out of favor is not news. Recent chase for yield have not propelled hotel REIT share price performance. Although dividend yields have been the highest among equity REITs, share price performance has been flat all year. This is because many believe hotel REITs have either already reached or are currently reaching their peak in the real estate cycle.

A promising hotel REIT that has failed to realize its value so far in FelCor Lodging Trust. FelCor’s share price has been 40% below its 52 week high and 20% below its 2016 high. While hotel REIT shares dropped by 0.4% this year, shares of FelCor dropped by 12%. The strongest activity has been in May, when its share dropped by 8%.

One good thing is that management is focused on propping up shares by selling 5 of its 41 hotels and using the cash to repurchase stocks and redevelop several hotels. Also, the sale of non-core assets will raise FelCor’s portfolio profile, improving hotel metrics, such as RevPAR, Hotel EBITDA per key, and hotel EBITDA margins. The company’s core assets have been in gateway urban markets and resort locations that can be more difficult to break into.

In addition, the company has also been the target of activist Land and Buildings, which owns approximately 4% of its shares. Although being an activist target doesn’t necessarily lead to future gains, they did make the management improve its governance by including two independent directors. In the end, the company seems to be working cooperatively with the activist, something that is positive in itself.

Finally, the company is actively looking to reduce its leverage level and improve its debt profile. The company doesn’t have any major debt maturity in the next two years as interest expense has decreased over time and debt metrics have improved.

If you buy FelCor, you’re buying it for long term appreciation, not for dividend yield, which has been one of the lowest among its peer group. Since the company is only reserving 43% of its AFFO to fund dividends, the company is concentrating its efforts on internal growth.

In summary, FelCor demonstrates the chance to be a good opportunity, but I’d limit its exposure in the portfolio because FelCor performance has been conditioned to the successful hotel sales.

Source: FelCor Lodging Trust Incorporated (NYSE: FCH)

Disclaimer: This newsletter is not engaged in rendering tax, accounting, or other professional advice through this publication. No statement in this issue is to be construed as a recommendation to buy or sell any security or other investment. Please do your own due diligence before making any investment decision. Some information presented in this publication has been obtained from third-party sources considered to be reliable. Sources are not required to make representations as to the accuracy of the information, however, and consequently the publisher cannot guarantee accuracy.

Disclosure: The author has no positions in any shares mentioned, and no plans to initiate any positions within the next 72 hours.

Hilton as a REIT & FelCor on a Roll

chart01Last Friday, Hilton Worldwide finally announced a plan to spin off its hotel and timeshare businesses and to create an REIT from the hotel assets. The new hotel REIT will encompass 70 properties and 35,000 rooms and will likely be one of the largest hotel REITs. The properties that are going into the REIT will be largely domestic, which according to the company will be more appealing to investors.

Although new legislation prevents an immediate tax-free spinoff into an REIT, Hilton should be exempted from such legislation because it had submitted a request to the IRS before December 7, 2015. The new legislation denies tax-free treatment to a spin-off in which either the distributing corporation or the spun-off corporation is an REIT. It also prevents a distributing corporation or a spun-off corporation from electing REIT status for a 10-year period following a tax-free spin-off.

FelCor

chart02Among all lodging REITs, FelCor Lodging Trust seems to be on a roll over the past weeks, especially after Land and Buildings made a series of proposals in late January. FelCor argued that they have already been pursuing the proposed initiatives. Land and Buildings cited an upside of 60% to NAV to justify a 2% ownership.

The first visible development is that FelCor and Land and Buildings have recently agreed to nominate two new independent directors to the board and reduce average board tenure. Two long-serving board members will step down by 2017. FelCor will also de-stagger the board, as proposed by Land and Buildings. This is what the board looks like today (Name, Position, Director Since):

Thomas J. Corcoran, Jr., Chairman of the Board and Co-Founder, 1994

Richard A Smith, President and Chief Executive Officer, 2006

Glenn A Carlin, Outside, 2009

Robert F. Cotter, Outside, 2006

Christopher J. Hartung, Outside, 2010

Charles A. Ledsinger, Outside, 1997

Robert H. Lutz, Jr., Outside, 1998

Robert A. Mathewson, Outside, 2002

Mark D. Rozells, Outside, 2008.

The decision to revamp the board seems to be in the right direction. FelCor also announced in its Q4 results that it is pursuing the sale of five hotels, including three in New York, to repay debt balances and repurchase stocks. Last April, Standard & Poor’s rated the company B, which is two notches below investment grade. The company posted a total debt to total capitalization of approximately 52%.

What is in the company’s favor is its portfolio composed of suburban, airport, and resorts, which is not one of the subsectors potentially affected by supply growth.

FelCor has come a long way before realizing its full NAV. Besides reducing leverage and renewing its board, FelCor is faced by the cyclical nature of the lodging industry. The possibility that hotels have reached its peak has scared off many investors.

FelCor stocks rallied by 34% from its 52-week low on January 19, but it still has to rally another 34% to reach Land and Buildings’ target of $10.50.

I’d place this stock in speculative/activist portfolio.

Source: Hilton Worldwide (NYSE:HLT), FelCor Lodging Trust (NYSE:FCH)

Disclaimer: This newsletter is not engaged in rendering tax, accounting, or other professional advice through this publication. No statement in this issue is to be construed as a recommendation to buy or sell any security or other investment. Please do your own due diligence before making any investment decision. Some information presented in this publication has been obtained from third-party sources considered to be reliable. Sources are not required to make representations as to the accuracy of the information, however, and consequently the publisher cannot guarantee accuracy.

Disclosure: The author has no positions in any shares mentioned, and no plans to initiate any positions within the next 72 hours.

Activists Ignore Investor Sentiment Against Lodging

chart02 Activists have ignored a lingering investor sentiment against lodging as a major driver. Instead, they have been looking for an uncertain fight. Last month, Sessa Capital targeted the Ashford REITs and Land & Buildings selected FelCor Lodging Trust.

While it’s impossible to deny that some lodging REITs have enjoyed a very strong operational performance, their share prices have all gone downhill anyway. In fact, the market hasn’t spared a single stock. We saw a big bloodbath in 2015 and 2016 hasn’t started out any differently. So far, lodging has been a bottom performer; something I hope will come to an end soon.

If I had to give a reason for this massive selloff, I’d say that investors have been afraid of oversupply. Although the lodging REITs deny that supply has outpaced demand, some investors are not keen on the steadily rising supply. Carter Wilson from STR wrote an interesting analysis of the current environment in the lodging industry.

Airbnb has also been mentioned as a reason, but anyone who travels abroad regularly knows that renting rooms, and even entire homes, is nothing new and has never made the hotel industry disappear. Yes, Airbnb has made it more secure and easier to rent rooms and homes, but I believe that it is farfetched to call it a major threat to hotels.

We have mentioned Sessa Capital’s case in a previous post. Early February they filed a lawsuit against Ashford Hospitality Prime questioning a huge termination fee that penalizes Ashford Prime if they elect a majority of directors not approved by its external management Ashford Inc. The share price fell by 33% this year, only trailing NorthStar Realty Finance’s 35% drop.

As to Land & Buildings, at the same time they were challenging NorthStar Asset Management for being undervalued, they were also making their case for FelCor Lodging Trust.

chart01 FelCor is a $1 billion market cap that invests in several types of hotels outside the gateway market, such as resorts and those in suburban and airport areas. If the new supply is being built in the gateway market, which currently receives most of the spotlight, the rationale was, why don’t we invest in a hotel REIT that is located elsewhere? According to L&B, FelCor is the hotel REIT in the best position to capitalize on this idea, as 57% of the investments are exposed to markets expected to outperform for the next two years.

When we last looked at FelCor in 2015, the company was experiencing a decline in revenues, as well as one of the highest leverage ratios among its peers. The good thing was that FelCor featured strong same store growth markets and its AFFO per share increased. To get rid of its reputation for low quality and reposition it as one of higher quality, the company has sold and renovated some of its assets.

Last month L&B listed several items that would help close FelCor gap between their net asset value per share and their share price. Among others, they recommended that they sell their NY hotels, reduce their current debt, buyback their shares, and enhance corporate governance. In response, FelCor said that they had already implemented these ideas.

FelCor, indeed, has an AFFO multiple that is below its peer average and like a good portion of the lodging REITs, FelCor has been undervalued. However, that doesn’t mean that I will be running out to buy their stocks just yet. The bloodbath in the sector is not over yet.

Source: FelCor Lodging Trust Incorpora(NYSE:FCH), Ashford Hospitality Prime(NYSE:AHP),Ashford, Inc.(AMEX:AINC),NorthStar Realty Finance Corp.(NYSE:NRF),Northstar Asset Management Gro(NYSE:NSAM),Land and Buildings, Fast Graphs, Yahoo!Finance

Disclaimer: This newsletter is not engaged in rendering tax, accounting, or other professional advice through this publication. No statement in this issue is to be construed as a recommendation to buy or sell any security or other investment. Please do your own due diligence before making any investment decision. Some information presented in this publication has been obtained from third-party sources considered to be reliable. Sources are not required to make representations as to the accuracy of the information, however, and consequently the publisher cannot guarantee accuracy.

Disclosure: The author has no positions in any shares mentioned, and no plans to initiate any positions within the next 72 hours.

U.S. REITs: Last Week’s Selloff & Redemption

chart01It is beneficial to be aware of stock selloffs due to the fact that they are able to provide actual data about the market sentiment regarding certain sectors and stocks. When stocks are dumped in times of desperation, this sends forth a loud message about what investors are thinking in relation to forecast. If this practice becomes a pattern, then this indeed aids in the formulation of investment strategies.

There are fundamentals which are geared to be the foundation for long term investing, while market sentiment can indicate the right moment to enter. Take into consideration, for example, the fact that though we’re not in agreement with the long standing market sentiment against lodging REIT stocks, being aware of it helps to keep us from investing at the wrong time.

On Wednesday, yet another minor selloff was witnessed, it gradually experienced redemption by the end of the week. During the previous week, the Dow Jones ended with being up by 0.7 percent, S&P 500 closed up by 1.4 percent, and the MSCI US REIT Index was up by 1.0 percent. By the third week into 2016, the Dow Jones was down by 7.6 percent, S&P 500 was down by 5.3 percent, while the MSCI REIT US Index was down by 4.3 percent.

It comes with surprise that there has been a loss of some momentum for the lodging selloff movement that commenced in 2015. No single stock had been spared with a nearly 40 percent negative average return for this sector since the end of 2014. This time, two lodging REITs were among the top best three performances, which proved to be FelCor Lodging Trust and Sunstone Hotel Investors.

The sectors with the best performance in the year of 2015, which included data centers and self-storage, emanated displays of weakness and were the leading runners in the selloffs during last week. Between Monday and Wednesday, equity REITs dropped to lower than the average because of these two sectors.

Other sectors that tanked last week were timber and office. By Wednesday, office had fallen by 3.4 percent; however, by the end of the week, this sector was well on the rebound. On the other hand, timber fell by 4.7 percent by Wednesday and did not rise back up. After spiking due to the Weyerhaeuser acquisition last November, the timber REIT Plum Creek share price dropped to pre-merger levels.

Additionally, most free standing retail REITs have demonstrated good returns, with the exclusion of Getty Realty, whose tenants are oil related companies.

Skyrocketing by 32 percent on Friday, Rouse Properties proved to be the stock with the best return last week. The Canadian giant Brookfield Asset Management made an unsolicited buyout offer of $17 per share, which certainly does not come off as a surprise due to the fact that Brookfield has already invested in Rouse and owns 33 percent of it.

Check the reports for Dividend Yield by Sector and Weekly Returns.

Companies: Companies: FelCor Lodging Trust Incorpora(NYSE:FCH), Sunstone Hotel Investors Inc.(NYSE:SHO), Rouse Properties, Inc.(NYSE:RSE), Plum Creek Timber Co. Inc.(NYSE:PCL), Weyerhaeuser Co.(NYSE:WY), Getty Realty Corp.(NYSE:GTY), Brookfield Asset Management In(NYSE:BAM)

Disclaimer: This is not a recommendation to buy or sell stocks. The highest-yield stocks are not necessarily the best portfolio investment choice. The purpose of this report — which is essentially a snapshot of information available on January 22, 2016 — is to reduce your stock analysis by enabling you to compare stock and sector performance. Please do your own due diligence before making any investment decision.

As of December 31, 2015, the equity REITs are constituent companies of the FTSE NAREIT All REITs Index. Companies whose equity market capitalization is lower than $100 million have been disregarded.

This report is not engaged in rendering tax, accounting, or other professional advice through this publication. No statement in this issue is to be construed as a recommendation to buy or sell any security or other investment. Some information presented in this publication has been obtained from third-party sources considered to be reliable. Sources are not required to make representations as to the accuracy of the information, however, and consequently the publisher cannot guarantee accuracy.

Disclosure: The author has no positions in any shares mentioned, and no plans to initiate any positions within the next 72 hours.