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Friday, December 26, 1997

Suburban Lodges of America
(Nasdaq: SLAM)
Phone: 770-951-9511
Price (12/24/97): $13 1/8


HOW DID IT FIND TROUBLE?

Lesson #1 for a public company: Don't choose a stock symbol that makes for easy Daily Trouble puns. Lesson #2: Don't miss earnings estimates by 39% two months after doing a stock offering.

After doubling between May and October to an all-time high of $30 1/4, extended-stay hotel chain Suburban Lodges saw its roof cave-in on December 16 when it said fourth quarter earnings would be $0.11 to $0.12 per share, below estimates of $0.18. The stock was -- you guessed it -- slammed for a $6 3/16 loss, closing at $13 a share after trading as low as $10 1/2.

Chair/CEO David E. Krischer said that 13 of the firm's 26 new hotel openings for 1997 will take place in the last two months of the year, concentrating expenses in the quarter and dragging down earnings. Also, three franchised hotels due to open this quarter won't be ready for suburbanites until the first quarter of 1998. Finally, the same-store occupancy rate, running at 92.6% in the third quarter, should fall to 85% this quarter, also less than expected.

Given that the company raised $80 million in a mid-October offering of 3.3 million shares at $25 1/2, this surprise was more than bad form. Last Friday, some lodge members (i.e. Suburban shareholders) filed a class-action lawsuit charging that the company knew it wouldn't meet earnings estimates when the stock offering was done.

BUSINESS DESCRIPTION

Atlanta-based Suburban Lodges develops, owns, manages, and franchises economy extended-stay hotels. As of September 30, there were 43 Suburban hotels (24 company-owned, 19 franchised), with 27 more under construction and another 40 sites in development. The company had expected to have 60 hotels open by year-end, with another 46 (24 company-owned) planned for 1998. Most are located in the Southeast, especially Atlanta, though the company has ventured into Texas as well as the Midwest.

The 134 guest rooms per lodge feature a living room/bedroom, bathroom, and kitchenette. Other amenities cable TV and coin laundries onsite, but no restaurant or pool. The average weekly rate runs around $154 compared to an equivalent average weekly rate of $539 for other extended-stay hotels such as Marriott's Residence Inns and $275 for economy hotels.

Suburban appeals to an apparently underserved market that includes business travelers with no expense accounts, people on temporary work assignments, folks relocating or purchasing a home, tourists, and others who want inexpensive lodging and the opportunity to cook their own meals.

The average guest stays five weeks. The occupancy rate for hotels opened more than a year was 93% earlier this year, versus 79% for other extended-stay hotels and 60% for economy hotels. The long stays limit the need for desk help. Suburban also saves money by cleaning and changing the linen on a weekly basis. The cookie-cutter lodges cost $3.9 million to build and have been reaching 90% occupancy 90 days after opening.

Krischer and other insiders own 3.9 million shares. The company went public at $17 a share in May 1996 and went back to the equity markets in October 1996 and October 1997. Competitors include Wayne Huizenga's Extended Stay America (NYSE: ESA).

FINANCIAL FACTS

Income Statement
12-month sales: $19.4 million
12-month income: $5.9 million
12-month EPS: $0.51
Profit Margin: 30.4%
Market Cap: $202.5 million

Balance Sheet
Cash: $33.5 million*
Current Assets: $36.4 million*
Current Liabilities: $16.7 million
Long-term Debt: $25 million
(*Excludes approximately $80 million raised in October secondary offering)

Ratios
Price-to-earnings: 25.7
Price-to-sales: 10.4

HOW COULD YOU HAVE SEEN IT COMING?

In mid-October, Suburban was trading for $26 a share, or about 42 times First Call consensus FY97 earnings estimates of $0.62 and 24.3 times FY98 estimates of $1.07. So the stock was certainly pricey, though hardly outrageous if you thought the hotel chain could deliver on projected growth. Based on the enthusiastic reception for the secondary offering, Wall Street agreed.

Then again, were the analysts accounting for the 21% share dilution due to the offering? And surely the company must have known (and investors should have asked) what affect all the hotel openings would have on fourth quarter expenses. Plus, what's Suburban worth if the funds for expansion dry up?

WHERE TO FROM HERE?

In the third quarter, EPS rose 125% to $0.18 per share on a 163% increase in revenues. Earnings before interest, taxes, depreciation, and amortization (EBITDA) tripled to $3.9 million. Still, Suburban saw only a negligible increase in the average weekly rate (AWR) for hotels opened more than a year, and revenue per available room (REVPAR) actually fell 3.4% to $142.21.

Taking all company-owned hotels into account, the AWR sank 9% to $158.86 and REVPAR dropped 0.4%. The culprits? Strong demand related to the summer '96 Olympics in Atlanta versus the lease-up of new hotels this year.

The fourth quarter results ought to be examined closely, but Krischer said on December 15 that he expects Suburban's "strong annual growth to continue into 1998." With the recent offering, the company appears to have enough cash for next year's planned openings.

Bear Stearns downgraded the stock from "attractive" to "neutral" after the earnings warning. More downgrades and earnings cuts are likely to follow. Though Suburban sports terrific profit margins, net income is small enough for lawsuit-related legal expenses to hurt. Finally, its trailing return on equity is just 5.4%, meaning the business has been a lousy investment as compared to bonds or just about anything else.

Nonetheless, Suburban appears to have a winning formula for those who can buy equity at a discount, as one can now. For comparison, Extended Stay America has an enterprise value ($1,129 million) to nine-month sales ratio of 12.9, while Suburban's enterprise value ($136 million, after subtracting $24 million for fourth quarter development costs) to nine-month sales ratio is just 8.2.

Meanwhile, Extended Stay's operating margins after depreciation and amortization but before one-time charges were 20.5% in the third quarter and 15.4% for the first nine months of '97. By contrast, comparable Suburban margins (which include franchisor fees) were 36.8% and 35.3%, respectively. Either Extended Stay is still overextended even near its lows, or Suburban may now be a real bargain.

The caveat is that Suburban remains a growth story only as long as equity financing remains an option. If the recent earnings debacle proves a longer-term obstacle to such financing, then Suburban Lodges could be sent to the slammer.

-- Louis Corrigan
(TMFSeymor@aol.com)


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