Hospitality Properties Trust (HPT) Q2 2018 Earnings Conference Call Transcript

Hospitality Properties Trust (SVC 0.67%)
Q2 2018 Earnings Conference Call
Aug. 9, 2018, 1:00 p.m. ET

Contents:

• Prepared Remarks
• Questions and Answers
• Call Participants

Prepared Remarks:

Operator

Hello and welcome to the Hospitality Properties Trust second quarter 2018 financial results conference call. All participants will be in listen-only mode. Should you need assistance, please signal our conference specialist by pressing the * key followed by 0. After today's presentation, there will be an opportunity to ask questions. Please note, this event is being recorded. I would now like to turn the conference over to Katie Strohacker, Senior Direct of Investor Relations. Please go ahead, ma'am.

Katie Strohacker -- Senior Director of Investor Relations

Good afternoon. On today's call, John Murray, President and CEO, 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'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 HPT's present beliefs and expectations as of today, August 9th, 2018. 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 FCC.

In addition, this call may contain non-GAAP financial measures, including normalized funds from operations or normalized FFO. For a reconciliation of normalized FFO and adjusted EBITDA's 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 10Q to be filed later today with the FCC and once again in our supplemental operating and financial data found on our website through 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 you, John.

John Murray -- President and Chief Executive Officer

Thank you, Katie. Good afternoon. This morning we reported second quarter normalized FFO of $1.07 per share, an increase of 0.9% compared to $1.06 reported in the second quarter of 2017 due primarily to increased minimal ramps and returns resulted from prior year hotel acquisitions and owner-funded capital improvements at our hotels and travel centers and improved operating performance at our comparable semester portfolio.

Starting with performance at HPT's travel centers, total margin increased by $9.7 million or 3.1% in the second quarter due to a $12.6 million or 5.2% increase in non-fuel margin offset by a $2.8 million or 4% decline in fuel margin due to modest fuel behind declines and lower per gallon fuel margins in the 2018 second quarter. Site level operating expenses increased $1 million or 0.5% compared to 2017. Mark will provide more details on these changes in a moment. Property level rent coverage for the quarter was 1.69 times, up from 1.6 times in last year's quarter despite HPT's rent increasing 2.5% compared to 2017 due to prior investments.

Turning to performance at HPT's hotels, second quarter 2018 comparable RevPAR increased by 2% versus the 2017 quarter driven by our rate quote. Our relative underperformance versus the industry average reflects a combination of HPT's hotel rooms being concentrated in the upscale chain scale which had the lowest RevPAR growth of all chain scales this quarter, new hotel rooms supply growth, and an increase of some of our hotels under renovation. Comparable GOP margins were relatively flat versus the 2017 quarter and 43.7% has increased food and beverage profitability and lower IT expenses were offset by increased wage and benefit cost.

Aggregate coverage of annual minimum returns and rents at all of our hotels was 1.22 times this quarter down from 1.26 times in 2017. All of the comparable hotel renovations were soft good renovations through fresh lobbies and guest rooms and were funded from our FF&E reserves. Factors that positively impacted second quarter results included strong performance at our comparable full-service hotels, which benefited from improved group demand and increases in food and beverage revenues in particular at our IHG window mid-semester portfolios.

 Faced with only modest report growth in the 2018 quarter, our operators did a nice job of controlling expenses to help maintain margins. Our comparable Sonesta portfolio grew RevPAR 3.4% this quarter led by occupancy increases of 2.5 percentage points. Group revenue growth increased significantly at our comparable Sonesta portfolio in both the full-service and extended stay portfolios. Performances driven by ramp-up from the extended stay hotels that were acquired in 2015 and subsequently renovated. These hotels increased RevPAR by 5.9%. Comparable Sonesta portfolio GOP margin percentage improved by 145 basis points and cash flow available to pay our minimum return increased 5.3%. IHG's comparable hotel RevPAR increased 2.3%, driven by a 4.1% increase in rate partially offset by a 1.5 percentage point decrease in occupancy.

Excluding the Anaheim Holiday Inn, which had a pipe burst that caused 177 rooms to be out of service, our comparable full-service portfolio outpaced the industry this quarter with 5.3% RevPAR growth partially offset by supply driven weakness at our Candlewood extended stay hotels where RevPAR increased 0.2%. Comparable portfolio GOP margins remain strong at 44.8% and coverage was relatively flat from last year at 1.32 times. Our Marriott 234 portfolio report increased 1.6% while GOP margin percentage was approximately flat from last quarter.

Supply growth, non-repeat group business at certain TownePlace Suite hotels and renovation activity negatively impacted growth this quarter. Coverage of the required annual return to this portfolio is 1.3 times for the quarter unchanged compared to coverage this time last year. Our Marriott #1 portfolio report increased 1.3% year-over-year light in the industry average primarily due to hotel renovations and supply growth in the Boston and LA suburban markets. HPT's asset managers and Marriott are currently engaged in strategies to increase sale support in the Boston market and yield optimization in the LA market.

At 1.52 times coverage this quarter, Marriott #1 remains among our best cover agreements. Our Wyndham portfolio RevPAR decreased by 2.9%. Wyndham is investing in certain marketing measures to drive more business through its own brand platform and reduce reliance on higher cost OTHM. This caused retaliatory OTA dimming, which coupled with weak corporate negotiated demand and supply growth, resulted in RevPAR declines of the full-service hotels and our Hawthorn Suites. We believe these OTA challenges have now largely been resolved and with the spin-off in La Quinta transactions completed, we hope to see a renewed focus on our portfolio.

During the three months into June 30th, 2018, Wyndham continued to pay HPT 85% of the minimum returns due under the management agreement for approximately $1 million less than the contractual amounts due. Our comparable Radisson portfolio experienced a RevPAR decline of 0.6% driven by occupancy declines of 2.5 percentage points offset by rate increases of 2.8%. Renovation displacement in San Diego and Brooklyn Center accounted for the weaker performance.

Excluding these two hotels, RevPAR would've exceeded industry RevPAR gains led by strong group revenue growth. HPT's asset management team is working with Radisson on yield management plans to limit displacement on the remaining six hotels that will undergo renovations in the near future so that post-renovation they can shift share and maximize rate lift.

Turning to investment activities, on May 8th, the lease agreement for The Clift hotel was terminated. Morgan surrendered possession of the hotel through HPT and it was rebranded as The Clift Royal Sonesta Collection hotel and added to our management agreement with Sonesta. This hotel is in need of a significant renovation, which is scheduled to begin later this year and continue into 2020. In June, HPT acquired a 360-room Radisson Blu hotel in downtown Minneapolis for $75 million and added it to HPT's management agreement with Radisson. The hotel features 29,000 square feet of flexible meeting and event space and the FireLake Grill House and Cocktail Bar.

This hotel is a flagship for the Radisson Blu brand in the United States. This acquisition increases our Radisson portfolio to nine hotels and materially improved its quality. Also in June, HPT acquired a Staybridge Suites extended stay hotel with 117 suites in Baton Rouge, Louisiana for $15.75 million and added it to our management agreement with IHG. This hotel is located adjacent to the LSU campus, walking distance to many local restaurants, and is five miles from Baton Rouge's convention center.

Looking ahead, our managers continue to project that for 2018 we will experience growth through rate improvement, such that comparable RevPAR will increase 1% to 2% with GOP margin percentage in the flat to down 50 basis point range, largely due to increased wages and benefit costs. We will continue to see supply growth, renovation impacts, and wage-related cost pressures. The combination of active asset management, strong brands, good locations, and continued regular capital investment give us confidence that our operators will meet their projections. I'll now turn the call over to Mark.

Mark Kleifges -- Chief Financial Officer

Thanks, John. Starting with the performance of our travel center investments, property level EBITDAR in the 2018 second quarter was 7.8% higher than the 2017 quarter due primarily to increases in non-fuel revenues and non-fuel gross margin percentage. For the quarter, fuel gross margin decreased by $2.8 million or 4% primarily as a result of a slight decline in fuel sales volume and a lower per gallon gross margin in the 2018 second quarter. The fuel volume decline was due to the continued effects of fuel efficiency gains and increased competition partially offset by PA's fuel pricing and marketing strategies, while the decline versus the prior year in cents per gallon margin was due primarily to higher loyalty program costs.

Non-fuel travel center revenues increased 3.8% versus the prior year due primarily to growth in truck service and reserve parking and non-fuel gross margin percentage increased 80 basis points from the prior year quarter to 60.9%. As a result, our travel centers grew non-fuel gross margin $12.6 million or 5.2% versus the 2017 quarter to $255.7 million. And non-fuel sales generated approximately 79% of total gross margin dollars of our travel centers in the quarter.

Site level operating expenses increased 0.5% versus the prior year due primarily to increased labor costs associated with the increase in non-fuel revenues. Second quarter property level EBITDAR of our travel centers increased by approximately $8.7 million or 7.8% compared to the second quarter of 2017. Annual minimum rent coverage under our travel center leases was a strong 1.69 times for the second quarter compared to 1.6 times last year.

Turning to operating results at our 305 comparable hotels this quarter, RevPAR increased 2%, GOP margin percentage increased by 8 basis points, and cash flow available to pay HPT's minimum returns and rents increased by 1.3%. The 2% increase in RevPAR this quarter resulted from a 2.5% increase in ADR partially offset by a 0.5 percentage point decrease in occupancy. Excluding the impact of 11 hotels under renovation during the quarter, comparable hotel RevPAR growth was 2.3%. The portfolios with the highest RevPAR growth this quarter were our comparable Sonesta and comparable IHG portfolios with increases of 3.4% and 2.3% respectively versus the prior year quarter.

Our Wyndham and comparable Radisson portfolios had the weakest RevPAR performance with declines of 2.9% and 0.6% respectively versus the prior year quarter. Our Radisson portfolio had two hotels under renovation during the quarter. GOP margin percentage for our comparable hotels increased 8 basis points from the 2017 quarter to 43.7%. In gross operating profit increased approximately $6.1 million or 2.7% from the 2017 second quarter. Of our portfolios, the comparable Sonesta and Hyatt portfolios had the largest increases in GOP margin percentage in the quarter up 145 basis points and 96 basis points respectively. While our Wyndham and Marriott #1 portfolios had the weakest margin performance in the quarter with GOP margin percentage down 409 basis points and 34 basis points respectively versus the 2017 second quarter.

The growth in gross operating profit for our comparable hotels was partially offset by the $3.9 million or 6.7% increase in below the GOP line costs resulting in a $2.2 million or 1.3% increase in cash flow available to pay a minimum returns in rents versus the prior year quarter. The increase in below the GOP line expenses was due primarily to higher real estate taxes and insurance costs. The two portfolios with the largest percentage increases in cash flow were our comparable Sonesta and Hyatt portfolios with increases of 5.3% and 4.4% respectively. The two portfolios with the largest percentage declines in cash flow were our Wyndham and comparable Radisson portfolios with decreases of 16.7% and 3.6% respectively.

Cash flow coverage of our minimum rents and returns for our 305 comparable hotels improved slightly to 1.28 times for the 2018 quarter compared to 1.27 times for the prior-year quarter. Coverage for all 325 of our hotels declined to 1.22 times from 1.26 times in the prior year quarter due to 14 of our 20 non-comparable hotels undergoing renovations for all or part of the 2018 quarter. With coverage for the 2018 quarter above one times for all but two of our agreements, the balances of available security deposits and guarantees were replenished by $15.7 million during the quarter.

The balance of available security deposits and guarantees at quarter end was $227.4 million. Turning to HPT's consolidated financial results, normalized FFO was $176.2 million in the 2018 second quarter compared to $173.6 million in the 2017 quarter. Normalized FFO per share was $1.07 for the second quarter, an increase of $0.01 or 0.9% from the 2017 quarter. This increase was due primarily for the $8.6 million or 4.2% increase in minimum returns and rents partially offset by a $2.2 million decline in additional returns and a $3.6 million increase in interest expense. Adjusted EBITDA was $226.9 million in the 2018 second quarter, a 3% increase from the 2017 quarter. Our adjusted EBITDA to total fixed charges coverage ratio was 4.7 times for the quarter and debt to annualized adjusted EBITDA was 4.6 times at quarter end.

Turning to our capital improvement fundings and commitments, we funded $25.1 million of hotel improvements and $15.7 million of travel center improvements in the second quarter. For the remainder of 2018, we expect to fund approximately $145 million of hotel improvements and $22.8 million of travel center improvements. The majority of these improvements are expected to be funded from operating cash flow. We plan to have 29 hotels under renovation for all or part of the 2018 third quarter, 15 of which are comparable hotels. Turning to our balance sheet and financing activities, as of quarter end, debt was 41.2% of total gross assets and we had $89.8 million of cash including $73.3 million of cash as growth for future improvements to our hotels.

In May, we amended the credit agreement governing our $1 billion unsecured revolving credit facility and $400 million unsecured term loan resulting in a 10 basis point reduction of the libor premium on borrowings for both the credit facility and the term loan and extension of the maturity dates to 2022 and 2023 respectively. At quarter end, we had $122 million outstanding on our credit facility and no debt maturities until 2021. Operator, that concludes our prepared remarks. We'd like to open the call up for questions, please.

Questions and Answers:

Operator

Yes, thank you. We will now begin the question and answer session. To ask a question, you may press * then 1 on your touchtone phone. If you're using a speakerphone, please pick up your handset before pressing the keys. To withdraw your question, please press * then 2. At this time, we will pause momentarily to assemble the roster.

And the first question comes from Bryan Maher with B. Riley FBR.

Bryan Maher -- B. Riley FBR -- Analyst

Good afternoon, John and Mark. Regarding Morgans and the Clift property, are you just done with them now? Like, there's no more Morgans I need to read about in the releases or in the supplementals?

John Murray -- President and Chief Executive Officer

That's correct, yes.

Bryan Maher -- B. Riley FBR -- Analyst

And then regarding that property, what type of renovation work is gonna be done? How much do you think you'll spend and how long do you think it'll take?

John Murray -- President and Chief Executive Officer

The renovation will be extensive. There's a significant amount of façade work, building systems work, public space, and room renovations. So we expect to start with model rooms later this year. We've already been through the planning for that so that they're in the process of ordering the materials and building out the model rooms.

But because of how extensive it is, it probably won't be completed until sometime 2020. The permitting process is longly complicated in San Francisco as well so that's currently our best estimate. And we think that -- we're still working on developing the budget. A lot of the building systems are still being evaluated but it's gonna be at least $60 million.

Bryan Maher -- B. Riley FBR -- Analyst

And then we look at the occupancy year-over-year decline in the second quarter roughly two percentage points, I know some of that was related to renovations, some was new supply. Would you put the brake out of that 2%, how much would be renovation? How much would be supply? Just kind of a guess.

John Murray -- President and Chief Executive Officer

There was a pretty decent dip during May in occupancy at the Clift hotel associated with the conversion around Morgans to Sonesta but I would say that coupled with renovations was probably --

Mark Kleifges -- Chief Financial Officer

On the comparable portfolio, occupancy was just down 0.4 points. In the 20 non-comp hotels, it was down 20 or so points.

Bryan Maher -- B. Riley FBR -- Analyst

Yeah, it did. Thank you. On the Wyndham agreement, that seems to continue to be pretty soft. What are your thoughts there for those 22 hotels? At what point do you come to the conclusion that things aren't getting really better and you want them to and maybe it's time to think about a change? Clearly, you guys have put in place Sonesta for those types of purposes many years ago. What is the thought process internally on Wyndham? How long does that get to drag on?

John Murray -- President and Chief Executive Officer

Well, we have an agreement with Wyndham, which they are living up to, or both sides are living up to. So there's no unilateral right to do something different there. I think the properties that Wyndham started with and the properties that Sonesta started with right after the last recession were a pretty challenged group of properties. A couple of the properties in this portfolio are in markets like Houston and Dallas where they've had some challenges between weakness in the energy sector and the effects of some significant natural disasters in hurricanes. I think we're giving Wyndham the benefit of the doubt. I think it falls back to there being two main properties; Chicago and Hamilton Park in New Jersey that make up about half of the performance of that portfolio.

On the revenue side, the New Jersey property is ramping up well. This past quarter it had some issues on the expense side that need to be worked out. I think that long story short, that now that Wyndham has their spin-off done and now that they have their acquisition of La Quinta done, they have the ability to be a little bit more focused. And I think that they have, because of the larger scale, they have more levers to pull in terms of trying to apply different strategies to the Hawthorns than the full-service hotels to improve the performance. So I'm optimistic that we're gonna see things get better at the Wyndham portfolio in the second half. And I think that if Wyndham felt differently about it then they would be taking a different approach rather than just operating and continuing the way they have. So we're optimistic that we're gonna turn the corner there.

Bryan Maher -- B. Riley FBR -- Analyst

TA this week talked about a ramping up growth for TA Express properties, which I'm sure you know will be slightly smaller versions of what they have now. How interested is HPT in getting involved in the TA Express business and helping that to grow?

John Murray -- President and Chief Executive Officer

We don't presently have an interest in investing in TA Express properties. We haven't even seen one yet. We're not looking at TA sites generally to the extent we're looking to do more than complete the renovations in our hotel portfolio than we're looking at hotel acquisitions where we can do add-ons and try to improve existing portfolios. My impression is that the TA, while they may own some of those smaller scale travel centers but that that's gonna be a bit of an engine for a franchising portion.

Operator

Thank you. And once again, please press * and then 1 if you would like to ask a question. And the next question comes from Michael Bellisario with Baird.

Michael Bellisario -- Baird -- Analyst

Good afternoon, everyone. Just on the two hotel acquisitions. Could you maybe provide an underwritten EBITDA multiples or cap rights that you guys expect to earn in year one?

John Murray -- President and Chief Executive Officer

We underwrote the Radisson Blu as about an 8% cap rate on projected 2018 EBITDA and the ES Suites was underwritten -- I mean the Staybridge Suites, I'm sorry, in Baton Rouge was underwritten with about a 10.5% cap rate on 2017 actual cash flow.

Michael Bellisario -- Baird -- Analyst

That's helpful. And then, just on your one Hawaii property and that agreement. Maybe specifically, anything change to your thinking now that that hotel's finally above one times coverage for the first time in financial years?

John Murray -- President and Chief Executive Officer

We're very happy to see it above one times coverage after quite a bit of time. I think a lot of that is driven by the volcano on one island essentially shutting off tourism there. Also, an increased airlift into Kauai, which has definitely helped the hotel. And I think the fact that there's a number of resorts in the Caribbean that remain closed has also caused more travelers particularly from the east coast of the United States to decide on Hawaiian vacations.

So I think there's several different reasons why performance has improved. I think Marriott's done a good job managing our hotel there this year, there's no question about it. And their increased scale from having merged with Starwood is also beneficial. Whether that is a long-term change or just a shorter-term phenomenon remains to be seen. But in terms of the relationship between Marriott and HPT, we're in continued discussions regarding the future of that property but no resolution has been found yet.

Michael Bellisario -- Baird -- Analyst

And then, I assume there's no major impact just yet from M&A heads going on currently on the Marriott timeshare side?

John Murray -- President and Chief Executive Officer

No impact from that.

Mark Kleifges -- Chief Financial Officer

No impact.

Operator

Thank you. And as there are no more questions, I would like to return the call to John Murray for any closing comments.

John Murray -- President and Chief Executive Officer

Thank you very much for joining us today. We look forward to seeing some of you soon.

Operator

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

Duration: 31 minutes

Call participants:

Katie Strohacker -- Senior Director of Investor Relations

John Murray -- President and Chief Executive Officer

Mark Kleifges -- Chief Financial Officer

Bryan Maher -- B. Riley FBR -- Analyst

Michael Bellisario -- Baird -- Analyst

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