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Better Buy: Summit Hotel Properties vs. Sunstone Hotel Investors

Jul 21, 2020 by Matthew DiLallo

This year has been a horrendous one for the hospitality industry. Hotel occupancy rates plummeted in March because governments put restrictions on travel to slow the spread of COVID-19. That put significant pressure on the financial results of hotel operators as well as REITs that own hotels.

That's evident in the share-price plunges of Sunstone Hotel Investors (NYSE: SHO) and Summit Hotel Properties (NYSE: INN), which have tumbled about 45% and 55%, respectively, this year. Those selloffs likely have bargain-hunting investors wondering which one is the better buy these days. Here's a look at the bull and bear case for these hospitality REITs.

The case for and against buying Sunstone Hotel Investors

Sunstone Hotel Investors currently owns 19 hotel properties with 9,988 rooms in major U.S. gateway, convention, and resort markets operated by well-known brands like Marriott (NASDAQ: MAR), Hilton (NYSE: HLT), and Hyatt (NYSE: H). The company focuses on what it calls Long-Term Relevant Real Estate (LTRR), which are properties that have the following characteristics:

  1. Desirably located.
  2. Difficult to replicate.
  3. Enduring demand drivers.
  4. Stands the test of time.
  5. Generally owned fee simple.
  6. Superior economics for capital costs and owner profit.

These hotels tend to produce higher RevPAR and EBITDA per key than other hotels. Thus, Sunstone Hotel Investors believes it can generate higher returns from its properties.

The company complements its concentrated portfolio with a fortress-like balance sheet. The hospitality REIT entered the year with the lowest leverage ratio in its peer group at less than 1.5 times debt-to-EBITDA, well below the sector's 3.9 times average and its 2.5 to 3.0 times target range. It also had more than $900 million in cash and equivalents at the end of the first quarter, which it recently bolstered by selling one hotel for $80 million. That cash-rich balance sheet gives it ample flexibility to navigate the currently challenging market conditions and take advantage of acquisition opportunities that could arise during this downturn.

That liquidity has come in handy this year because Sunstone suspended operations at 14 of its then-20 hotels due to COVID-19. Meanwhile, the operating results of the six locations that remained open were extremely challenging: Total revenue plummeted 95.9% year over year in April as occupancy plunged from 86.4% to just 6.7%. Because of those brutal conditions, the company suspended its dividend to conserve cash. While hotel occupancy levels have improved over the past couple of months as states reopened their economies, the recent wave of new cases across the country could put renewed downward pressure on that number as more people opt to stay home.

The case for and against buying Summit Hotel Properties

Summit Hotel Properties owns a much larger portfolio consisting of 72 upscale hotels with 11,288 guest rooms. It focuses on "markets that matter," which are U.S. cities with favorable supply/demand dynamics and many hotel demand drivers. It owns premium branded hotels operated by companies like Marriott, Hilton, Hyatt, and InterContinental (NYSE: IHG). Those properties and brands tend to generate higher EBITDA margins and RevPAR than other hotel properties, which should enable Summit to earn higher returns for its investors.

Summit Hotel Properties supports its operations with a flexible balance sheet. It doesn't have any debt maturing until 2022. It also has a decent amount of liquidity, including $144.3 million of cash at the end of April and $150 million of borrowing capacity on its credit facility. That's enough funding to support its operations for about two years at its current cash burn rate.

The hope is that Summit Hotel Properties doesn't continue burning through cash but will soon start producing it as its hotels reopen and occupancy picks back up. That initially seemed likely as states began to open their economies. However, with COVID-19 spreading rapidly in many areas, some states are starting to pull back on their reopenings, which will likely weigh on hotel occupancy and Summit's results.

Cash is king

Shares of both Sunstone and Summit have the potential of bouncing back sharply once the COVID-19 outbreak is a thing of the past. Unfortunately, it will likely be quite some time before that happens, given the accelerated spread in the U.S. and the current vaccine timeline. Because of that, these companies could be operating in the red for several months. While both have lots of liquidity, Sunstone has an abundance of cash, which puts it in a stronger position to navigate the market's current challenges, including the flexibility to make acquisitions if the right deal comes around. That makes it the better hotel REIT to buy right now, in my opinion.

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Matthew DiLallo has no position in any of the stocks mentioned. The Motley Fool recommends Hyatt Hotels and Marriott International. The Motley Fool has a disclosure policy.

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