This year has been brutal for the hospitality sector. Government restrictions on travel and non-essential businesses to help slow the spread of the COVID-19 outbreak have had a significant impact on hotel stays, which has torpedoed profitability within the sector. That has put substantial weight on shares of most hotel REITs, including Apple Hospitality REIT (NYSE: APLE), which has seen its shares tumble more than 30% this year.
While industry conditions remain tough, some investors might see the sell-off in Apple Hospitality's stock as a buying opportunity. Here's a look at the case for and against buying the hospitality REIT these days.
The bull case on Apple Hospitality
Apple Hospitality owns a large and diverse portfolio of upscale, room-focused hotels. It currently has 233 hotels in 87 markets across 34 states, primarily consisting of two brands: Marriott (NYSE: MAR) at 104 hotels and Hilton (NYSE: HLT) at 126 hotels. Because of that, it caters more to business and recreational travelers.
Apple Hospitality believes its focus on select-service hotels has several competitive advantages. First, there's a reduction in:
- Rooms to fill.
- Space to manage.
- Dependence on groups.
Meanwhile, there's an increase in:
- Consumer demand.
- Ease of renovation.
- Lender and buyer appeal.
- Adaptability to change.
Because of that, these hotels generally earn higher profit margins than full-service hotels, upper-upscale hotels, and resorts. That leads the company to believe it can generate better returns for its investors.
Apple Hospitality complements its upscale, room-focused portfolio with a healthy balance sheet. It doesn't have any debt maturing this year and only has a small amount of property-level debt coming due next year. That provides it with the flexibility to navigate through the current challenging market conditions as well as continue making acquisitions and other growth-focused investments.
The bear case on Apple Hospitality
The biggest concern with Apple Hospitality is the impact COVID-19 is having on occupancy. After averaging 77% last year, and between 67% to 76% through early March of this year, Apple Hospitality's occupancy level plummeted to a low of around 15% by April. While it rebounded into the low-30s by the end of May, most market forecasters project a meaningful year-over-year decline in occupancy for the U.S. hotel industry this year of between 38% to 45.8%. They also expect significant decreases in the average daily room rate (ADR) and revenue per available room (RevPAR) of between 19.9% to 22.5% and 51.9% to 57.5%, respectively. While those same forecasters project a substantial rebound in those metrics for 2021, they don't anticipate anywhere near a full return to the 2019 level. Because of that, hotel earnings could remain under pressure for quite a few years, which could weigh on Apple Hospitality's results.
That outlook doesn't bode well for Apple Hospitality's dividend, which it suspended earlier this year. While that move will save it about $67 million a quarter, which will help prevent its balance sheet from deteriorating, it makes the company an unattractive option for most REIT investors who want a steady income stream. That could hold down its valuation.
Finally, a prolonged market downturn could also impact Apple Hospitality's long-term growth prospects. The company already terminated one hotel purchase agreement and plans to reduce its capital spending by $50 million this year. While the company has three other hotels under contract, it might not complete those transactions due to conditions in those agreements. If the company continues holding back on investments, it could impact its ability to grow earnings over the long term once market conditions improve.
There's too much uncertainty with this hotel REIT right now
The 30% decline in Apple Hospitality's share price might make it seem appealing to value-focused investors. However, it could be quite a while before the hospitality industry returns to stable footing. Because of both that and Apple Hospitality's current lack of a dividend, it's not an appealing buy for most REIT investors right now.
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