Service Properties Trust Q2 2024 Earnings Call Transcript

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Provided by Quartr
August 7, 2024

Key Takeaways

  • Portfolio RevPAR increased 1.6% year‐over‐year excluding hotels under renovation, led by a 13.8% surge in group room nights at Royal Sonesta properties.
  • Normalized FFO declined to $0.45 per share (versus $0.58) and adjusted EBITDAre fell 7.4% to $171.5 million, pressured by higher interest expense and renovation disruptions.
  • Completed a $1.2 billion senior notes offering at ~8.4%–8.7%, repaid all 2025 debt, now have no maturities until 2026 and an undrawn $650 million revolver.
  • Renovation program impacted Q2 with a $5.7 million hotel EBITDA decline from five hotels under refresh; 21 hotels will be under renovation in Q3 with expected short‐term revenue displacement but long‐term quality gains.
  • Declared a $0.20 per share dividend (44% of normalized FFO) yet reported a 110% trailing CALP payout ratio due to high CapEx and weaker EBITDA, which may prompt Board evaluation.
AI Generated. May Contain Errors.
Earnings Conference Call
Service Properties Trust Q2 2024
00:00 / 00:00

There are 7 speakers on the call.

Operator

Good day, and welcome to the Service Properties Trust Second Quarter 20 24 Earnings Call. All participants will be in a listen only mode. 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 Stephen Colbert, Director of IR.

Operator

Please go ahead.

Speaker 1

Good morning. Joining me on today's call are Todd Hargreaves, President and Chief Investment Officer Brian Donnelly, Treasurer and Chief Financial Officer and Jesse Abare, Vice President. Today's call includes a presentation by management 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 SEC. 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.

Speaker 1

These forward looking statements are based on SCC's present beliefs and expectations as of today, August 7, 2024. 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 filings with the SEC, which can be accessed from our website atsvcreit.com or the SEC's website. 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. In addition, this call may contain non GAAP financial measures, including normalized funds from operations or normalized FFO and adjusted EBITDAre.

Speaker 1

We are also introducing our calculation of cash available for distribution or CAD this quarter. Reconciliations of these non GAAP financial measures to net income as well as components to calculate AFFO are available in our financial reporting package, which can be found on our website. And finally, we are providing guidance on this call, including hotel EBITDA. We are not providing a reconciliation of this non GAAP measure as part of our guidance because certain information required for such reconciliation is not available without unreasonable efforts or at all. And with that, I'll turn the call over to Todd.

Speaker 2

Thank you, Stephen, and good morning. As Steven mentioned, Jesse Abare joined SVC in June as our Vice President. Jesse is also a Vice President at the RMR Group, where he leads the team responsible for the sourcing, underwriting, entitlement and leasing of all development projects managed by RMR. Welcome, Jesse. Now onto our results.

Speaker 2

During the quarter, we experienced RevPAR growth at our full service and select service portfolios, led by gains in our group and contract segments, while our extended stay hotels continue to be impacted by reduced occupancy related to longer term stays. While we are seeing a pullback in leisure travel, our 34 urban hotels outpaced the market with a 4.1% RevPAR increase. 8 of our top 10 performing hotels from a top line perspective in terms of year over year improvement were Sonesta full service hotels, much of which was driven by group and our urban concentration, while our bottom performing hotels were either under renovation during the quarter or experienced softer transient demand due to non repeat market specific events in markets such as Chicago, Nashville and Atlanta. Portfolio wide, performance was affected by revenue displacement at our hotels that were under renovation during the quarter. Excluding the renovation properties, portfolio RevPAR increased 1.6% year over year, led by occupancy, which improved by 1.7 percentage points and was highlighted by a 13.8% increase in group room nights at our Royal Sonesta Hotels.

Speaker 2

Moving to performance by service level. Our full service portfolio experienced top line gains in our group and contract segments, where RevPAR increased 10.6% and 5.5%, respectively. This was offset by a decline in transient RevPAR of 3.5%, resulting from market softness and renovation displacement. Excluding the 5 hotels under renovation, our full service portfolio RevPAR increased by 2.9% year over year, outpacing the industry. Increased group revenues at our Sonesta branded hotels in Cambridge, Washington DC, Redondo Beach and Denver, as well as our Radisson Managed Hotels in San Diego and Seattle contributed to the improvement and the increased group demand led to higher M and B revenues, which increased $1,200,000 during the quarter.

Speaker 2

Notably, we experienced outside RevPAR growth in some of the hotels and markets that have been most challenged, including 38% growth at our Royal Sonesta Minneapolis and 34% growth at our Royal Sonesta in Seattle. Our extended stay portfolio experienced a 1.6% decline in RevPAR year over year. Consistent with the trend from previous quarters, our longer term extended stay occupancy has been decreasing with notable declines experienced in our hotels in Salt Lake City, Portland, Oregon and Dallas. Performance at our select service hotels was led by our Sonesta Selects reporting increased RevPAR of 3.3% year over year, led by our contract segment at our hotels in Philadelphia, Nashville and Atlanta. Hotel operating expenses impacted margins during the second quarter due to cost increases in insurance premiums and deductibles, as well as labor, our largest expense representing 44% of total OpEx, where we realized a 5.5% increase year over year on a per available basis.

Speaker 2

Segmentation is shifting away from transient towards the group, which now represents 20.8 percent of total revenues, up from 19.3% during the previous year quarter and group pace is up 11.9% from the same time last year with strong contributions across all our operators. Tenesa has made progress on this brand building initiatives measured by its TravelPass revenue mix, which increased 8.6 percentage points in the full service portfolio to 29.4 percent and TravelPass on property enrollments are up 7% year over year. Turning to our net lease portfolio, which represents 44 percent of SVC's portfolio by investment. As of June 30, 2024, our 7 49 service oriented retail net lease properties were 97.3% leased with a weighted average lease term of 8.4 years. Our lease maturities are well laddered and only 3.4% of our net lease minimum rents expire before 2026.

Speaker 2

The aggregate coverage of our net lease portfolio's minimum rents was 2.25 times on a trailing 12 month basis as of June 30, 2024. The decline from the previous year quarter results from the lower EBITDAR reported by TA and increased TA rents. As an update to our previously announced 22 non core planned hotel dispositions, subsequent to quarter end, we closed on 2 hotels at an aggregate sales price of $10,800,000 and are under purchase and sale agreement to sell 16 hotels for $113,200,000 We are either marketing or negotiating contracts for the remaining 4 hotels, which have an aggregate net book value of $23,000,000 In conclusion, we expect our hotel portfolio to benefit from the needed renovations, although we may see mixed results due to revenue displacement until they are completed. Ultimately, these refreshed properties combined with the anticipated removal of some of our more challenged hotels as sales are completed will allow Sonesta to focus on offering a higher quality portfolio and improve our market share. Furthermore, our balance sheet is well positioned with no debt maturities until 2026, and the performance of our net lease portfolio remains strong and is anchored by an investment grade rated tenant in BP.

Speaker 2

I'll now turn the call over to Brian to discuss our financial results in more detail.

Speaker 3

Thank you, Todd, and good morning. Starting with our consolidated financial results for the Q2 of 2024, normalized FFO was $73,800,000 or $0.45 per share versus $0.58 per share in the prior year quarter. Adjusted EBITDAre declined 7.4% year over year to $171,500,000 Financial results this quarter as compared to the prior year quarter were impacted by higher interest expense and lower hotel EBITDA. Results from our net lease portfolio remain consistent year over year. For our 218 comparable hotels this quarter, RevPAR decreased by 20 basis points, gross operating profit margin percentage declined by 170 basis points to 32.7 percent and gross operating profit decreased by $5,900,000 from the prior year period.

Speaker 3

Below the GOP line costs at our comparable hotels increased $6,300,000 from the prior year, driven primarily by increased insurance expense along with higher real estate taxes as a result of favorable tax appeals that benefited the prior year quarter. Our 2 20 hotels generated hotel EBITDA of $82,400,000 a decline from the prior year of $11,000,000 but in line with our guidance range provided last quarter. High service level hotel EBITDA year over year decreased $5,000,000 for our 48 full service hotels, declined $1,900,000 for our 61 select service hotels and $4,000,000 for 111 extended stay hotels. For the 21 hotels that were under renovation during the quarter, hotel EBITDA declined $5,700,000 Turning to our expectations for Q3, we're currently projecting full quarter Q3 RevPAR of $94 to $97 and hotel EBITDA in the $65,000,000 to $69,000,000 range. To the balance sheet, during the second quarter, we successfully executed on a new $1,200,000,000 senior notes offering comprised of $700,000,000 of 8.38 notes due in 2029 $500,000,000 of 8.7eight notes due in 2,032.

Speaker 3

We repaid all $1,200,000,000 of unsecured notes that was scheduled to mature in 2025. Interest expense is projected to be $99,200,000 for Q3 of 2024 as a result of these financings. We currently have $5,700,000,000 of rate debt outstanding with a weighted average interest rate of 6.4% and no debt maturities until February 2026. Our $650,000,000 revolving credit facility remains undrawn. Turning to our investing activity, we made $66,000,000 of total capital improvements at our properties during the Q2 comprised of $22,000,000 of recurring capital and $44,000,000 related to our hotel renovation program.

Speaker 3

We continue to expect full year capital expenditures of $300,000,000 to $325,000,000 We expect 21 hotels across all our service levels to be under renovation in the Q3 and we will have completed major renovations at 34 hotels during the full calendar year, including 5 full service hotels, 18 select service hotels and 11 extended stay hotels. Subsequent to quarter end, we sold 2 hotels and 3 net lease properties for $12,600,000 of total proceeds. We currently have 18 hotels with a carrying value of $97,000,000 and 10 net lease properties with a carrying value of $6,000,000 remaining as held for sale. The 22 hotels sold or to be sold as of June 30, 2024 generated losses of just under $1,000,000 for the 2nd quarter. In July, we announced our regular quarterly common dividend of $0.20 per share, which represents a normalized FFO payout ratio of 44%.

Speaker 3

This quarter, we have introduced our calculation of CAD in our earnings presentation. For the trailing 12 months ended June 30, 2024, our CAB annualized payout ratio was 110% as a result of our elevated CapEx spending, higher cost of capital and declining hotel EBITDA. That concludes our prepared remarks. We're ready to open the line for questions.

Operator

We will now begin the question and answer session. The first question comes from Bryan Maher with B. Riley. Please go ahead.

Speaker 4

Thank you and good morning. Just a few for me today. Can you talk a little bit about the actual and or expected return on capital of the CapEx spending and how you think about that relative to just selling a particular hotel and avoiding that CapEx altogether?

Speaker 3

Sure, Brian. Good morning. I'll start and let Todd weigh in on some of the sales decisions. When we deploy CapEx, the CapEx is really as we've tried to show in our calculations recurring versus call it non recurring renovations or redevelopment or repositioning. The repositionings and redevelopments, we've talked about this in prior calls or investor conferences where we target around an 8% return on average.

Speaker 3

Some will do better, some might come in a little bit under that depending on the market or the type of work we've done. And we're starting to see some of the progress. We don't have enough volume yet to definitively say we're meeting or exceeding that. There are some that are and some that aren't. It really depends on what's going on in the overall macro environment as well.

Speaker 3

So it's not always easy to measure, but what we do is we look at a period prior to doing any renovation work, let the hotel stabilize for a period and then see where we are from a return standpoint. Sure. And I'll add

Speaker 2

to that. When we're looking at potential sale candidates in the portfolio, that's one of the primary things we look at is, do these hotels need capital? What is the expected lift in terms of market share RevPAR and EBITDA that we're going to get from putting this money in? If we don't think we're going to get the appropriate return, that could factor into our decision to put a hotel on the sale list. So it's just one of the many factors that we consider.

Speaker 4

And how deep is the buyer pool that you're speaking with? Who are these people? At what point do you stop selling? And do you have some kind of optimal mix in your heads as to how much full service you want to have versus how much select service? I mean, I guess what I'm asking is kind of where is the end game here?

Speaker 2

Sure. So we're in the midst of selling the 22 hotels now. We've closed on a couple and a number of others are under purchase and sale. And that's on the heels of the 68 Sonesta hotels we sold back in 2021 2022. I'll take it in pieces here.

Speaker 2

The first question in terms of the buyer pool, most of the hotels that we're selling are negative EBITDA producing hotels. They're towards the lower end of hotel quality and market, I would say, in our portfolio. Most of the buyers that are looking at these hotels are the hotels are losing money, so they're not looking at it on a in place cap rate, obviously. They're looking at it on a price per key basis and they'll look at it on a total cost. Most of these hotels are in need of a renovation.

Speaker 2

If they're sold and encumbered of a Sonesta franchise or if they're going to go to another brand or there's typically a PIP that they'll need to do. So that typically gets added on, I'd say, anywhere from 25,000 to 40,000 a key depending on which hotel. So most of these buyers are looking at it as they're pricing it on a stabilized return on cost basis. My guess is anywhere from 8% to 10% on a non levered basis, probably mid teens return on a levered basis. Most of these groups are local operators.

Speaker 2

Most of what we're selling are select service and extended stay hotels. We have a handful of full service in there as well. But most of these are local operators that 2, 3, up to 5 hotels in their portfolio. They're going to be very focused on driving local business and have a business plan that they can operate it better than a national operator like Sonesta or one of the larger brands. In terms of the ultimate mix for us, I'd say over 95% of what we sold or are selling are either select service or extended stay hotels.

Speaker 2

We've sold a couple of full service hotels as well, but we're not selling any of the Royal Sonesta branded hotels. I think we're trying to shift the mix more toward away from business, more towards leisure oriented hotels that Sonesta has proven the ability to compete or outperform the market. If you look at our Royal Sonesta Hotels in the past two quarters, quarter 1, we saw RevPAR increase over 6% year over year. This quarter, we saw it increased 3.3% year over year. So we're just trying to shift the mix more towards leisure oriented hotels away from business.

Speaker 2

So that's some of the rationale behind why we're selling what we're selling. There may be more coming. We haven't identified any yet. We're in the market with these 22, but there could be more coming next year as we get more data points, as we get more history on the performance, as we see the results of some of these renovations and the success we're having, the success we're not having that could lead to selling additional hotels as well. And part of the rationale and what we look at too is what market are we selling into.

Speaker 2

Right now, it's still very challenging to get any transaction done. Hopefully, or potentially, we see some relief in terms of interest rates, which should lead to more transaction activity and easier time selling hotels. But right now, we're selling what we think we can get done, and that comes into the equation as well.

Speaker 4

Okay. Just last for me. We're getting a lot of calls and emails on the dividend and we appreciate the CAD publication information to kind of cross check versus our model. Is it fair to say that the CAD payout is above 100% because we're only capturing kind of the stronger second quarter, Q2, Q3 strong, Q4, Q1 weak. And as we get past 3rd quarter that the CAD payout ratio will be back under 100%.

Speaker 4

And just any general thoughts on the dividend here would be helpful. And that's all for me. Thank you.

Speaker 3

Sure, Brian. I know it's been a lot of focus for a lot of people. The kind of calculation, as I said in my prepared remarks, is over 100% on a trailing 4 quarter basis. The CapEx spend, even just the recurring CapEx that we deduct out of that calculation is still pretty high, it will be for the foreseeable future. Our Board will continue to evaluate the dividend level.

Speaker 3

Consider, we talk about many factors, including the performance outlook of the portfolio, looking at our leverage, our liquidity needs and other points that matter. So we'll continue to evaluate it ongoing as we have continuously done. So I would say that.

Speaker 4

Thank you.

Operator

The next question comes from Dorey Kestin with Wells Fargo. Please go ahead.

Speaker 5

Thanks. Good morning. If you think about your expectations back in the beginning of the year, has the recovery in business transient been in line with better than or softer than you

Speaker 2

expected? Hi, Dorey. I think it's been relatively in line. I think we started to see a little bit of Some of that Some of that is due to some displacement at some of our business oriented hotels that in our portfolio as well. I would say it's somewhat as expected, maybe slightly lower.

Speaker 5

Okay. And then during prior multiyear renovation programs that you've gone through, the portfolio RevPAR growth tends to lag the chain scales in U. S. In the years you're doing the program and then outperform in the following several years. Is there anything different about the timing or the extent of this program that could allow you to outperform earlier, such as bigger or higher return projects being front end loaded?

Speaker 2

I wouldn't say Brian, you can weigh in too. I wouldn't say there's any major difference this time around than other times around. A lot of the hotels that we're doing now are full service hotels like Sonesta, Hilton had, which may take longer to do. But I don't see I don't think the lift in terms of RevPAR gain in market share is going to be any different than it's been in prior cycles.

Speaker 5

Okay. And then my last question, the results implied at Senesna this quarter, just based on your ownership stake, seemed to be much lower than we were expecting. Was there anything one time flowing through there this quarter? Or are there incremental near term costs flowing through that for longer term gains? I'm just wondering if there was anything specific to this quarter you'd note.

Speaker 3

There's a couple of things Dory. Similar to what we're doing, Sonesta also owns hotels directly. They have a large portfolio in New York and some of those have been under renovation. They've been using construction loans to fund that. So there's additional cost there.

Speaker 3

They're also spending more on sales and marketing and then other initiatives at the corporate level that have affected the bottom line. So those are really the driving factors.

Speaker 5

Okay. Can you comment on, I guess, the timing of that and when you would start to see more of an uplift?

Speaker 3

I think that there's a handful of properties that will finish up this year. There's pretty extensive work going on and New York doesn't always move the fastest as far as projects. But I think they'll also have to look at the financing side too and where we're at in the market.

Speaker 2

Yes. The displacement for the New York hotels, that should be over shortly. They've met the Benjamin Hotel. The room renovations are substantially completed. As Brian mentioned, some of that was there's a loan in place where those renovations are being funded with that loan.

Speaker 2

But I think you should see that noise start to come off in the coming quarters.

Speaker 6

Question on the extended stay hotels in the portfolio during the quarter. Occupancy has been down a couple of quarters in a row. Can you just talk a little bit more about what's going on? I'm not sure if there's maybe some market specific issues that play or perhaps just the strong growth in prior years, just making comparisons a little bit challenging?

Speaker 2

Hi, Tyler. That is the service level unit on it. That is the area where we've seen somewhat of a pullback and we started to see this last quarter as well. And what we're seeing is a lot of non repeat longer term extended stay business, true extended stay business at those hotels. So we classify those into 4 different tiers.

Speaker 2

You have the Tier 3 that's 15 plus room 15 plus nights or longer. The Tier 4, which is 30 plus room nights or longer. And you really need that business for those hotels to succeed. And what you've seen in our portfolio is some of that project related business that stays for those longer period of times has been non repeat this year for one reason or another. We saw it in Q1 as well.

Speaker 2

And what you have to do there in terms of backfilling that occupancy is you have to rely on the OTAs to fill out those transient rooms, any stays of 1 to 6 nights. And that's been impacting ADR because you're paying fees associated with those OTAs. So there's a handful of hotels specifically in the ES Suites portfolio that where we've seen the losses concentrated in. If you look at Simply Suites, we actually saw an increase in RevPAR year over year, but it's really related to a handful of project related business at some of the suites.

Speaker 6

Okay. And then to follow-up on the guidance, if I'm doing my math right, it looks like at the midpoint RevPAR up 1% year over year roughly, EBITDA hotel EBITDA down double digits close to 10%. So did I do that correctly? And then just talk a little bit more about what's going on the EBITDA side of things in Q3, how much is that renovation disruptions that's impacting that number too?

Speaker 3

Sure. Yes, you're doing the math correctly, Tyler. And as we look at Q3, and as I said in my remarks, we expect to have 21 hotels under renovation. Again, that's probably half of the expected decline, similar pattern we had in Q2. The 21 hotels we had under renovation this quarter declined $5,800,000 So it was a big part of the year over year change.

Speaker 3

So that trend will continue into Q3. We'll continue to see some seasonal shifts as well, especially as we get into the latter half into Labor Day holiday similar year over year in the prior year. So we'll see similar seasonal trends as well.

Operator

This concludes our question and answer session. I would like to turn the call back over to Todd Hargraves for any closing remarks.

Speaker 2

Thank you, everyone, for joining today's call. We appreciate your continued interest in SVC.

Operator

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

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