DiamondRock Hospitality Company (NYSE:DRH) Q3 2023 Earnings Call Transcript

DiamondRock Hospitality Company (NYSE:DRH) Q3 2023 Earnings Call Transcript November 1, 2023

DiamondRock Hospitality Company misses on earnings expectations. Reported EPS is $0.12 EPS, expectations were $0.23.

Operator: Good day, ladies and gentlemen. Thank you for standing by. Welcome to the DiamondRock Hospitality Third Quarter 2023 Earnings Conference Call. At this time, all participants are on a listen-only mode. After the speaker’s presentation, there will be a question-and-answer session. [Operator Instructions] Please note that today’s conference is being recorded. I’ll now hand the conference over to your speaker host, Briony Quinn, Senior Vice President and Treasurer. You may begin.

Briony Quinn: Thank you. Good evening, everyone. Welcome to DiamondRock’s Third Quarter 2023 Earnings Call and Webcast. Before we get started, let me remind everyone that many of our comments today are not historical facts and are considered to be forward-looking statements under federal securities laws. As described in our filings with the SEC, these statements are subject to numerous risks and uncertainties that could cause future results to differ materially from those expressed in our comments today. In addition, on today’s call, we will discuss certain non-GAAP financial information. A reconciliation of this information to the most directly comparable GAAP financial measure can be found in our earnings press release. With that, I’m pleased to turn the call over to Mark Brugger, our President and Chief Executive Officer. Mark?

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Mark Brugger: Thank you for joining us. Global travel demand remains strong. Annual hotel stays in the United States are expected to surpass the pre-pandemic record of 1.3 billion room nights, 2023 is also setting a new normal in hotel patterns as the changes to the way global citizens travel settles in post-pandemic. During this recovery, DiamondRock has been a leader, and we believe we are well positioned to outperform going forward. Our confidence stems from our high-quality portfolio. We have spent more than a decade renovating, repositioning and recycling our portfolio to curate a collection of hotels and resorts specifically designed to attract today’s travelers. By full year revenue, our portfolio remains approximately 60% urban and 40% resort.

An important aspect of our strategy, which distinguishes DiamondRock from its peers is that nearly 95% of our properties are unencumbered by long-term management contracts. This gives us greater control over operations at the properties and higher values upon sale. These portfolio advantages are a key element that enabled DiamondRock to deliver solid results. Total revenue for our portfolio in the third quarter is up 12% as compared to 2019 and just over flat to last year. We were pleased with these results, which were modestly ahead of our expectations. RevPAR in the third quarter contracted 1.1% as compared to the same period in 2022. Compared to 2019, RevPAR in the quarter was up 7.6%, which is more than 100 basis points ahead of the midpoint of our expectation.

While urban total RevPAR was up 2.9% in the quarter over last year, it was the sequential improvement in resorts that exceeded our expectations. As measured by total RevPAR, we saw strength at the Landing Lake Tahoe Resort up 15.2% last year. Tranquility Bay Resort in the Florida Keys, up 10.4% to last year and our luxury resort in Vail, up 9.3% to last year. Of course, some resorts continue to adjust and were down to the prior year, but we are encouraged that the year-over-year decline in our resort revenue improved 340 basis points sequentially from last quarter and are still nearly 26% higher than 2019. Moreover, we expect additional sequential year-over-year improvement in resort revenues for the fourth quarter. Overall, total revenues for DiamondRock’s entire portfolio in the third quarter were $277.1 million.

While up only modestly from 2022, it was still a new record for DiamondRock as it marked the highest third quarter revenue in the history of the company. This led to hotel adjusted EBITDA in the third quarter of $81.1 million, which was $6.6 million or 8.9% and ahead of 2019. It is worth noting that we achieved these third quarter 2023 revenue and adjusted EBITDA results despite about $2 million of disruption impact stemming from renovations at the Salt Lake City Marriott and Hilton Boston repositioning to the Dagny Okay. In reviewing the quarter, let’s look a little closer at the trends that we saw. At our urban hotels, year-over-year RevPAR increased 2.2% and exceeded 2019 by 2.1%. The group segment at the urban hotels was up modestly across the portfolio.

However, we did have several stars on the group side in the quarter. On a year-over-year basis, group business in the third quarter was terrific at the DC Westin, up 33%. The Westin Boston up 10.4%; the Westin San Diego, up 15.6%, the Worthington Fort Worth, Texas, up 15%; and the Phoenix Palomar, up high single digits. This strong group performance from our Stars was somewhat offset by lower group business from the softer convention calendar in Chicago this quarter, as we discussed last earnings call, along with the anticipated renovation impact from the Salt Lake City Marriott. Business transient in the third quarter saw demand increased 5.6% as compared to Q3 2022. Over the summer, the business demand landscape evolved quickly. We work closely with our operators to aggressively adjust and we were successful in executing on our revenue maximization strategies.

This BT strategy involves channel shifts and carefully calculated occupancy for rate trade-offs. As we move beyond Labor Day and into the fall, we are seeing gradual gains in business transient demand, but at levels that remain well below prior peak. For our resort portfolio, third quarter resort RevPAR increased nearly 24% over 2019 despite contracting 8.2% compared to last year. Encouragingly, the year-over-year quarterly decline in resort RevPAR improved a full 500 basis points from the prior quarter. Importantly, we expect that year-over-year quarterly comparable RevPAR will improve yet again in the fourth quarter as we settle into the new normal secular travel patterns for resorts. Clearly, resorts have been a big winner for DiamondRock.

In the third quarter alone, our resorts had adjusted EBITDA that was 23% higher than in 2019. Going forward, despite some near-term adjustments, it looks like resorts are likely to outperform the industry over the next decade from the acceleration and adoption of hybrid work in the U.S. Remember that there has been 2.7 billion more days of locational flexibility created post pandemic from the average worker being in the office 3.35 days per week from the prior 4.4 days per week in 2019. To put this into context, the number of nights of locational flexibility is two times the annual demand for all hotel rooms of all types in the United States and resort hotels specifically comprised just 10% of the existing supply. And resource supply in many of the resort markets is likely to remain near zero from legal restrictions like in Key West or the unavailability of developable land like Huntington Beach and Coastal California.

As you can tell, we remain constructive on the long-term outlook for resorts. Okay. Let’s turn to internal growth. While DiamondRock has always invested in its assets to keep them highly competitive, spending more than $0.5 billion over the last five years. One of our biggest competitive advantages is derived from the large number of high-impact ROI opportunities within the portfolio. These ROI projects drive cash flow and lead to outsized NAV increases. In the last 24 months, we have delivered on a number of projects, including the conversion and up-branding of the Hythe Vail to a luxury collection, the Clio Denver to a luxury collection, the Key West house to a Margaritaville and the Lodge at Sonoma to an Autograph. Those four hotels alone generated a collective RevPAR increase of 27.4% over 2019 in the third quarter, with the hotel adjusted EBITDA up 42.8%.

We will continue to benefit from the completion of these and a number of other recently completed ROI projects. In the last 36 months, we have executed a total of $58 million in ROI projects that touched more than a third of our hotels. The benefits of these projects often play out for several years, and we should continue to reap market share gains and increase profits that will bolster overall portfolio results. And we’re not done. DiamondRock has a strong culture of excellence that has driven our quest to identify and execute additional value-add ROI opportunities. For example, on August 1st, we announced the successful conversion of The Dagny Boston which marks our 15th independent hotel. The Dagny is projected to increase its EBITDA by $4 million next year and ultimately stabilize in excess of $15 million of annual EBITDA.

Additionally, we are actively underway with other ROI repositioning. The Hilton Burlington is in the process of being converted to a lifestyle hotel to be name, Hotel Champlain, a member of the Curio Collection. It is on track to be completed during the summer of 2024. The Bourbon Orleans is also underway with its repositioning to be The Premier Urban Resort in the French Quarter of New Orleans. This ROI project is expected to be completed late next year. And behind these, DiamondRock has a large pipeline of future opportunities. I’ll list just a few. At Orchards Inn Sedona, we are in the permitting process to move that hotel to a luxury level and make it part of the adjacent L’Auberge de Sedona Resort. The repositioning is projected to increase ADR there by $300.

At The Landing Tahoe, we have the opportunity to add almost 20% more keys. At the Chico Hot Springs Resort, we are evaluating adding more cabins on our 748 acre property. At Tranquility Bay, we are seeking permits to build DiamondRock’s first Marina with about 30 suites. These are just some examples and there are many more. So stay tuned. That’s a good transition to give you an update on the acquisition market. While Jeff will discuss our capital allocation options in a few moments, we have been disciplined in working to find more of the transactions that have worked so well for us. Owner-operated experiential hotels often in unique destinations, we have a deep well of understanding about unlocking value at these types of properties, which puts us in a great position to create value, when we can, pry them loose.

However, as we said last call, any deal we would do this year will have to be something we really love. Our one deal this year, the Chico Hot Springs Resort in Paradise Valley Montana certainly fits that deal. This independent owner-operated hotel has lots of upside opportunities. We bought it at an 8.1% NOI cap rate. And in the third quarter 2023, comparable RevPAR grew a robust 10.8% for our period of ownership. We project our investment in the Chico Resort will ultimately stabilize north of a 10% NOI yield, just from the implementation of our best practices and a modern revenue management system. While the Chico Resort was a special opportunity, we continue to vigorously work our proprietary database of opportunities with similar characteristics.

I should also mention that we are testing the market with a few potential dispositions, but we will remain disciplined with release prices. Now, let me turn it over to Jeff, for more details on the quarter.

Jeff Donnelly: Thanks Mark. Starting at the top, DiamondRock’s RevPAR contracted 1.1% in the quarter from the prior period, exceeding our guidance of a 1.5% to 2% decline. This better-than-expected performance was largely due to the improving performance of our resorts. Food and beverage and other revenues saw mid-single-digit growth, pushing same-store portfolio revenue up slightly versus last year. The growth in comparable total revenue breaks down between the 2.9% increase for our urban hotels and a 4.6% decrease in our resort portfolio. It is important to highlight, the steady improvement we are seeing in our resorts comparable total revenues at the resorts declined 8% in the second quarter, just 4.6% in the third quarter.

And in September, they declined only 2.8%. We expect this trend to continue in October. Compared to 2019, comparable total revenue at our urban hotels was 5.8% higher with steady mid-single-digit gains each month over the quarter. Comparable total revenue in our resort portfolio finished the third quarter nearly 26% above 2019 and September was the strongest month with nearly 32% in gross. Before I move on to profits, I want to spend a moment on the group segment. We expected group revenue gains in the third quarter to be softer than the strong results seen in the first half of the year. We discussed on our last conference call, this was mainly due to the shifts in the citywide calendar in Chicago. Third quarter group revenues were in line with our original expectation, but group room rates were slightly stronger than forecast.

We expect comparable group revenue will exceed 2019 levels this year, but we forecast group room nights will still be 10% or 79,000 room nights below 2019. Next year is shaping up to be very strong, with group revenue pacing up over 23% compared to the same time last year. Our footprint continues to serve us well. In our largest group markets, the Westin Boston’s group revenue is pacing up nearly 18%, and the Chicago Marriott is up over 40%. Several other stars on the group side are emerging. Group revenues at the Worthington, Westin D.C., Westin Fort Lauderdale and Westin San Diego are collectively up over 60% compared to the same time last year. We believe the strength and breadth of our group set up for 2024 is a unique advantage for DiamondRock.

Moving on to profits. Comparable gross operating profit or GOP was $111 million or a 4.2% margin on $277 million of comparable total revenue. To put this in context, this means our asset managers were able to keep same-store hotel operating expenses to just 1.4% growth, despite the disruption of Dianne and flat revenue. Hotel adjusted EBITDA was $81 million and a 29.3% margin and corporate adjusted EBITDA was $73 million. Hotel adjusted EBITDA margins were 210 basis points lower than third quarter 2022. The adjusted EBITDA comparisons were made more challenging mainly by two events that discussed on the last earnings call. First, disruption and displacement mainly at the Dianne; and second, the property tax relief in Chicago last year or not for these two factors, we estimate our hotel adjusted EBITDA margin would have been 170 basis points higher than reporting results.

Let me reconcile variances to the third quarter hotel adjusted EBITDA compared to 2022. The disruption and displacement shaved better than $2 million from the quarter, we had a successful tax appeal in Chicago in 2022. That resulted in a $2.8 million increase in our property taxes in the third quarter this year. Remember, we will face a $6.2 million increase in property taxes compared to last year in the fourth quarter. Our insurance policies renewed on April 1. So our third quarter results reflect a full quarter impact of higher costs, which was up $1.9 million over 2022. Finally, wages and benefits were up 2.8% year-over-year. Labor cost growth is slowing because we are fully staffed and wage inflation has moderated. You can see this trend in the sequential comparisons where second quarter labor costs rose 6.5% over the prior year versus just 2.8% in the third quarter.

These costs were offset by aggressive asset management initiatives that increased other income by 8.5% as the team aggressively pursued opportunities to rebid parking agreements, adjust resort fees and promote our spots. I’d like to point out a few stars in the quarter. The Dagny in Boston officially opened on August 1, and the on-site team has done a superlative job keeping the project on schedule and on budget and the hotel looks fantastic. Importantly, third quarter EBITDA was 5% ahead of our internal expectation after conversion. Collectively, our luxury resorts held EBITDA margins nearly flat despite the competitive pressures this season from Europe and cruise alternatives. For example, the Hythe in Vail posted a nearly 400 basis point EBITDA margin increase on a nearly 5% increase in RevPAR.

Returning to Boston. RevPAR at our Westin Seaport was up 7.6%, which is 4.8% higher than 2019. Moreover, the Westin had a very strong quarter for advanced bookings, helping us set up for a successful 2024. Tranquility Bay posted a 4.8% increase in RevPAR and a 10.4% increase in revenue in what is otherwise a slow seasonal period for the keys. As Florida returns towards historical seasonal patterns, our occupancy focused revenue strategy allowed us to drive year-over-year EBITDA growth and an EBITDA margin change that surpassed the portfolio average. The same strategy was successfully deployed at the landings in Lake Tahoe resulting in a 19% year-over-year increase in EBITDA and over 150 basis point margin increase. Finally, I want to point out that comparable F&B profit margins were excellent in the third quarter at 30.7%.

That’s 50 basis points better than in 2022 despite food inflation. By making smarter choices on the menu along with rigorous changes in competitive sourcing, we improved food costs year-over-year. We also had success growing beverage profits, too, with margins of 140 basis points. This was achieved from an increased focus on selling more profitable cocktails and utilizing lower cost providers. Let’s talk about capital allocation. We prioritize capital towards the highest IRR opportunities on a leverage-neutral basis. We constantly evaluate internal ROI projects, common and preferred share repurchases; and finally, external growth opportunities. Beyond the ROI projects Mark has already spoken about, in the past four months, we have repurchased over 1.8 million shares for approximately $14.7 million or $7.77 per share.

We are exploring dispositions, the proceeds of which can be used to fund additional repurchases, ROI projects or external growth. Regardless of the ultimate capital allocation, our focus is on maximizing shareholder value. We remain committed to having a flexible balance sheet. We are conservatively leveraged, as demonstrated by the low net debt-to-EBITDA ratio of 3.8 times trailing fourth quarter results. Our liquidity is very strong at over $0.5 billion comprised of $102 million in cash and an undrawn $400 million revolver. Importantly, our current liquidity is nearly 140% of our debt maturities through 2025 and nearly seven times our 2024 maturities. Let me provide a few building blocks on our 2023 numbers. Our corporate overhead remains on track to be around $32.5 million.

Debt service costs are expected to be about $63 million. Preferred equity dividends are at $9.8 million. I also want to note that Westin is rolling out its heavily bet 2.0 program. And by committing to the new betting package in the fourth quarter, we can secure a 30% price reduction. This will result in an expense of $1 million in the fourth quarter to better position our Westins in 2024. Looking ahead to 2024, we expect several expense comparisons to get easier as we put inflation field wage growth, rising staffing levels, a hard insurance market and property tax scrubs in the rearview mirror. With that, let me turn the call back to Mark.

Mark Brugger: Thanks, Jeff. Overall, travel trends remain solid, but the current environment continues to adjust as the market establishes its new normal in 2023. We expect fourth quarter comparable RevPAR to be approximately flat year-over-year. This represents a 100 basis point sequential improvement from the third quarter, largely due to improving performance at our resorts. We are also pleased that our current full year forecast is generally consistent with Wall Street analyst estimates. For 2024, while the US economy will certainly impact actual industry results, we believe that the industry has a potential to perform relatively well. This belief is based on a few factors. ADR is likely to increase at/or above inflation.

Corporate transient should continue to improve, albeit gradually, but with special corporate rates up mid to high single digits. Group demand should continue to stay strong as forward bookings nationally are solid. And finally, limited hotel supply in most markets provides a good backdrop for fundamentals. Now for DiamondRock, we like our particular set up. Let me give you a few specifics. First, we have room to run for our hotels to get back to prior peak occupancy, we expect to end 2023 about 5.5 percentage points of occupancy behind prior peak. Closing that gap is worth $57 million in incremental room revenue. Second, there is an opportunity on group. Our geographic setup is good for 2024 with terrific convention calendars in important markets for us like Chicago, DC and San Diego.

If group room nights just get back to 2019 levels, that is worth over $34 million in incremental room revenue and concomitant outside the room spend. As Jeff noted, DiamondRock has a strong group pace for 2024, up over 23%. And lastly, ROI projects will continue to fuel results. For example, the Dagny Boston repositioned in 2023 is expected to experience 50% profit growth in 2024 with EBITDA projected to increase $4 million. As you can tell, we remain constructive on the future of the travel industry. Travel is one of the highly valued assets in our society and around the world. And we believe that DiamondRock is well-positioned for this cycle with a model portfolio, focused strategy and ample liquidity to move opportunistically. At this time, we would like to open it up for any of your questions.

Operator: Thank you. [Operator Instructions] And our first question coming from the line of Austin Wurschmidt with KeyBanc Capital Markets. Your line is open.

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Q&A Session

Austin Wurschmidt: Thanks and good morning everybody. Just starting off, I wanted to clarify a couple of items around the recent trends in resorts you referenced, is the sequential improvement in resort performance. Is that a reacceleration in year-over-year growth that you’re alluding to? And does that include the Fort Lauderdale Kimpton Beach? And then separately, I’m just curious, is it fair to say that you think the normalization period in resorts is kind of starting to improve and that you expect it to reaccelerate again in 2024?

Mark Brugger: Yes, Austin, this is Mark. It’s a great question on resorts. I think it’s a mix. So at some resorts like the Florida Keys, we’re seeing stabilization. We’re also seeing easier year-over-year comps in some of the markets that started, I would say, correcting to the new normal patterns earlier. We’re getting into the comparable periods for those now. But there are other resorts that are, I would say, we saw good footing year-over-year, ones we called out. And we are adjusting some of the strategies, given the shift in some of the demands, so I would call out Lake Tahoe, our asset, the landing there, where we did some carefully calculated rate for occupancy trade, which led to substantial outperformance on revenues, but also more importantly, on profits.

So I think it’s a combination of all three. So it’s easier comps in some markets. It is some markets that are, I would say, stabilize or reaccelerating. But really, some of that is, I would say, more focused asset management revenue strategies being executed successfully.

Austin Wurschmidt: So if you were to stack up, I guess, the three segments of your business without pinpointing ’24 guidance between group, leisure, you mentioned kind of a gradual continued recovery in BT. I guess how would you rank those three segments as it stands today?

Mark Brugger: For 2024, we’re still just rolling up the budgets right now. So I think it’s a little early to give you kind of — we’ll know a lot more in 30 days after we’ve been through the budgets. I wouldn’t want to jump in before then through each of those.

Austin Wurschmidt: Okay. All right. Thanks for the time.

Operator: Thank you. Our next question coming from the line of Smedes Rose with Citi. Your line is open.

Smedes Rose: Hi. Thanks. It sounds like you just have some improved visibility, I guess into 2024 as the world kind of continues to normalize and some of the asset management tools that you’ve talked about. Would you consider at some point sort of reintroducing a more kind of formal guidance for the full year? Or are you thinking more in terms of just kind of giving some color around the next quarter as far as you’ve been doing?

Mark Brugger: Hey good morning, Smedes. I think as the world settles down, we’ll see where we are when we get to February. We’ll certainly have the discussion at the Board meeting. We’d like — right now, you have two wars going on. You have the uncertainty of the Fed going on and a number of other factors. Hopefully, by the time we get to February, things will be a little bit clearer and we’ll be able to do kind of give more forward outlook. But I think we’ll have to take it kind of one quarter at a time right now.

Smedes Rose: Okay. And then can I just ask you, I know it’s a relatively small piece of the overall portfolio, but it was the Lake Austin was a big quirky investment and I think when you bought it, you had expected this year’s contribution to be in the around $7 million. It looks like it’s running significantly below that. And I was just wondering what kind of went wrong relative to your initial forecast? And do you think it can reach the $7 million contribution at some point next year?

Mark Brugger: Sure. Yes, I think we’ve had a little bit of struggle in Austin sort of going from an owner-operated resort to more of an institutional set of revenue management tools, while we saw some falloff in high-end leisure demand. So, we’ve come back from a pricing strategy, that’s a little bit more occupancy. We’ve seen a lot of success there. And I think a lot of the things that we saw as opportunities going from an owner-operated resort in terms of increased group contribution and really group as a significant part of the segmentation, which has never really been there. We’ve seen a lot of inroads going. So, I think we’re still confident about our overall underwriting, especially on the on the group and through the connection to GDS, which didn’t previously exist. Just taking a little bit longer to implement, I think some of those revenue growth strategies that we saw at acquisition.

Smedes Rose: Okay. Thank you.

Operator: Thank you. And our next question coming from the line of Peter Laske [ph] with Evercore ISI. Your line is open.

Duane Pfennigwerth: Hey, this is actually Duane for Peter. How are you guys? Good morning.

Mark Brugger: Hey Duane.

Duane Pfennigwerth: As you think about trends into 2024, just a follow-up on an earlier question, which markets do you think have the most headroom, which ones would you expect to lag? You mentioned, I think, for a couple of quarters now, a good building convention calendar in a market like Chicago, how would you see that market kind of trending in total?

Mark Brugger: Yes. I mean I think the most visibility we have into 2024 is on the group side. So, we can look at the forward bookings at our hotels and the citywide convention calendars. So, if you look at Chicago, we’re up, as we mentioned, significantly over 40% in our — in revenues for next year of forward bookings and the city-wides are actually going to be ahead of and room nights ahead of 2019. So, that one feels very good. Boston is having a good year this year and next year is still supposed to remain significantly above 2019 levels in room nights. And our forward bookings there are low double-digits. That appeal is good as well. D.C. looks like it’s going to be outstanding, significantly ahead of where it was last year and 2019.

San Diego, kind of, same thing in another very good year substantially ahead of prior peak. So, all those markets are particularly attractive. Our forward bookings at our hotels correspond with the strength in those markets. So, that’s where the visibility is right now. We’ll go through the budgeting process at the individual hotels that really kicks off this week. And 30 days from now, a little much better sense having spent more time with properties and seeing those detailed budgets on how 2024 will shape up.

Duane Pfennigwerth: Thanks. And then just on the conversion to independent like The Dagny, can you talk about how your mix changes and any changes you see on distribution channels. For example, how much of the prior demand was staying on points and what do you backfill that demand with? And is it really as you convert to independent, is it really OTAs that pick up share when you transition to an independent? Thanks for the thoughts.