Pebblebrook Hotel Trust (NYSE:PEB) Q3 2023 Earnings Call Transcript

Pebblebrook Hotel Trust (NYSE:PEB) Q3 2023 Earnings Call Transcript October 27, 2023

Operator: Greetings and welcome to the Pebblebrook Hotel Trust Third Quarter Earnings Call. At this time, all participants are in a listen-only mode. A brief question-and-answer session will follow the formal presentation. [Operator Instructions] As a reminder, this conference is being recorded. It is now my pleasure to introduce your host, Raymond Martz, Co-President and Chief Financial Officer. Thank you. You may begin.

Raymond Martz: Thanks, Donna, and good morning everyone. Welcome to our third quarter 2023 earnings call and webcast. Joining me today is Jon Bortz, our Chairman and Chief Executive Officer; and Tom Fisher, our Co-President and Chief Investment Officer. But before we start, a reminder that today’s comments are effective only today, October 27, 2023, and our comments may include forward-looking statements under federal securities laws. Actual results could differ materially from our comments. Please refer to our latest SEC filings for a detailed discussion of potential risk factors and our website for reconciliations of the non-GAAP financial measures referred to during our call. Now let’s turn our attention to our Q3 results.

A luxurious resort hotel with a pool and beach in the backdrop.

We are pleased to report that despite two negative weather events and continuing entertainment industry strikes in L.A. We were able to achieve same-property hotel EBITDA, adjusted EBITDA and adjusted FFO at the top end of our outlook due to a continued recovery in corporate group and transient demand across many of our urban markets, and solid cost controls and gradually moderating expense environment. Washington, D.C. led the rebound with hotel occupancy surging an impressive 13.68% and RevPAR increasing 21.4% and this was closely followed by San Francisco, which climbed over 10 occupancy points, 72%, with RevPAR up 13.1%. In Los Angeles, our occupancy improved nearly 6 points to healthy 78%, with RevPAR growing 5%. Significantly, weekday occupancies at our urban hotels, a good bellwether, business travel demand, rose to a solid 75.4%, up from 72.3% in the prior year quarter and a meaningful recovery over last year.

Our urban properties also gained from a resurgence in leisure travel, particularly during the summer, bolstered by concerts and other leisure cultural events. Consequently, weekend, urban occupancies elevated to an impressive 82.3%, almost surpassing our weekend resort occupancy of 83.9%, which itself nearly 2 points higher than the prior year quarter. As a result, RevPAR at our urban hotels increased by 3% compared to last year’s third quarter. This improvement helped to offset moderating room rates and demand for suite and premium room upgrades, particularly in the leisure segment at our resorts. Sort RevPAR was down 10.2%, with occupancy flat. Resort rates continue to be on average about 40% or $111 higher than those in 2019. The resorts bore the brunt of the two weather impacts to their results would have been better otherwise less negative.

For the quarter, we recorded a marginal increase of 0.2% for same-property total RevPAR. While room revenue dipped by 1%, non-room revenue rose by 3% attributable to the benefit of recovering occupancy levels a persisting trend across our portfolio, along with continued healthy out-of-ring spend by our guests. The third quarter was not without its challenges, though. First, two named storms adversely affected demand on both coasts, triggering cancellations and curtailing bookings from mid-August through mid-September in several key markets. This led to an approximate 90 basis point decline in our RevPAR growth and saved an estimated $2.5 million of our same-property EBITDA. Second, West Los Angeles properties continue to feel the impact of their writers and actors strikes, which have notably dampened demand from the entertainment sector.

We estimate this caused a 30 basis point decline in RevPAR in the quarter and $0.5 million decrease in same-property EBITDA. While the writers have recently settled, the continuing after strike is expected to curtail demand in the LA market in Q4, which we have estimated and reflected in our Q4 outlook. Finally, the completion of the redevelopment of Solamar into Margaritaville, San Diego Gaslamp Quarter, coupled with extensive renovations as a guest house that at Southernmost, resulted in an approximate 45 basis point impact to RevPAR and a $1.4 million reduction in same-property EBITDA. These renovation-related disruptions are largely anticipated and aligned with our original Q3 outlook. Despite these hurdles and one-off weather events, overall portfolio occupancy continued its upward trajectory reaching the quarter at a healthy 75.4%, an increase of 2.5 points over year-over-year.

Our same-property EBITDA at $114.3 million hit the upper end of our Q3 outlook, with EBITDA margins at 29.4%, also at the top end of our expectations. These positive achievements were aided by prudent cost management strategies across all operating departments, as well as successful reductions in property taxes at several of our properties. Overall, wage rate pressures and other operating costs have notably eased as the year progressed as compared with the significant strains witnessed throughout 2022. The year-over-year growth rate in our total hotel operating expenses excluding property taxes has declined from 27.8% in Q1 to 10.2% in Q2 to 5.4% in Q3. And on a prorated by the room basis, they’ve declined from 7% in Q1 to 5.3% in Q2 and down to 1.8% in Q3.

We provided these numbers excluding property taxes, since they may vary materially on an unpredictable basis, as we are successful in winning reduced assessments and making multiyear true-ups, but these growth rates would have been even lower if we included property taxes. We expect further easing the growth of more normal course operating expenses, meaning excluding the noise from things like property tax drops or property insurance in the fourth quarter as we are lapping the success we’ve had restaffing in the last four months of last year. Energy expense growth also moderated to 10.7% in Q3, down from the nearly 14% spike experienced in the first half of the year. This reduction in the growth rate resulted primarily from our significant investments in energy and water conservation across the portfolio and some moderation and energy rates.

However, we continue to have energy contracts we locked in several years ago that will roll over at significantly higher percentage increases. As a result, this will keep our energy cost growth rate from a moderating in the next 12 to 18 months. Insurance costs were also a headwind, increasing 34.4% over the prior year quarter. On a monthly breakdown, the RevPAR in July dipped by 0.5%. August saw a 1.1% decline probably due to tropical storm Hillary, which made landfall on August 20, resulting in cancellations and reduced bookings at our 17 hotels in Santiago and Los Angeles. September RevPAR ended down 1.7%, partly due to Hurricane Idalia, which made landfall on August 30th, which increased cancellations and negatively impact bookings at our six resorts in the Southeast.

Our adjusted EBITDA and FFO benefited from business interruption proceeds of $10.9 million for LaPlaya, slightly exceeding our forecasted $10.5 million. Lower than expected G&A also contributed to our positive variances versus our outlook. During the third quarter, we deployed $33.1 million in capital investments across our portfolio with a significant portion related to two major redevelopments. The newly transformed market redeveloped San Diego Gaslamp, which occurred on August 15th and the $12.5 million redevelopment and substantial repositioning of the four guest houses comprising 50 guestrooms and suites at Southernmost Resort in Key West. Renovations of the guest houses at Southernmost are on track for completion in November. The public space renovations at Estancia La Jolla are scheduled to commence in November with completion expected in early Q2.

This marks the final phase of a 15-month-long comprehensive redevelopment and repositioning of Estancia, which began with a full guest room renovation. And our last major redevelopment project for 2023 involves the sweeping transformation of Newport Harbor Island Resort, which is set to commence on November 13th, with the closure of this property. We aim to complete this redevelopment in Q2 next year before the resort’s peak season. We remain on track to invest $145 million to $155 million in the portfolio for the year, and we’re pleased to report that the bulk of revenue disruptions and overall investment dollars associated with our strategic capital redevelopment projects are in the rearview mirror. We remain bullish about the substantial upside these repositioned properties will generate in both market share and cash flow in the foreseeable future.

Shifting focus on LaPlaya Beach Resort & Club in Naples, substantial strides continue to be made in the resorts ongoing repair and refurbishment. The 40-room Bay Tower and 70-room Gulf Tower, which accompanies resorts to key amenities like the lobby, restaurant and club, are substantially complete and full operational. LaPlaya is beginning to look like an upscale resort again. Rebuilding work on the 79-room beach house is now well-along with clear end in sight. We currently are forecasting this final portion of this resort to be substantially complete and reopened in the first quarter next year. This represents a delay from our prior year-end estimate due primarily to delays in permitting with accounting. Impressively, despite the absence of a full-fledged resort experience and the inevitable noise and disruption from very visible ongoing construction, the 110 guest rooms currently available across the two operational towers achieved a notable 50% occupancy rate and average daily rate of $389 during the third quarter, a seasonally slower period and is striking a 60% uptick over 2019 rates.

For context, it’s important to note that before the devastation brought by Hurricane Ian, we project the LaPlaya to contribute over $4 million in EBITDA for Q3 as opposed to the $0.2 million loss it actually incurred. This underscores the impact of the loss of the resort had on our financial results. And as a reminder, we currently exclude LaPlaya from our same property operating results. Regarding our Q4 outlook, we have not incorporated any additional business interruption or BI proceeds related to Q3 losses. Instead for LaPlaya, we anticipate that BI proceeds for lost income for both Q3 and Q4 in the current year will occur in 2024. As of the end of the third quarter, we have recorded approximately $33 million in BI related revenues. As part of our strategic capital reallocation strategy, we have entered into a contract to sell Hotel Zoe Fisherman’s Wharf for $68.5 million with the sale targeted for completion in Q4.

Assuming a successful closing, this will bring our total asset sales for the year to six properties, generating $300.8 million in gross proceeds year-to-date. All divested properties have been urban properties in line with our overarching strategy to rebalance the leisure and business segments of our portfolio for optimal long-term risk-adjusted returns. John will speak more about this strategy in his remarks. And on the capital allocation front, we did not purchase any common shares during Q3. However, we reduced our total debt and increased our cash position, while replacing $165 million loan secured by our Margaritaville Hollywood Beach Resort with a new secured loan of $140 million. This loan carries a three-year term extendable by two one-year options with a rate fixed at 7% for the issuing four-plus years.

Regarding our balance sheet and liquidity position, we have over $829 million of liquidity, comprised of $191.6 million in cash and $637 million available on our unsecured line. The weighted average cost of our debt is 4.4%, with 78% currently with fixed rates and 92% unsecured. Our increase in cash reserves and unsecured credit facility augmented by additional asset sales provided us with more than sufficient liquidity to navigate our upcoming debt maturities over the next 12 months to 24 months. And with that comprehensive update, I’ll like to turn the call over to Jon. Jon?

Jon Bortz: Thanks, Ray. I’d like to touch on three topics this morning. First, our observations on industry trends. Second, I intend to discuss our ongoing strategic capital allocation program and our continuing pivot from a heavy urban and business travel focused investment company to a more balanced portfolio, more evenly split between business and leisure and between urban and resort. And then third, I’ll talk about our outlook for the fourth quarter. In terms of industry trends, it’s fair to say the industry has seen a flattening out of the recovery in demand on an overall basis. In fact, the industry was unable to successfully absorb even the smallest amount of supply growth in Q3, with overall industry occupancy declining, albeit slightly in every month in Q3, a trend that continues from Q2.

We were surprised that this trend did not reverse in Q3. However, the revenge travel related to outbound international and cruising this year seems to have overwhelmed improving demand in business travel and international inbound travelers. We believe business travel both group and transient, continues to gradually recover. Leisure, on the other hand, has declined slightly as international outbound travel and cruising rebounded to above pre-pandemic levels. An international inbound travel, especially, leisure has only gradually returned. The leisure softness has primarily been reflected at resorts, while urban weekend occupancies have continued to recover. We believe next year, leisure will normalize at higher levels of domestic travel as we lap this revenge travel and international inbound continues its gradual recovery.

The resurgence in business travel we’ve seen is evident by the improving occupancies in the urban and top 25 markets, specifically during weekdays. This trend is particularly strong in the luxury and upper upscale segments, hotels, which are predominantly located in major cities. The STR data for Q3 shows a consistent softening of occupancies at the mid to lower end of the spectrum. We’ve not seen any evidence of trading down in the industry. In fact, the STR numbers show the weakest demand and worst performing properties are at the bottom end of the quality and price spectrum with the economy hotel category performing the worst. Geographically, in general, the previously slower recovery markets such as Chicago, San Francisco, Washington, DC and New York are now experiencing stronger demand growth and the earlier to recover markets such as Miami, Tampa, Orlando and Atlanta are witnessing weaker demand growth.

The top 25 markets continue to see increasing demand in occupancies while other markets continue to see declining demand in occupancies. Amidst this industry-wide stabilization of demand, ADRs in Q3 also displayed a moderating growth rate. So ADRs in September and so far in October have bumped up from the low points in July and August. None of these trends come as a surprise, and we don’t expect much change in these industry trends for the rest of the year. However, we do expect a modest boost in October’s performance due to the favorable calendar of the Jewish holidays this year following completely in September. Of course, given the Fed’s efforts to bring down inflation and slow the growth of the economy, we shouldn’t be surprised if we see a slowdown or a recession sometime in the next 12 months.

Now, I’d like to move on to a brief discussion of our capital investment strategies and our overall pivot to a more evenly balanced business and leisure demand mix. Our reduction in urban properties has been going on since 2016 when we began to sell out of New York. Prior to the LaSalle transaction in late 2018, we sold a total of seven properties for gross proceeds of $592 million and all of them were urban. Acquiring LaSalle added six unique resorts, all with significant repositioning upside. Simultaneously with the corporate transaction, we also disposed of five LaSalle’s urban properties for total gross proceeds of $821 million. Since then, we’ve sold 24 additional properties, including the upcoming sale of Hotel Zoe in San Francisco, all urban generating gross proceeds of an additional $1.725 billion.

In total, we’ve sold 36 urban properties since 2016 for over $3.1 billion. In 2021 and 2022, we acquired five leisure-focused resort properties and two guest houses in Key West, which were added to Southernmost Resort for a total of $822 million. Jekyll Island, Estancia La Jolla, Newport Harbor Island, and the two guest houses have and are undergoing extensive upgrades, repositioning, and operator changes that will drive significant upside going forward. This is on top of the very substantial investments in our other resorts, including Skamania Lodge, Chaminade, Mission Bay Resort, the Marker Key West, Southernmost Resort, L’Auberge Del Mar, and LaPlaya in Naples. And we believe all of these resorts, due to the investments we’ve made in upgrading them and re-merchandising them, will continue to gain market share, thereby enhancing cash flow.

So, from 2016 to today, we went from two resorts to 13 resorts, which also helped us increase the leisure mix within our portfolio. Today, we believe the business leisure mix in our portfolio is roughly 50-50. And assuming we sell additional urban properties over the next couple of years, we expect the leisure portion to edge slightly higher. We don’t think it will move a lot, as many of the urban properties we’ve sold or are selling, such as those in San Francisco, Portland, Seattle and Washington, D.C., have a strong leisure mix, as these markets are very attractive to leisure travelers. Moreover, most of the resorts we’ve been acquiring have very large business group components while their business and corporate transit mix tends to be more limited.

This helps explain the actual increase in our group mix overall in our portfolio as this pivot has continued. We believe this roughly 50-50 mix between business and leisure will serve us well in the years to come, as we believe the slowest to recover segment will continue to be business transit travel and we believe that secular trends favor leisure travel as well as group, particularly group in resort locations with significant outdoor meeting and events-based and numerous amenities, activities and experiences. As we move forward, we continue to focus on taking advantage of the public-private arbitrage opportunity that exists today. We’re selling urban properties in slower-to-recover markets with lower cash flows and within our individual property NAV ranges, and then using those proceeds to reduce our net debt and repurchase our common and preferred shares at very significant discounts to the NAV of the company.

Since the pandemic began, we’ve sold 14 properties, including the upcoming sale of Hotel Zoe in San Francisco for gross proceeds of $881.8 million at an average trailing 12-month NOI cap rate of 0.5% and a trailing 12-month EBITDA multiple of 105.8 times. We’ve generally sold our lowest quality properties in the slowest recovering urban markets, thus improving the quality and growth prospects of our remaining portfolio. We’ve sold five properties in San Francisco, two in Portland, two in Seattle, one in Nashville, one in New York, one in Coral Gables, one in Philadelphia, and a small retail property in Chicago. We believe strongly that taking advantage of the significant financial arbitrage opportunity, which is being funded by the sales of urban properties in slower-to-recover markets at attractive relative pricing, is by far our best capital investment strategy.

The opportunity available in the past year, including right now, represents a far better value creation opportunity for our shareholders than either using all of the proceeds to pay down our debt, which we believe is at a modest level or holding cash to take advantage of undefined opportunities in the acquisition market at an undefined time in the future. We just don’t believe any opportunities in the future will be more attractive or available at a bigger discount than buying our current properties at a 25% to 30% discount to their estimated current gross values and a 50% plus discount to the overall value of the company. Now, let me turn to our view of the near-term. As we look at the fourth quarter, October started out well with healthy business and leisure travel.

October is also benefiting from both Jewish holidays falling into September this year, versus them being split between September and October last year. This, of course, helps the performance of the entire industry. In addition, we have some favorable convention calendars in the fourth quarter in San Diego, San Francisco, Washington, D.C., and Boston, which benefit a significant portion of our portfolio. This is evident in the year-over-year pace for our fourth quarter, which shows robust growth in both group and transient business. Specifically, compared to a year ago, we have a 9.6% increase in room nights on the books at a 2.9% higher ADR, resulting in total revenues on the books substantially higher, up 12.8%. Breaking it down further, our group business on the books is particularly strong with a healthy 10.3% year-over-year increase in room nights, a very strong 7.5% increase in group ADR, and 18.6% growth in total group revenue.

Transient is not as strong, but is still very favorable with room nights and revenues up 9.1% and rates flat year-over-year. As a note of caution, about how our pace may ultimately translate into our performance, we need only to look at this past quarter. We had a great pace advantage going into the third quarter, but we experienced the deficit and pickup in the quarter for the quarter. We feel comfortable in saying that we believe this doesn’t represent a slowdown in business activity, but a normalization and booking patterns. We believe that more business is being put on the books further out, consistent with more normal pre-pandemic patterns as business and leisure customers have increasingly felt more confident looking further out as their comfort level grows, with pandemic-related concerns increasingly in the rearview mirror.

In Q3, we booked almost $10 million or 8.2% less in room revenues for the third quarter than we did a year ago. So, our 5.5% revenue advantage turned into a 1% deficit by the time the quarter ended. We expected this normalization of booking patterns as evidenced by our down 2% to plus 1% outlook. What we didn’t forecast was the impact from the negative weather patterns. So, while we’re very pleased and encouraged by the fact we’re almost $14 million ahead of the rooms revenue that was on the books for the fourth quarter at the same time last year, we expect a significant reduction in the PACE advantage over the course of the quarter. As a result, our outlook for Q4 RevPAR versus last year is forecasting growth ranging from 1% to 4%, which certainly compares favorably to our Q3 actual results.

As has been the case all year, we expect the bulk of this growth will be driven by increased occupancy. Our outlook for total revenues for Q4 is for growth of about 1.5% to 4.5% or approximately 50 basis points higher than our outlook for rooms’ revenue growth. So that completes our prepared remarks. We’d now like to turn to your questions. Donna, you may now proceed with the Q&A.

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Q&A Session

Operator: Thank you. The floor is now open for questions. [Operator Instructions] The first question today is coming from Dori Kesten of Wells Fargo. Please go ahead.

Dori Kesten: Thanks. Good morning. I think operating expenses, if you hold to the site, energy taxes insurance is in the 3% to 4% range for Q4, do you think that’s fair as a run rate for the medium term?

Tom Fisher: Hey Dori. Yes, I mean, I think that’s certainly in the ballpark. And obviously, the more — more volume we do, either in occupancy or food and beverage or other revenue activities. But there’ll be expenses that are tied to that, and we’ll see growth in expenses at a higher level. But as a baseline for sort of a stabilized operation, I think that’s reasonable.

Dori Kesten: Okay. And just within that, would you expect your total RevPAR to continue to outpace RevPAR?

Tom Fisher: Yes. Yes, we think — and in particular, we think as group continues to recover that volume will be apparent in our food and beverage revenues and many of our other revenues and that should also help with the margins on the F&B side.

Dori Kesten: Okay. Got it. Thank you.

Operator: Thank you. The next question is coming from Bill Crow of Raymond James. Please go ahead.

Bill Crow: Good morning. Jon, hopefully, you can hear me better than I can hear you.

Jon Bortz: Yes. Sorry about that.

Bill Crow: We talked about group for next year and the outlook and which markets might be the better markets, which ones might be the worst markets?

Jon Bortz: Sure. So currently, our pace for group for next year is positive. Let me see if I can pull it up here. So we’re — we’re currently sitting at a revenue pace advantage of about 14.4%. That is about 10.5% for group. It’s almost 30% for transient. Again, those are small numbers in terms of how much transient on the books, so the percentages should be ignored. But in total, we’re up 12.2% in room nights, 1.9% in ADR, 14.4% in total pace. Group is up 8.7% in room nights, 1.7% in rate and revenue on the books is up 10.5% year-over-year. The stronger markets next year include Chicago, San Diego and Washington, D.C. Boston will be probably flat on a year-over-year basis, but actually, it’s at a very high level for this year.

And then we see San Francisco, which is up in the first half of the year will be down substantially in the second half of the year with some of the cancellations that occurred over the last 12 months. So that’s, I think, how they generally break out within our portfolio.

Raymond Martz: And then, Bill, just a little of color on the convention calendars 2024 in D.C., the room nights on the books 2024 versus 2023 is up about 32%. San Diego is up about 17%. Chicago is up 13% and Boston and L.A. are flattish. And as we know San Francisco is down mostly in the second half of 2024.

Bill Crow: Yeah. Thank you. I just wanted to follow-up on the question that Dori asked earlier about the expense normalization. I know if she cut out property taxes, insurance and energy. But that’s kind of like how food and housing and CPI. So, where is expense growth? Where do you think it’s going to be next year? Are we looking at another year of, call it, 5% expense growth? And I guess the question I keep getting from investors is — at what point does 3% RevPAR growth translate into growing margins and EBITDA?

Jon Bortz: Well, you should ask them what their predictions are for inflation, because that’s really what’s driving the increases in the industry that we see I think the intent of cutting out those three categories was not to say they’re not important. It was because they tend to be more volatile on a year-over-year basis, particularly property taxes, which are volatile, not because of volatility on the part of cities raising the tax rates but because we tend to be unsatisfied with the initial assessments that we get because the cities are trying to keep as much revenue as they can, as you and I have talked about before, and as a result of that, it takes us one, two, three, four, five years, in some cases, to fight through the process to get successful appeals and reduced assessments.

And when that happens, it tends to have a multiyear effect on property taxes for those properties in terms of true-up because we’re accruing them at the levels generally that we get the bills at — and then we have reductions when we get those bills reduced. And so because of how long it takes. We also generally don’t know, and it’s hard to forecast when those things are going to occur. So as it relates to that one, when we look at next year, Bill, it will be likely a headwind for us from a expense growth perspective because we’re going to be coming off three quarters, the first three quarters of this year, where property taxes actually declined in our portfolio significantly because of reductions we got and true-ups that we got. So it doesn’t represent a run rate, because it’s being impacted by these true-ups.

Now, we hope we’ll get some true-ups next year. We don’t know when those processes will be successful. And we expect to get true-ups over the next three or four years, frankly, from these pandemic years when the assessments didn’t come down, but as we all know, the values have come down dramatically. So, we’ll have to come up with those numbers as it relates to the run rate on the property taxes and look at what percentage impact that will have on the overall revenues. But it will have some — it’s going to have some impact on an overall basis. Insurance, Ray, I mean, you can speak to that.

Raymond Martz: Yes. So Bill, we know insurance. The good news is we pretty much know what the cost is going to be here over the next couple of quarters because as part of our renewal on June 1 that — those rates did increase. So for the next couple of quarters to the second quarter, we know we’re continuing to have this as a headwind, and we’ll have to see what happens at the renewal. Now if you look back to what happened after Katrina, same thing happened where the rates got jacked up the year following Katrina, that stayed elevated for two years, it was a pretty benign storm environment. And then they started declining double-digit rates for a number of years. We refer those as the good years, by the way, as opposed to our insurance carriers.

So we’ll have to see what happens this year. Typically, property insurance, unlike other expenses tends to go up and down. So we could be looking a year from now, property insurance being lower than it is now, unlike things like wages and other costs that tend to be stickier and stay up there.

Bill Crow: Okay. All right. But it sounds like when you put all together, it’s likely that margins are probably going to have a tough time being flat next year just with all these fed wins. I mean maybe I misunderstood, but that would be my takeaway.