Service Properties Trust (NASDAQ:SVC) Q2 2024 Earnings Call Transcript

Service Properties Trust (NASDAQ:SVC) Q2 2024 Earnings Call Transcript August 7, 2024

Operator: Good day, and welcome to the Service Properties Trust Second Quarter 2024 Earnings Call. [Operator Instructions] Please note, this event is being recorded. I would now like to turn the conference over to Stephen Colbert, Director of IR. Please go ahead.

Stephen Colbert: Good morning. Joining me on today’s call are Todd Hargreaves, President and Chief Investment Officer; Brian Donley, Treasurer and Chief Financial Officer; and Jesse Abair, 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 SVC. 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. These forward-looking statements are based on SVC’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 at svcreit.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. 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.

Todd Hargreaves: Thank you, Stephen and good morning. As Stephen mentioned Jesse Abair joined SVC in June as our Vice President. Jesse is also Vice President at the RMR Group, where he leads a team responsible for the sourcing, underwriting, entitlement and leasing of all development projects managed by RMR. Welcome Jesse. Now on to our results. 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. Eight 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 nonrepeat 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. 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 five 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 F&B revenues, which increased $1.2 million during the quarter. Notably, we experienced outsized 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 Select, reporting increased RevPAR of 3.3% year-over-year, but 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 and where we realized a 5.5% increase year-over-year, on a per available room basis. Segmentation is shifting away from transient towards the group, which now represents 20.8% 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.

Sonesta 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% and TravelPass on-property enrollments are up 7% year-over-year. Turning to our net lease portfolio, which represents 44% of SVC portfolio by investment, as of June 30, 2024, our 749 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. 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 EBITDAre reported by TA and increased TA rents.

As an update to our previously announced 22 noncore planned hotel dispositions, subsequent to quarter end ,we closed on two hotels at an aggregate sales price of $10.8 million and are under purchase and sale agreement to sell 16 hotels for $113.2 million. We are either marketing or negotiating contracts for the remaining four hotels, which have an aggregate net book value of $23 million. 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. I will now turn the call over to Brian to discuss our financial results in more detail.

Brian Donley: Thank you, Todd and good morning. Starting with our consolidated financial results for the second quarter of 2024, normalized FFO was $73.8 million or $0.45 per share versus $0.58 per share in the prior year quarter. Adjusted EBITDAre declined 7.4% year-over-year to $171.5 million. 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 remained 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% and gross operating profit decreased by $5.9 million from the prior year period.

Below the GOP line costs at our comparable hotels increased $6.3 million 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 220 hotels generated hotel EBITDA of $82.4 million, a decline from the prior year of $11 million but in line with our guidance range provided last quarter. By service level, hotel EBITDA year-over-year decreased $5 million for our 48 full-service hotels, declined $1.9 million for our 61 select service hotels, and $4 million for 111 extended stay hotels. The 21 hotels that were under renovation during the quarter, hotel EBITDA declined $5.7 million. Turning to our expectations for Q3, we’re currently projecting full quarter Q3 RevPAR of $94 to $97 and hotel EBITDA in the $65 million to $69 million range.

Turning to the balance sheet. During the second quarter, we successfully executed on a new $1.2 billion senior notes offering comprised of $700 million of 8.375% notes due in 2029 and $500 million of 8.775% notes due in 2032. We repaid all $1.2 billion of unsecured notes that were scheduled to mature in 2025. Interest expense is projected to be $99.2 million for the third quarter of 2024 as a result of these financings. We currently have $5.7 billion of fixed rate debt outstanding with a weighted average interest rate of 6.4% and no debt maturities until February 2026. Our $650 million revolving credit facility remains undrawn. Turning to our investing activity. We made $66 million of total capital improvements at our properties during the second quarter comprised of $22 million of recurring capital and $44 million related to our hotel renovation program.

We continue to expect full year capital expenditures of $300 million to $325 million. We expect 21 hotels across all our service levels to be under renovation in the third quarter and we will have completed major renovations at 34 hotels during the full calendar year, including five full-service hotels, 18 select service hotels, and 11 extended stay hotels. Subsequent to quarter end, we sold two hotels and three net lease properties for $12.6 million of total proceeds. We currently have 18 hotels with a carrying value of $97 million and 10 net lease properties with a carrying value of $6 million remaining as held for sale. The 22 hotels sold or to be sold as of June 30, 2024 generated losses of just $1 million for the second quarter. In July, we announced our regular quarterly common dividend of $0.20 per share, which represents a normalized FFO payout ratio of 44%.

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

Q&A Session

Operator: We’ll now begin the question-and-answer session. [Operator Instructions] The first question comes from Bryan Maher with B. Riley. Please go ahead.

Bryan Maher: 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?

Brian Donley: 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 nonrecurring 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. Some will do better. Some might come in a little bit under that pending on the market 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.

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.

Todd Hargreaves: Sure. And I’ll add 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 sales. So it’s just one of the many factors that we consider.

Bryan Maher: 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?

Todd Hargreaves: 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 and 2022. I’ll take it in pieces here. 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 on an 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 these hotels are in need of a renovation.

If they’re so an encumbered of a Sonesta franchise or if they’re going to go to another brand or there’s typically a PIP that don’t need to do. So that typically gets added on I’d say anywhere from $25000 to $40000 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 an unlevered basis probably mid-teens return on a levered basis. Most of these groups are local operators. 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 own two, three up to five hotels in their portfolio they’re going to be very focused on driving local business and have a business plan that they can operate better than a national operator like Sonesta 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. 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 towards 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 one 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. 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. 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 needs time selling hotels. But right now we’re selling what we think we can get done and that comes into the equation as well.

Bryan Maher: Okay. Just last for me. We’re getting a lot of calls and e-mails 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 — second quarter, third quarter strong, fourth quarter, first quarter weak. And as we get past third quarter that the CAD payout ratio will be back under 100%. And just any general thoughts on the dividend here would be helpful. And that’s all for me. Thank you.

Brian Donley: Sure, Bryan. I know it’s been a lot of — a focus for a lot of people. The kind of calculation, as I said in my prepared remarks is over 100% on a trailing four 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 — consider we talk about many factors, including the performance outlook of the portfolio, look at leverage, our liquidity needs and other points that matter. So we’ll continue to evaluate it ongoing as we have continuously done, I would say that.

Bryan Maher: Thank you.

Operator: The next question comes from Dori Kesten with Wells Fargo. Please go ahead.

Dori Kesten: 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 expected?

Todd Hargreaves: Hi, Dori, I think it’s been relatively in line. I think we started to see a little bit of softening towards the end of last year. This quarter, we’ve seen corporate-negotiated revenues declined slightly year-over-year. 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.

Dori Kesten: Okay. And then during prior multiyear renovation programs that you’ve gone through, the portfolio RevPAR growth tends to lag the chain scale US in the years you’re doing the program and then outperformed 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?

Todd Hargreaves: I wouldn’t say — Brain, can weight into, 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 and market share is going to be any different than it’s been in prior cycles. .

Dori Kesten: Okay. And then my last question. The results implied at Sonesta this quarter, just based on your ownership stake seemed to be like lower than you were expecting. Was there anything onetime 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.

Brian Donley: There’s a couple of things, Dori. 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. 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.

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

Brian Donley: I think that, there’s a handful of properties that will finish up this year. There’s pretty extensive work going on in New York wasn’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.

Todd Hargreaves: Yeah, 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. But I think you should see that noise start to come off in the coming quarters.

Dori Kesten: Okay. Thank you.

Operator: The next question comes from Tyler Batory with Oppenheimer. Please go ahead.

Tyler Batory: Thank you. Good morning. A 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 at play or perhaps just the strong growth in prior years, just making comparisons a little bit challenging?

Todd Hargreaves: Hi, Tyler. That is the service level and 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 four different tiers. 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 not repeat this year for one reason or another. So we saw in Q1 as well. 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 one to six 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 the 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 ES suites.

Tyler Batory: Okay. And then the 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?

Brian Donley: 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 $5.8 million. So it was a big part of the year-over-year change. 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 the Labor Day holiday, similar to year-over-year in the prior year. So we’ll see similar seasonal trends as well.

Tyler Batory: Okay. All right. I’ll leave it there. That’s all for me. Thank you.

Todd Hargreaves: Thank you.

Brian Donley: Thanks Tyler.

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

Todd Hargreaves: 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.