Service Properties Trust - Q1 2024

Transcript

Operator (participant)

Morning and welcome to the Service Properties Trust first quarter 2024 earnings conference call. All participants will be in listen-only mode. Should you need assistance, please signal a conference specialist by pressing the star key followed by zero. 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 Investor Relations. Please go ahead.

Stephen Colbert (Director of Investor Relations)

Good morning. Joining me on today's call are Todd Hargreaves, President and Chief Investment Officer, and Brian Donley, Treasurer and Chief Financial Officer. 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 would 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, May 8th, 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. 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. 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. With that, I'll turn the call over to Todd.

Todd Hargreaves (President and Chief Investment Officer)

Thank you, Stephen, and good morning. Our first quarter results are indicative of typical seasonality patterns in our lodging portfolio, as well as the stability of our net lease portfolio. Our full-service hotels experienced top-line growth through increased group demand, while our select-service hotels were impacted by softening transit travel and renovation activity. Our focus remains on improving the performance and quality of our portfolio through the disposition of non-core hotels and capital projects to put our operators in the best position for long-term success. Beginning with the hotel portfolio for the quarter, comparable RevPAR declined 3.5% year-over-year. When excluding the 23 active renovations, ADR declined 0.7% and occupancy declined 0.2%, leading to a RevPAR decline of 1.1%. The renovation hotels, which include our Hyatt Place portfolio, Sonesta Hilton Head, and others, experienced approximately $3.9 million of displacement during the quarter.

Cost pressures led to a hotel EBITDA margin decline of 290 basis points over the prior year quarter for our 218 comparable hotels, as wages, property taxes, and insurance increases more than offset our operators' improved reliance on contract labor. Full-service was our top-performing segment during the quarter, where we gained 80 basis points of RevPAR over the previous year quarter, led by increases in group and contract sales. Full-service group performance was led by our Royal Sonesta hotels in San Juan, San Francisco, and Kauai, while the increase in contract revenues was led by our Sonesta hotels in Redondo Beach and Denver. F&B revenue gains occurred across our full-service hotels as well, led by our Royal Sonestas in St. Louis and Kauai.

Our portfolio of select-service hotels continued to see the most disruption during the quarter, as 18 of our 61 hotels were under renovation, including our 17 Hyatt Place hotels, which began renovations in 2023. Overall, select-service RevPAR declined by 13.2% due to these disruptions, as well as decreased year-over-year income from our five select-service hotels located in the Phoenix area that benefited from the 2023 Super Bowl. Our extended stay portfolio experienced a 4.6% decline in RevPAR year over year. Consistent with a trend from previous quarters, our longer-term extended stay occupancy, stays of 7+ nights, has been declining due to the loss of non-repeat project-based room nights. While Sonestas successfully pivoted to shorter-term stays at these hotels to fill occupancy, the increased room nights were not enough to offset the reduced rates.

Group pace is up $15 million, or 12.3%, over the same time last year due to increases in room nights and ADR in both the Sonesta and Radisson portfolios. The most notable gains were related to corporate group at the Royal Sonesta Cambridge and at our Sonesta Chicago hotels, where the Democratic National Convention will be held in August. Combined revenues from our business travel for our operators declined slightly year-over-year due to the ongoing renovations in our Hyatt Place portfolio and the shift in the Easter holiday from April last year to March this year, while business travel increased in our Sonesta portfolio from key corporate accounts at our select-service hotels.

OTA revenue, as a percentage of total revenues, declined from 25.6% to 24.8% year-over-year during the quarter, and our operators continue to concentrate efforts on driving bookings to their websites to lessen the dependency on third-party channels that charge commissions. Sonesta remains focused on building its brand through numerous initiatives and recently merged its Travel Pass Rewards program with the legacy Red Lion loyalty program, doubling its overall size. During the quarter, 25.9% of our Sonesta full-service hotel revenues were from loyalty program members, up 3.5 percentage points from 2023. Other ongoing Sonesta initiatives include a focus on driving ancillary revenues at the hotels, building out a sales organization, and investing in technology.

Turning to our net lease portfolio, which represents 44% of SVC's portfolio by investment, as of March 31st, 2024, our 749 service-oriented retail net lease properties were 97.3% leased, with a weighted average lease term of 8.7 years. Our lease maturities are well laddered, and only 1.3% of our net lease minimum rents expire prior to the end of 2024. The aggregate coverage of our net lease portfolio's minimum rents was 2.37 times on a trailing 12-month basis as of March 31, 2024. The decline sequentially is largely driven by softer EBITDA reported by TA for Q1, 2024. Transaction activity during the quarter was limited to three net lease dispositions and one hotel disposition, a Country Inn & Suites in suburban Minneapolis, for an aggregate sales price of $6.2 million. We continue to market 22 Sonesta hotels with a book value of $160 million.

The sale process is well underway, and we are working with potential buyers to negotiate terms. In conclusion, we are optimistic that our hotel portfolio will see meaningful operational improvements as the result of our renovation program, as hotels benefit from much-needed refreshes over the coming quarters. Additionally, the performance of our net lease portfolio remains steady and is anchored by an investment-grade rated tenant and BP. With more than $700 million of liquidity and no debt maturities in 2024, we are well positioned to implement our strategic plan. I will now turn the call over to Brian to discuss our financial results in more detail.

Brian Donley (Treasurer and CFO)

Thanks, Todd, and good morning. Starting with our consolidated financial results for the first quarter of 2024, normalized FFO was $21.1 million or 13 cents per share versus 23 cents per share in the prior year quarter. Adjusted EBITDAre declined 1% year-over-year to $115.5 million. Financial results this quarter, as compared to the prior year quarter, were impacted by higher interest expense and a decline in hotel EBITDA. Rental income increased by $5.6 million this quarter compared to the prior year due to higher rental income recognized under our TA leases as a result of the BP transaction last May. Turning to the performance of our hotel portfolio, for our 218 comparable hotels this quarter, RevPAR decreased by 3.5%, gross operating profit margin percentage declined by 200 basis points to 23.3%, and gross operating profit decreased by $6.5 million from the prior year period.

Below the GOP line, costs at our comparable hotels increased $2.8 million from the prior year, driven primarily by increased insurance expense. Our 220 hotels generated hotel EBITDA of $28.9 million, a decline from the prior year but in line with our guidance range provided last quarter. By service level, hotel EBITDA year-over-year increased $676,000 for our 48 full-service hotels, declined $5.6 million for our 61 select-service hotels, and $3.4 million for our 111 extended stay hotels. Turning to our expectations for Q2, we're currently projecting full-quarter Q2 RevPAR of $95-$99 and hotel EBITDA in the $80-$85 million range. Turning to the balance sheet, we currently have $5.6 billion of fixed-rate debt outstanding with a weighted average interest rate of 5.9%. Our next debt maturity is $350 million of unsecured senior notes maturing in March 2025.

We currently have $80 million of cash, and our $650 million revolving credit facility remains undrawn for a total liquidity of over $700 million. Turning to our investing activity during the first quarter, we sold one hotel and three net lease properties for an aggregate sales price of $6.2 million. We made $69 million of total capital improvements at our properties during the first quarter. We currently expect full-year capital expenditures of $300-$325 million, up from our previous guidance range of $250-$275 million. We currently expect maintenance-type capital to be $100 million of the total spend this year. Our capital program is focused on ensuring the best guest experiences, upgrades to brand standards, and positioning the hotels to improve their respective market share. To date, we've completed renovations at nine Sonesta hotels, and we're pleased with the post-renovation returns we're seeing thus far.

We expect 22 hotels across all service levels to be under renovation in the second quarter and expect to have completed major renovations at 33 hotels during the calendar year, including five full-service hotels, 18 select-service hotels, and 10 extended stay hotels. Finally, in April, we announced our regular quarterly common dividend of $0.20 per share, which we believe is well covered, representing a 51% normalized FFO payout ratio for the 12 months[guess] ending March 31st, 2024. That concludes our prepared remarks. We're ready to open the line for questions.

Operator (participant)

We will now begin the question-and-answer session. To ask a question, you may press star, then one on your telephone keypad. If you are using a speakerphone, please pick up your handset before pressing the keys. To withdraw your question, please press star, then two. At this time, we will pause momentarily to assemble our roster. Our first question is from Bryan Maher with B. Riley Securities. Please go ahead.

Bryan Maher (Managing Director)

Thank you. Good morning, Todd and Brian. Maybe just sticking with the CapEx for a minute. Your $50 million increase, I think I did that math right, can you talk about why and what that $50 million is going to be allocated to?

Brian Donley (Treasurer and CFO)

Morning, Brian. Thanks for the question. Yeah, a lot of it is this pace of projects. As we plan the rest of the year, each quarter we decide which projects we think we should move forward with, which ones make sense from a timing standpoint to limit disruption. We also have a combination of major renovations at certain hotels as well as more routine stuff that we want to get in this year to continue to improve the position of the hotel. It's a combination of a couple of things, but it's more so just the pace of projects has moved a little quicker than it has in past quarters. It's more of a planning thing than anything. This is a multi-year program that we've now started at the end of last year, and it'll continue for a couple of years.

Bryan Maher (Managing Director)

Would you consider some or all of that $50 million a pull forward from what you would have spent in 2025?

Brian Donley (Treasurer and CFO)

Some of it, yes. Yes.

Bryan Maher (Managing Director)

Okay. And when we think about the Hyatt renovation disruption, can you talk about when you think that is fully wound down and maybe give us some ideas as to how much you're spending per key on those renovations and kind of how deep they are?

Todd Hargreaves (President and Chief Investment Officer)

Sure. I can take that one, Brian. Good morning. So the Hyatt Place, we started those late last year. I would say we're through the majority of those, or we should be getting through the majority of those shortly. I would expect most of that to wrap up this quarter and have those back online fully. So I think we should start to see the benefit of that starting in the second quarter but really fully, hopefully, in the third quarter. The total cost for those renovations is right around $90 million, which Brian's calculating the per key cost now.

Brian Donley (Treasurer and CFO)

Yeah, per key, it's around 40,000. Yeah, 40,000.[crosstalk]

Todd Hargreaves (President and Chief Investment Officer)

Yeah, and it's rooms, common areas, façades. It's a pretty intensive renovation. Those hotels hadn't been renovated in a while, so we expect to see a pretty significant pickup once those renovations are complete.

Bryan Maher (Managing Director)

Okay. And maybe kind of the same dialogue on Sonesta, kind of how much more what you're spending per key. I think you mentioned in your prepared comments that you're selling 22 hotels, book value $162 million. I mean, what does that sales do to your kind of future CapEx spend that you had been planning for?

Brian Donley (Treasurer and CFO)

Yeah, from a Sonesta standpoint, it depends on the Chain Scale and the brand. The Simply Suites at the lower end is $30,000-$35,000 per key and could be upwards of $50,000 a key for some of the bigger boxes that we're doing. We've got various full-service hotels that are in the plan for this year, including our Hilton Head property and some of the airport hotels. But as we look at different Chain Scales and different needs, when the last refresh happens.

Todd Hargreaves (President and Chief Investment Officer)

Yeah, and that should take off probably another $150 million total that we otherwise would have had to spend at these hotels.

Bryan Maher (Managing Director)

Just two more for me. What kind of uplift are you looking for in RevPAR, roughly speaking, from the Hyatt renovations and the Sonesta renovations, if you can break them out? I don't know what the best way to break it out is, but clearly, you've thought about what your RevPAR uplift would be. Can you share with us what you're thinking there?

Brian Donley (Treasurer and CFO)

Yeah. I mean, I think RevPAR index is one metric. I mean, we're very focused on bottom-line EBITDA, and we expect high single-digit returns on a lot of the money we're deploying for what we're calling renovation capital. You're not going to get that same lift from more routine stuff that is just maintenance-type capital. But there are various ROI projects built into our program, and the amount of money we're putting in, we expect a significant lift that will high single-digit EBITDA returns over the longer-term post-renovation periods. We finished nine Sonestas this quarter. Not a lot of anecdotal evidence yet of some of these. They're only a couple of months post-renovation.

But some of the ones that have been finished for close to a year, if you look at the periods prior to when before we started the renovations to a good ramp-up period afterwards, we're seeing those returns that we had forecasted.

Bryan Maher (Managing Director)

Okay. Thank you.

Brian Donley (Treasurer and CFO)

Thank you.

Operator (participant)

The next question is from Dori Kesten with Wells Fargo. Please go ahead.

Dori Kesten (Director)

Well, thanks. Good morning. I appreciate the Q2 RevPAR and hotel EBITDA guide. I was wondering what you're thinking of for the back half of the year. I know peers have highlighted a strong second half versus first, but I'm not sure if you feel the SVC portfolio would participate as much given limited group exposure in the renovation headwinds.

Brian Donley (Treasurer and CFO)

Yeah, it's a great question, Dori. Thank you. I think our trends will mirror patterns that we've had in previous years. We expect Q2 to be a stronger period, obviously, than Q1. We think Q3 will be in line with Q2 before it starts trailing off. There is a lot of noise in our portfolio given the renovation activity we've highlighted. So when we do see ramp-up from certain hotels and picking up different business and market share, that could be weighed down by some of the other hotels that we're moving into renovation.

Dori Kesten (Director)

Okay. And as you wrap up negotiations on the 22 Sonestas, I'm wondering, what did you learn from the marketing process and the negotiation process so far? And just based on level of interest, would you expect there to be a round two of asset sales, or would you consider yourself done for the year after these 22?

Todd Hargreaves (President and Chief Investment Officer)

Sure, Dori. The marketing process, so just to clarify, we have gone through multiple rounds of bidding on the hotels. We've identified buyers for the majority of those hotels, and so we are, as you point out, negotiating contracts. It's not going to be a portfolio sale. It's not going to be to two or three buyers. There's going to be likely more than 10 buyers for these 22 hotels, and we're likely to maximize proceeds that way. I think the process has gone somewhat as expected in terms of interest level from a lot of smaller operators for these types of hotels, a lot of local operators. If you recall, these hotels today are losing. They're negative EBITDA for the most part. They need CapEx. So local operators are coming in and really focusing on turning around some of these hotels.

We did get a lot of interest, and I think the types of hotels that are trading, even with transaction activity down, are these types of hotels, kind of the lower-price point hotels where buyers can come in at a good basis. So again, it was similar to what we expected. There was a lot of repeat buyers from the time we sold the 68 hotels a couple of years ago as well. So I'm not sure we necessarily learned anything further. I think there continues to be interest in these hotels or continues to be interest in groups buying these hotels and entering into franchise agreements with Sonesta, which was a positive to see as well. To answer your question on more hotels, I think we want to get through these first, but there could be other hotels in the system.

I think it's just going to be a continuing evaluation of the performance of the hotels. And so there could be other hotels, but we haven't identified any yet.

Dori Kesten (Director)

Okay. And then my last one is just on tracking trends. So you've talked about the normalization of trends and that, therefore, it makes sense your rent coverage is coming in post-pandemic. But for context, what level of rent coverage would make you consider the trend less of a normalization and more worrisome? And to be clear, I don't think you're there. I'm just wondering what your line in the sand is.

Todd Hargreaves (President and Chief Investment Officer)

Right. It remains to be seen. It's good, the commentary is we agree with that commentary. Back in 2017, 2018, 2019, the coverage for those assets was probably closer to 1.8x or 1.9x. And then once we came out of the or once the pandemic hit and trucking activity picked up significantly, e-commerce activity picked up significantly, and you saw diesel volumes and, more importantly, margins get to levels that we hadn't seen before, and that really drove coverage up. I think what you've seen over the past three or four quarters is that really get back down to more what we view as normalized levels. We don't have nearly as much insight now given the Lease Amendment to the performance of these sites, but we're following what BP says publicly.

We have very little concern given the investment-grade credit backing these properties and leases and just the underlying value of the real estate. But I don't have necessarily a number where I'd say I would start to be concerned, but we're far away from that number.

Dori Kesten (Director)

Okay. Thank you so much.

Todd Hargreaves (President and Chief Investment Officer)

No problem.

Operator (participant)

The next question is from Tyler Batory with Oppenheimer. Please go ahead.

Tyler Batory (Executive Director)

Good morning. Thank you. Follow-up question on the guidance for the second quarter. It looks like RevPAR at the midpoint, flat. Year-over-year, 80%-85% of hotel EBITDA. Margins still down year-over-year. Is there a way to think about the renovation disruption that's in those numbers? And then talk a little bit more about what needs to happen, maybe outside or even including renovation disruption. I mean, what needs to happen for you to really see some margin improvement and margin growth?

Brian Donley (Treasurer and CFO)

Hey, Tyler. Good morning, and thanks for the question. I'll start and talk if you want to add anything. But as far as disruption goes in Q2, it's going to be more of the same. I think it'll have a little bit more of a lift side of the thing. Portfolio from the Hyatts coming out of renovation, all 17 of those hotels are going to be coming out throughout the quarter, so we're going to start to see some lift from that. So it's sort of going to negate some of the disruption we're seeing. I mean, these are some of our stronger seasonal periods. We're going to try to limit rooms that are out of service. So it's tough to fully quantify. Once you start a project and get into it, how fast it moves, how many rooms you take out can vary.

But the bigger overall question, how to drive margin, we believe it's an occupancy issue. We need to drive more demand at our hotels. We're doing that through various initiatives, including the CapEx program. So that's our operators. Our other operators are also very focused on driving demand through different initiatives and marketing promotions and other projects they're working on to drive business.

Todd Hargreaves (President and Chief Investment Officer)

Yeah, I'll just add to that. I mean, we saw we were very pleased with how the full-service portfolio did, especially the Royal Sonesta that grew over 6% in RevPAR year-over-year, really driven by group business. But also our urban hotels really were increased as well, just driven by increased citywide demand. So I think we're really optimistic with what we're seeing on the full-service side of things. We touched on a couple of things in the prepared comments, but especially, it's tough to get a good comp on the select-service portfolio because so many were disrupted during the quarter. But in terms of the extended stay, I think our focus really is on having our operators really get back to getting that true tier four extended stay business of more than seven nights.

In some cases, you can get 30-60 nights, 30-60 nights. And especially in the seasonally weak quarters, you really rely on that occupancy for those types of hotels. But ideally, we see some of that more longer-term project-based business come back online. I think that's something our operators, especially Sonesta, are very focused on.

Tyler Batory (Executive Director)

Okay. Okay. Great. So in terms of the Sonesta brand, I think you cited 30% of stays in the quarter were loyalty members. I think a little bit lower than some of the other brands that are out there. Obviously, this loyalty program is still pretty new. So just talk a little bit more about kind of the adoption of the loyalty program and more broadly, just kind of an update on how Sonesta is resonating in the marketplace for travelers.

Todd Hargreaves (President and Chief Investment Officer)

Right. And the number was about 26%, I believe, for the full-service hotels. I mean, it's a little bit lower on the select-service hotels. But we are seeing increases there. I think the full-service, we saw a 300 basis-point increase year-over-year. So we are really seeing the adoption, especially on the Sonesta and Royal Sonesta hotels. But as you know, especially on the select-service side, it's so much of business-oriented hotels. You see it with some of the other brands, it's really driven by loyalty members. So that's really where we need to continue to see pickup. But it's certainly a positive that you're seeing it on the full-service side, an increase of that much in terms of bookings through the loyalty program. So Sonesta, still at this size, is a relatively newer, younger company.

We're seeing things move in the right direction, and we are seeing that brand adoption in some of the numbers.

Tyler Batory (Executive Director)

Okay. Great. And then last question from me. Obviously, no time maturity this year. At what point do you start to think more about the 2025s and what sort of options might be on the table for those? And as you sit today, can you rank order kind of what looks most attractive to you in terms of handling those maturities?

Brian Donley (Treasurer and CFO)

Hey, Tyler. It's a great question. We continue to monitor the debt markets, and we are going to continue to be proactive on our debt maturities. As we've demonstrated, we've got multiple options using SVC's portfolio, but our real preference is unsecured corporate debt. So that's something we're going to take a hard look at in the near term to stay ahead of our maturity wall. But we do have multiple options out there.

Tyler Batory (Executive Director)

Okay. That's all from me. Thank you.

Operator (participant)

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

Todd Hargreaves (President and Chief Investment Officer)

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

Operator (participant)

The conference is now concluded. Thank you for attending today's presentation. You.