Apple Hospitality REIT Inc

NYSE:APLE

Earnings Call Transcript 2018-Q3

[Operator]

Greetings, and welcome to Apple Hospitality REIT Third Quarter 2018 Earnings Conference Call. At this time, all participants are in a listen-only mode. A question-and-answer session will follow the formal presentation. [Operator Instructions] As a reminder, this conference is being recorded.

I would now like to turn the conference over to your host, Kelly Clarke. Please go ahead.

[Kelly Clarke, Vice President, Investor Relations]

Thank you, and good morning. We welcome you to Apple Hospitality REIT’s third quarter 2018 earnings call on this, the 6th day of November 2018. Today’s call will be based on the third quarter 2018 earnings release, which was distributed yesterday afternoon.

As a reminder, today’s call will contain forward-looking statements, as defined by Federal Securities Laws including statements regarding future operating results. These statements involve known and unknown risks and other factors, which may cause actual results, performance, or achievements of Apple Hospitality to be materially different from future results, performance, or achievements expressed or implied by such forward-looking statements.

Participants should carefully review our financial statements and the notes thereto, as well as the risk factors described in Apple Hospitality’s 2017 Form 10-K and other filings with the SEC. Any forward-looking statements that Apple Hospitality makes speaks only as of today, and the company undertakes no obligation to publicly update or revise any forward-looking statements, except as required by law.

In addition, certain non-GAAP measures of performance such as EBITDA, adjusted EBITDA, FFO, and modified FFO will be discussed during this call. We encourage participants to review reconciliations of those measures to GAAP measures as included in yesterday’s earnings release and other filings with the SEC. For a copy of the earnings release or additional information about the company, please visit applehospitalityreit.com.

This morning, Justin Knight, our Chief Executive Officer; Krissy Gathright, our Chief Operating Officer; and Bryan Peery, our Chief Financial Officer, will provide an overview of our results for the third quarter of 2018 and an outlook for the sector and for the company. Following the overview, we will open the call for Q&A.

At this time, it is my pleasure to turn the call over to our CEO, Justin Knight.

[Justin Knight, President and Chief Executive Officer]

Thank you, Kelly. Good morning, and thank you for joining us today. Before we get started, I’d like to take a moment to commend the operating teams at our hotels in the paths of Hurricanes Florence and Michael, who in the phase of challenging and evolving circumstances work tirelessly to serve and care for our guests, associates and surrounding communities.

In many ways, we reported on the storms and still to capture the magnitude of the damage caused in the affected areas. While the majority of our hotels in the paths of these storms did not sustain material damage remained operational, the Panama City, Florida area sustained a direct hit from Hurricane Michael. And at this time, we anticipate that our Hampton Inn & Suites in Panama City Beach and our TownePlace Suites in Panama City will be closed through the end of the year.

Although the buildings remain structurally sound, the devastation in the area has lengthened the lead times to complete the necessary remediation and repairs for the hotels to reopen. We look forward to the conclusion of this hurricane season and a full recovery for the resilient communities impacted by those – these storms.

Storm disruption during the third quarter exacerbated what we had already anticipated to be a difficult quarter due to tough year-over-year comparison. RevPAR declined 2%, which offset growth for the portfolio during the first-half of the year. Year-to-date through September, RevPAR growth for our portfolio was flat to last year.

Adjusted EBITDA grew by approximately 2% for the quarter and year-to-date. Continued efforts to augment ancillary income and manage expenses enabled us to achieve comparable hotels – adjusted hotel EBITDA margin of 38% for the quarter and year-to-date.

I’m pleased that despite challenges, our portfolio continues to produce industry-leading bottom line results. However, based on our performance year-to-date and our outlook for the remainder of the year, we have reduced our full-year 2018 guidance.

Since the beginning of the year, we have acquired four hotels for an aggregate purchase price of $137 million and have six hotels under contract for a total purchase price of $146 million. Five of these hotels are new construction projects, which we anticipate will be delivered over the next two years.

All of the new build projects, which we have discussed in greater detail during prior calls are with trusted developers with whom we have done business in the past. As with prior turnkey development projects, our contracts enable us to acquire the assets upon completion at a fixed maximum price, which locks in attractive per key pricing in the current rising cost environment.

In addition to these development projects, we are pleased to announce that in October, we entered into a contract for an existing Hyatt Place in Jacksonville, Florida. If all conditions to closing are met, we expect to acquire the Jacksonville Hotel in December of this year.

During our last call, I highlighted the fact that we have been receiving an increased number of inbound inquiries from private equity looking for diversified portfolios of Marriott and Hilton select service hotels. The relative age and general quality of our portfolio enables us to be strategic in exploring these opportunities and to act only when we feel we can secure attractive pricing for the assets and redeploy proceeds in ways that further enhance the value of our remaining portfolio.

In August, we entered into a contract to sell 16 hotels for a combined sales price of $175 million to one of these groups. Assuming completion of the transaction, the sale will improve top line performance and margins for our portfolio overall and adjust our market mix in ways, which we feel will further enhance the strength and stability of our platform for coming years.

Combined with the July sale of our TownePlace Suites and SpringHill Suites hotels in Columbus, Georgia and the anticipated sale of the Residence Inn located in Springdale, Arkansas, which we currently have under contract. These asset sales will provide nearly $200 million to fund acquisitions and share buybacks.

Given the recent pullback in our share price, the purchase of our stock has been increasingly compelling relative to hotel acquisitions opportunities in the market. Under our share repurchase program, we have repurchased more than 1.6 million shares of our stock since the end of the third quarter. These shares were purchased at a spread to the pricing for the portfolio we currently have under contract for sale and the bulk of the acquisitions opportunities we have underwritten in recent months.

We will continue to assess share repurchases as we look at available opportunities for hotel acquisitions and deploy funds, where we feel we can generate the greatest value for our shareholders.

Ramping new hotel supply in some of our markets contributed to slower RevPAR growth for our portfolio during the quarter. However, given the current rising cost environment and limited availability of construction financing, we are beginning to see a moderation in new construction starts.

Based on the outlook for our markets, we anticipate that supply could peak over the next year, and that as we push into the latter part of 2019, ramping new supply will represent less of a headwind for us.

At the end of the third quarter, approximately 63.5% of our properties had one or more Upper Midscale, Upscale or Upper Upscale new construction projects within a five-mile radius. As a percentage, supply growth for our markets has exceeded industry averages.

Although demand has generally kept pace when competing new supply opens and ramps within our markets, we are often challenged to drive rate until occupancy levels out and the new hotels stabilize. Strength of our brands, the low effect of our – and actual age of our hotels, our locations within markets and the quality of our onsite management teams, all help maintain our competitive positioning and offset the long-term impact of new supply within our markets.

Despite recent stock market volatility and geopolitical uncertainty, broad economic indicators for the U.S. continue to improve, marked by robust GDP growth, low unemployment and rising corporate profit. Demand for hotel rooms remained strong in the majority of our markets and we continue to see improvements in the business transient segment.

Although top line growth was challenged during the third quarter, we continue to achieve high operating margins and strong bottom line results. With a focus on providing our investors with consistent dividends and appreciation in the value of their underlying investment, Apple Hospitality was structured to provide solid operations and be able to maximize results in any environments.

Our portfolio consists of rooms-focused hotels that are aligned with industry-leading brands operated by best-in-class management companies and broadly diversified across markets and demand generators. We are constantly looking to refine and strengthen our portfolio of hotels through meaningful transactions and renovation. And we maintain a flexible balance sheet that provides additional security during periods of volatility and the ability to pursue opportunities in the marketplace.

Today with 241 hotels diversified across 88 U.S. markets, we have the largest publicly-traded REIT focused on the select service segment of the lodging industry. Each element of our strategy contributes to our ability to make good on our commitment to our shareholders, and we are confident we are well-positioned as we head into 2019.

I would now like to hand the call over to Krissy to provide additional detail on performance across our markets.

[Kristian Gathright]

Thank you, Justin. Third quarter results were challenged by calendar shift, tough year-over-year comparisons due to elevated demands in the solar eclipse and restoration and recovery business following Hurricanes Harvey and Irma in 2017. Disruption from Hurricane Florence at the end of September, as well as continued competitive pressures in certain markets, while new supply is being absorbed.

Although we experienced an indirect impact from increased cancellations ahead of the Hurricane Florence landfall and the short-term disruption in operations for the five hotels that were directly impacted, we are benefiting from some recovery demand that will continue through the fourth quarter. This lift will help mitigate, but not offset continued challenging comparisons from Hurricanes Harvey and Irma in the prior year.

And as Justin mentioned, our two hotels in the Panama City area that were impacted by Hurricane Michael in October are not expected to be fully operational before the end of this year. Our estimated third quarter impact from the natural disasters, both current and prior year and the prior year eclipse was 100 to 130 basis points.

From a segmentation standpoint, our corporate-negotiated business increased 100 basis points, offset by decline in group room nights. Some of the declining group is attributable to prior year storm recovery business and in some, it’s purposeful remixing to higher-rated segments.

We have identified certain hotels, primarily in markets with ramping new supply that have an opportunity to grow group share and are working with the respective management companies on targeted efforts to proactively increase group bookings, especially on the shoulders and weekends.

From a revenue strategy standpoint, we are often challenging our operators to ensure that revenue management, direct company sales and e-commerce functions are strategically aligned to drive the most profitable business to our hotels, factoring in the unique market dynamics.

For the quarter, some of our better-performing markets included Knoxville, Chicago Anchorage, Fort Worth, Panama City, Phoenix, Huntsville and Atlanta. Difficult hurricane-related comparisons resulted in lagging performance in the Houston and Miami, Fort Lauderdale area.

While our Dallas and Austin markets were also challenged with non-repeat hurricane-related benefits, performance in these markets has also been affected by the absorption of above-average growth in supply. Elevated demand surrounding last year’s solar eclipse created tough comps for the Boise, Nashville, Idaho and Kansas City markets.

Cancellations associated with Hurricane Florence impacted the Richmond and Virginia Beach market. And while we feel positive about the long-term outlook for markets like Seattle and Oklahoma City, year-to-date supply growth of around 6% led to short-term underperformance.

Significant new demand generators are in the works for both markets, including a new convention center in Oklahoma City and an expanded convention center in Seattle in addition to Google’s new 930,000 square foot campus and Amazon’s continuing campus expansion to make Seattle like in some markets.

After a noisy and difficult September, October RevPAR growth was slightly positive. However, current booking position and forecast for November and December indicates moderate declines in RevPAR as we continue to face challenging year-over-year hurricane comps that will begin diminishing in early 2019.

While demand for both business and leisure is still increasing across our portfolio, we do expect ongoing supply increases to limit RevPAR growth until supply growth levels start diminishing towards the latter part of 2019, helping to partially offset the continuing difficult hurricane comps will be an expected boost from our three Atlanta area hotels during the Super Bowl and the ramp up of our Downtown Phoenix, Hampton Inn & Suites, which opened in May of this year.

From a profitability standpoint, even with a modest decline in revenue, we were still able to achieve an impressive 38% hotel EBITDA margin. Continued focus on ancillary revenue, primarily cancellation revenues, resulted in a 23% increase in other revenues during the quarter.

As for expenses, we’re very pleased to see same-store expense growth just under 1% in a challenging labor environment. Same-store hotel labor dollars increased 2%, accounting for 70 basis points of margin impact. With the decline in occupancy, same-store payroll per occupied room increased 3.6% for the quarter, bringing the increase to just under 3% per occupied room year-to-date through September.

We continue to see productivity gains through increasing utilization of property labor management technology platform. At the same time, we are focused on ensuring that appropriate staffing levels are maintained and associate satisfaction and retention are prioritized to balance the objectives of mitigating cost increasing – increases and maintaining guest satisfaction.

Outside of payroll cost, increases in insurance expense and property taxes resulted in a 50 basis point impact to margin. As we have always said, we continue to look for opportunities to gain greater value for the dollars we spent.

I will now turn the call over to Bryan to provide additional detail on hurricane cost impact and our overall financial results.

[Bryan Peery]

Thanks, Krissy, and good morning. Quickly summarizing some results for the quarter. Total revenue was $332 million, an increase of 2% from the third quarter of 2017. Adjusted EBITDA was $123 million, also an increase of 2% from the same period last year. And modified FFO per share was $0.47 per share, down a $0.01 per share compared to the third quarter of 2017.

Year-to-date through September 30, total revenue increased 3% to $975 million. Adjusted EBITDA increased 2% to $354 million, and modified FFO per share declined 1% to $1.36 per share. Year-to-date, we have invested $43 million in capital expenditures and anticipate an additional $25 million to $30 million throughout the remainder of the year consistent with our normal annual spent.

Krissy and Justin touched on it, but in addition to the revenue disruption, we did experience additional costs in the quarter related to Hurricane Florence. Three of our hotels in the hurricanes path have named storm insurance deductibles due to their location. As a result, we recognized approximately 600,000 of cost, or 20 basis points of margin to remediate and repair the affected hotels.

We do not anticipate any additional Hurricane Florence-related costs net of business interruption proceeds for these hotels. In the fourth quarter, we will incur approximately $900,000, or 30 basis points of margin impact of costs related to the remediation and repair of hotels in the path of Hurricane Michael.

Our two Panama City area hotels incurred considerable wind and water damage and also have named storm deductibles due to their location. Restoration work on these hotels is anticipated to be completed over the next several weeks. Since we are working through the claims and restoration process, we are not currently able to provide estimated business interruption proceeds.

However, for reference, that hotels have been effectively closed since October 8 and will be for much of the fourth quarter. The business interruption proceeds will be recognized in our results upon receipt from the insurance carriers.

We mentioned in the subsequent event last quarter, but to highlight for the quarter, in July and August, we completed the refinancing of over $1 billion of our credit facilities. The new facilities extended the maturities of the previous facilities, further spread maturities, reduced applicable spreads and provide additional flexibility in terms.

At September 30, we had total outstanding debt of approximately $1.3 billion, with a weighted average maturity of 5.5 years, an average rate of 3.7%. Availability under facilities totaled $327 million at the end of the quarter. Almost 80% of our debt was effectively fixed rate, with a weighted average rate of 3.9% and an average remaining term of 4.6 years/

As Justin highlighted, subsequent to the end of the quarter, we have acquired over 1.6 million shares of our common stock through our share repurchase program for a total of $26 million. We currently have a written trading plan in place intended to comply with rule 10b5-1. And repurchase program may be suspended or terminated at any time. As we have historically, we will execute on the program, where we believe value can be created for our shareholders.

Based on our operating performance today, our visibility in the business drivers for the remainder of the year and announced transactions, we anticipate results for 2018 to be in the following ranges. Net income between $193 million and $207 million, the midpoint of $200 million is a reduction of $5 million from our prior guidance; comparable hotels RevPAR growth to be flat to down 75 basis points, the midpoint of down 38 basis points is a reduction of 138 basis points from our prior guidance; comparable hotels adjusted – hotel EBITDA margin between 36.6% and 37.1%, the midpoint of 36.9% is a reduction of 45 basis points from our prior guidance; and adjusted EBITDA between $437 million and $447 million, the midpoint of $442 million is a reduction of $5 million from our prior guidance.

During the third quarter, the company paid distributions of $0.30 per share for a total of approximately $69 million. Through September, the company paid distributions of $0.90 per share, or a total of $207 million. Annualized $1.20 per common share represents a annual 7.4% yield based on our November 2nd closing price of $16.13.

Thank you for joining us this morning. Although the second-half of the year has had and will have operational growth challenges, we do believe our portfolio will continue to produce strong results and that we have the balance sheet and experience to opportunistically improve value for our shareholders.

Thank you for joining us this morning. We will now open up the call for questions.

[Operator]

At this time, we will be conducting a question-and-answer session. [Operator Instructions] Our first question comes from the line of Amanda Sweitzer with Baird. Please proceed with your question.

[Amanda Sweitzer, Robert W. Baird & Co.]

Good morning, everyone.

[Justin Knight, President and Chief Executive Officer]

Good morning.

[Bryan Peery]

Good morning.

[Kristian Gathright]

Good morning.

[Amanda Sweitzer, Robert W. Baird & Co.]

I just had a few questions on the 16 hotel portfolio sale. Can you talk a little bit more kind of the profile of that buyer? I believe you mentioned private equity, but was it more of a regional player? And then can you also tell us about how you chose which hotels to include in that portfolio?

[Justin Knight, President and Chief Executive Officer]

Sure. Good morning. Thanks for joining us. I’ve highlighted, I think, in the past several calls the fact that we have, for sometime, been communicating or responding to reverse increase from a number of smaller private equity shops. The groups generally speaking has had national reach and haven’t been specifically regionally focused.

As we look to assemble portfolios for the various groups, in part, we were guided by their investment interest, obviously, looking to align those interests with the interest that we had. The makeup of this portfolio specifically has been a – it contained some of our assets that are in smaller markets and those assets themselves tend to be smaller than our average for our portfolio and while there are high-quality assets as are all the assets in our portfolio. These assets tend to run on slightly lower RevPAR, and as a result, slightly lower margin than our portfolio overall.

For that reason, I highlighted in my earlier remarks, we feel that given the pricing that we’re able to achieve in this particular transaction and the results on the remaining portfolio, augmented by our ability to utilize proceeds, both to buy shares and to reinvest in additional assets, we saw the opportunities advantages.

[Amanda Sweitzer, Robert W. Baird & Co.]

And then in terms of that pricing that you mentioned, you think you are achieving a portfolio premium with this sale, and then if so, can you quantify it?

[Justin Knight, President and Chief Executive Officer]

Yes. And I highlighted that, that was something that we felt would exist given the availability of financing for existing Hilton and Marriott like service hotels. We feel relative to the individual assets that we’ve been selling that we’re able to achieve in the neighborhood of 100 basis point cap rate spread on the portfolio, which again, we think drives incremental value.

[Amanda Sweitzer, Robert W. Baird & Co.]

And then last question for me, can you just talk about the debts of demand that’s remaining in the market for portfolio sales? Do you think you’ll be able to achieve a similar premium later this year, or early next year and some additional portfolio sale?

[Justin Knight, President and Chief Executive Officer]

It’s interesting., The debt markets continue to be relatively strong. Even with interest rates going up, we continue to see wide availability of debt financing for existing assets. Spreads have tightened a little bit and loan to values have increased a little bit on the margin, offsetting increases in interest rates.

I think, well, one, this is a group that we have never done business with before, and this is a large portfolio for this particular group. There are others like this group, who I think are looking for transactions in this size. It will be interesting to see how they respond to the recent pullback in the public market.

Typically, private equity follows those markets. And I think, availability of equities for transactions of this kind on a go-forward basis will really depend on broad sentiment for the industry as a whole as we get into the latter part of the year. But certainly, from a debt financing standpoint, we continue to see sufficient availability to facilitate transactions of this size on a go-forward basis.

[Amanda Sweitzer, Robert W. Baird & Co.]

That’s helpful. Thanks for the time.

[Justin Knight, President and Chief Executive Officer]

Thank you.

[Kristian Gathright]

Thank you.

[Operator]

[Operator Instructions] Our next question comes from the line of Anthony Powell with Barclays. Please proceed with your question.

[Anthony Powell, Barclays Capital]

Hi, good morning, everyone. Similar question. How many more hotels do you have in your portfolio that meet the criteria that is that or somewhere in the hotel you sold. Just kind of figure out how many backups we can do – sold over time and proceeds we could generate?

[Justin Knight, President and Chief Executive Officer]

Good question, Anthony, and thanks for joining us. As we look at our portfolio, as I mentioned in my prepared remarks, we’re really strategic in pursuing potential sales. We are fortunate to have a relatively young portfolio with brands that are very consistent and high-performing brands. Even within this portfolio, the assets that we are looking to sell would continue to be a good fit if the transaction were for some reason not to proceed.

I think, as we look at our portfolio, we’re continually looking for opportunities to improve on the margin. But I don’t think, I could effectively highlight for you a portion of our assets that, that we’re aggressively looking to dispose of that. That’s really not how this particular transaction came about, nowhere how we would look at transactions on a go-forward basis.

We feel comfortable keeping the assets that we have by a margin, I’d say by that, I mean nearly 100% of our assets did very well within our product portfolio and our strategy for significant geographic diversification. And we’ll pursue opportunities like this, where we feel we can achieve pricing that enables us to redeploy proceeds in a way that’s accretive for our shareholders.

[Anthony Powell, Barclays Capital]

Got it. So if your stock remains at current levels kind of in the $16 range, would you be likely to sell more assets more quickly, or does that not play into it?

[Justin Knight, President and Chief Executive Officer]

No. I think, given what we’re seeing in the market and the value of our stock and the variance between that and where we can sell assets from our portfolio, I think, it makes sense for us to continue to pursue asset sales and to buy shares. We don’t think that this is a perpetual stage, but it certainly created an opportunity in the short-term or the near-term for us to drive incremental value for our shareholders.

[Anthony Powell, Barclays Capital]

Got it. Thanks. And moving on to 2019, I guess, I know you’re not giving guidance now, but it seems like you highlighted that supply will remain elevated through at least the back-half of the end of 2019. So are you implying that you – that kind of a similar RevPAR growth for most of the year next year or was that not what you’re trying to imply?

[Justin Knight, President and Chief Executive Officer]

I think and Krissy can add to this. But we’re at disadvantage this year by particularly challenging comps in the back-half of the year. While we do anticipate that in the fourth quarter, where – into the beginning of the first quarter, we’ll have some benefit as we see recovery business in a few of our markets that were hit by the hurricane. We don’t see ourselves facing the same type of year-over-year comps that, that really were large contributors to the underperformance for our portfolio in the third quarter.

So in terms of fundamentals, I think, we continue to see reasonably strong fundamentals. On the demand side, we’re seeing very strong demand. As Krissy highlighted in her remarks and I did in mine, we have several markets that are challenged by increased levels of supply and we see the supply levels beginning to moderate in terms of new deliveries as we push towards the back-half of next year.

And that, that combined with easier year-over-year comps should produce recently strong numbers for our portfolio. And while we’re not giving guidance and you can remember consistency in our portfolio would be with what we anticipated as we started this year.

[Kristian Gathright]

And I’ll just – good morning, Anthony. Thank you for getting up for us so early in the morning, we really appreciate that. Looking at next year just to give a little bit of additional color some benefits will be that we will – we have more concentration in Atlanta than we did in Minneapolis.

So we should benefit from the Super Bowl. Also, we have a relatively mature portfolio, but we do have some hotels that are ramping this year. Phoenix, for instance, the Downtown Hampton Inn & Suites has had a negative impact on us this year even in a strong market. But next year should have outsized growth with it being open a full-year in May of next year.

Justin mentioned that there will be some left. I don’t foresee it being material continuing from the first Hurricane Florence. But also Panama City, that market has definitely been very negatively impacted unfortunately from Hurricane Michael. And once we’re able to get those hotels back open, we should be able to benefit from recovery business.

With that being said, we are still going to be challenged into the first quarter of next year with comps from – with tough comps from the Houston and to some extent, even the Southern Florida market from the hurricanes in 2017. And if you look overall at the overall economy, while things are still going very well with corporate profits and consumer confidence and things overall from a macroeconomic standpoint look good with some potential headwinds from a global standpoint.

There is an expectation for a slightly lower GDP growth next year. So we will be factoring that into our guidance, as well as Justin just mentioned that, that supply will continue to pressure us to some extent, until we enter the latter part of next year. So we’ll be taking all those things into account as we look to finalize our guidance for next year. We’re in the process of collecting all the budgets now. So we don’t have a – we have an idea, but we don’t have a – we don’t have a full picture at this point.

[Anthony Powell, Barclays Capital]

All right. Thanks a lot for all the detail.

[Kristian Gathright]

You’re welcome.

[Justin Knight, President and Chief Executive Officer]

Thank you.

[Operator]

Ladies and gentlemen, we have reached the end of our question-and-answer session. And I would like to turn the call back over to Justin Knight for closing remarks.

[Justin Knight, President and Chief Executive Officer]

Thank you, and thanks to everybody for joining us this morning. We recognize this is an election day. We hope you take the opportunity to go out and vote. And as you travel, as always, we hope you take the opportunity to stay with us at one of our hotels. Have a great day. We’ll talk to you soon.

[Operator]

This does conclude today’s teleconference. You may now disconnect your lines at this time. Thank you for your participation.