Lodging REIT 2Q Preview
Summary
Lodging REITs Lose Momentum, Remain Attractive In Our View. After falling sharply at the end of 1Q, Lodging REITs rallied in 2Q through early June (rising +49.8% through June 8), before losing momentum near the end of the quarter (ending the quarter +5.5% for 2Q). We believe the group retreated as investors became overly optimistic surrounding the outlook for lodging, which stretched valuations across the sector. That being said, we believe the group has once again become oversold, and while we continue to expect there to be near-term noise, we believe Lodging REITs offer compelling value to shareholders with a long-term view. 2Q numbers will largely be ignored, with investors instead likely to be focused on commentary surrounding operating trends, cash burn, the transactions' environment, business mix and balance sheet management. Our top pick in the group remains DiamondRock Hospitality (DRH, $5.13, Buy).
Key Points
Industry Numbers Begin to Move Higher, But Could Stall Late Summer. Industry numbers likely saw a bottom in April, with Smith Travel reporting a RevPAR decline of 79.9%, compared to June RevPAR of down 60.6%. Although numbers have trended in a more positive direction, it is important to note that a number of lodging REITs are more concentrated in the luxury and upper-upscale segments, which continue to be more severely impacted. To this point, the luxury segment reported June RevPAR down 80.8% and the upper-upscale segment down 80.6%. While we continue to expect April to represent the trough for industry, numbers could regress post-summer, as portfolios begin to lose leisure demand, which has been a large driver of hotel demand this summer. Additionally, concerns surrounding a second wave of state shutdowns (Florida, Texas, California) could stall some of the progress that the industry has experienced. We believe it is important to note that STR has started to exclude closed hotels from their data, which in our view, is making the recovery read-through more difficult to gauge. Nonetheless, we continue to view the sector as offering attractive long-term risk/reward, as the group offers compelling value at currently depressed levels.
Who We Like In The Current Environment: DRH. Going into earnings season we favor DRH. While we expect RevPAR for DRH to outperform in 2Q due to the company's higher resorts exposure, we believe 2Q numbers are of little importance to investors. That being said, we continue to favor the company due to its strong liquidity position ($360 million of liquidity as of the end of 2Q), no near-term debt maturities, and its more attractive business mix for the current environment (less group exposure, higher leisure component). Additionally, over the long-term, we believe the company completing and reopening its property in St. Thomas should be an additional EBITDA tailwind over the medium to long-term.
2Q20/FY20 Numbers Are Largely Irrelevant, Focus On 2021/2022. Similar to 1Q, we strongly believe that 2Q numbers (EBITDA and FFO) as well as FY20 will be largely considered irrelevant by investors. There is more of a focus on determining a realistic portfolio run-rate for names in the group. To this point, we believe determining a realistic 2021/2022 run-rate, and the timing of when we could potentially begin to see operations start to stabilize, are much more important in considering the space. Additionally, we believe cash burn, and its implications for leverage, should be an additional focus of investors.
Management Commentary/Overall Macro Environment To Drive Near-Term Performance. With near-term numbers being mostly irrelevant, we believe investors will instead be focused on management commentary, surrounding cash burn, liquidity, permanent and temporary cost cuts, and potential acquisitions will be a focus of investors. Additionally, the heavily cyclical reliant sector will be impacted by both positive and negative macro news, which will be a key driver for the group.
Pricing as of the close, July 22, 2020.
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Simon Yarmak, CFA | (443) 224-1345 | yarmaks@stifel.com Moshe Levin, CFA | (443) 224-1264 | levinm@stifel.com Connor Shockley | (443) 224-1357 | shockleyc@stifel.com Stifel Equity Trading Desk | (800) 424-8870