Description

Company

FelCor Lodging Trust (“FCH”) is a lodging REIT that owns 40 core hotels with over 12,000 rooms. FCH focuses on upscale and luxury hotels primarily in urban and resort locations.

Summary

FCH is worth $14/share (23% upside) in our base case scenario. FCH management recently has laid out a plan to grow EBITDA and de-lever the balance sheet over the next two years. The company’s published EBITDA targets have faced skepticism from some investors, but appear achievable to us under reasonable assumptions. As FCH delivers on its EBITDA and FFO projections and the leverage ratio comes down to be more in-line with peers, we believe that the stock should trade in-line with its peer group on an EBITDA and FFO basis over the next 12 months.

Background

Following the financial crisis, FCH set out to transform its portfolio by selling under-performing and/or low-barrier-market hotels. Since 2010 FCH has sold 35 of these “non-strategic” hotels, and has just 5 non-strategic hotels remaining which will be sold in 2015 (3 of which are under contract). This transformation process has resulted a core portfolio of 40 higher-quality, higher-RevPAR hotels. The transformation plan created significant shareholder value, but has nearly been completed. FCH management recently laid out “phase 2” of the plan which outlines 2016 EBITDA & FFO targets as well as an improved leverage profile. We believe management’s earnings targets are realistic, and if achieved will create additional shareholder value, especially from the current share price.

Recent Events

On April 8, 2015 FCH issued 18.4M shares at $11.25/share. FCH will use the net proceeds of $198.5M to redeem its 8% Series C preferred shares for $170M and use the remaining amount to fund future renovation projects and other growth opportunities. On April 6, 2015, the day FCH announced the secondary offering, the company also announced Q1 2015 RevPAR growth of +13.1% y/y (with occupancy +6.2% and ADR +6.6%), which compares favorably to Q1 industry RevPAR  estimates of up 7-8%. FCH shares have been weak since the announcement of the secondary offering, which we think provides a great entry point.

EBITDA Bridge – 2014 to 2016

EBITDA growth over the next two years can be broken out into three main buckets. Our estimates below do not include any additional acquisitions (which management has indicated they will pursue if the asset(s) is high-quality, in the right market, accretive to FFO and EBITDA, and can be acquired at the right price).

$194M   2014 Core Adj. EBITDA (40 Properties)

+$22M   Incremental Knickerbocker Hotel EBITDA

+$16M   Incremental Wyndham Portfolio EBITDA

+$47M   Incremental Core Portfolio EBITDA

-   $2M   Incremental cash corporate overhead expense

$277M   2016 Core Adj. EBITDA (40 properties)

• Knickerbocker Hotel: +$22M in EBITDA in 2016. The Knickerbocker Hotel is a luxury hotel in NYC Times Square. FCH purchased the property in 2012 and has redeveloped it for a total project cost of $250M. The timeline for the hotel opening was pushed back due to construction delays from early 2014 to February 12, 2015, when it officially opened. We believe 2016 EBITDA may be slightly lower than management’s projection given increased hotel supply in NYC and a stronger dollar likely negatively impacting travel to the U.S. Our base case estimate for Knickerbocker Hotel EBITDA is $22M in 2016 (lower than FCH management’s projection of $26M).

• Wyndham Portfolio: +$16M in EBITDA in 2016. The Wyndham portfolio consists of 8 former Holiday Inn hotels that were converted to Wyndham properties in 2013. The agreement with Wyndham includes an annual NOI guaranty of up to $21.5M/year that ensures FCH a minimum level of annual NOI on the portfolio. All 8 hotels have been recently renovated – two in 2012, four in 2013, and two in 2014. The positive impact to RevPAR from the rebranding, renovation, and repositioning was seen in 2014 (RevPAR up 20% y/y) and we believe will continue to be seen this year as we estimate RevPAR growth of 16% in 2015. The NOI guaranty in 2015 and 2016 is $54M and $57M, respectively. Our base case estimate for Wyndham Portfolio EBITDA is $59M in 2016 (in-line with FCH management’s projection), a $16M increase from 2014.

  

• Remaining Core Portfolio: +$47M in EBITDA in 2016. The remaining Core Portfolio (31 hotels) is comprised mostly of Embassy Suites hotels (18), and includes other upscale hotel brands such as Renaissance, Hilton, Sheraton, and DoubleTree. We believe Core Portfolio RevPAR will continue to benefit over the next 12-24 months from positive hotel industry trends of increasing demand and limited supply growth as well as recent hotel renovations (guestroom renovations were completed on 5 of the 31 Core Portfolio hotels in 2014). We estimate the Core Portfolio will generate 8% RevPAR growth in 2015, which we view as a reasonable estimate considering Core Portfolio RevPAR was up was up an estimated 10-12% in Q1 2015 based on preliminary results reported by FCH management on April 6th. Our base case estimate for Core Portfolio RevPAR growth is 6% in 2016, as it benefits from light renovations at 5 additional hotels scheduled to be completed from Feb 2015 – Jan 2016 (our estimates do not factor in any renovation projects not already specifically outlined by the company). We assume a 50% EBITDA flow through on incremental revenue. Our base case estimate for Core Portfolio EBITDA is $217M in 2016 (higher than FCH management’s implied projection of $44M), a $47M increase from 2014.

FFO Bridge – 2014 to 2016

FFO growth will come from incremental EBITDA as well as lower interest expense and lower dividend payments related to the recent redemption of preferred shares.

    $         FFO/Shr.

  $55M      $0.38  2014 Core FFO (40 Properties)

+$22M      $0.15  Incremental Knickerbocker Hotel EBITDA

+$16M      $0.11  Incremental Wyndham Portfolio EBITDA

+$47M      $0.33  Incremental Core Portfolio EBITDA

-   $2M     -$0.01  Incremental cash corporate overhead expense

+  $5M      $0.03  Reduction in interest expense from refinancing $525M of 6.75% bonds due in 2019

+  $4M      $0.03  Reduction in interest expense from repaying $140M in term loan debt

+  $2M      $0.01  Reduction in interest expense from repaying $64M in mortgage debt

+$14M      $0.10  Reduction in preferred dividends from redeeming $170M of 8% Series C preferred shares

$163M      $1.14  2016 Core FFO (40 properties)

Note: FFO/Share does not tie due to rounding. Assumes 143.6M shares (pro forma for 18.4M shares issued in April 2015).

• Refinance the 6.75% bonds due in 2019: +$5M in FFO. These bonds are callable in June 2015. Management has indicated they will refinance these bonds in the late 2015/early 2016 time period.  We estimate FCH can refinance at approximately 100bps lower that the current rate. This will reduce interest expense (and increase FFO) by ~$5M/year. We assume the refinance happens 12/31/2015.

• Repay $140M of L+250bps Term Loan: +$4M in FFO. FCH plans to use proceeds from the sale of 5 non-strategic hotels to repay its $140M term loan. This will reduce interest expense (and increase FFO) by ~$4M/year.

• Repay $64M of L+300bps mortgage debt: +$2M in FFO. After repaying the $140M term loan, FCH plans to use remaining proceeds from the sale of 5 non-strategic hotels to repay $64M in mortgage debt. This will reduce interest expense (and increase FFO) by ~$2M/year.

• Redemption of $170M of 8% Series C preferred shares: +14M in FFO. In April 2015 FCH issued 18.4M shares at $11.25/share, receiving $198.5M in net proceeds. FCH will use these proceeds to redeem all $170M of its 8% Series C preferred stock in May 2015. This will reduce preferred dividends (and increase FFO) by ~$14M/year.

De-Leverage the Balance Sheet

At the end of FY 2014, FCH had 8 non-strategic hotels remaining that it planned to sell in 2015. Year-to-date FCH has sold 3 of those hotels for $93M. We believe the remaining 5 hotels will be sold for ~$150M (3 are currently under contract), generating an estimated $243M in total proceeds. With those sale proceeds plus the estimated net increase in cash over the next two years (we estimate $50M in 2015 and $80M in 2016), FCH’s leverage ratio (defined as Net Debt Including Preferred / TTM Core EBITDA) will be reduced by 50%, from 10.6x to 5.3x, by the end of 2016. Peers average 4.6x.

Valuation & Catalysts

Using 2016 consensus estimates, Hotel REIT peers currently trade at 12x - 13x EBITDA and 11x - 13x FFO.

Using our 2016 estimates, FCH currently trades at 11.8x EBITDA and 10.1x FFO (pro-forma for the recent equity raise and $243M in estimated proceeds from the sale of non-strategic hotels).

FCH is a high-quality hotel REIT that currently trades at a discount to its peers. We believe much of the discount is due to investor skepticism about management’s EBITDA and FFO projections and the company’s leverage profile. As FCH 1) delivers on its earnings projections and 2) de-levers the balance sheet over the next 12-24 months we believe it should trade more in-line with peer multiples.

Applying a 13x EBITDA multiple to our 2016 base case estimate of $277M yields $14.0/share.

Applying a 12x FFO multiple to our 2016 base case estimate of $1.14/share yields $13.6/share.

At $14/share, there is 23% upside from the current share price.

There is potential upside to our base case earnings estimates from future asset sales, acquisitions, and/or redevelopment projects not already announced by the company. Additionally, in one year from now we believe the multiples on 2016 EBITDA and FFO could be closer to 14x and 13x, respectively, which would imply a share price of ~$15-$16/share.

Other Potential Catalysts

• Additional asset sales: FCH has indicated that it is looking at every option for the Morgans and Royalton hotels, which have underperformed the rest of the Core Portfolio. In 2014 the two hotels combined to generate -2.0% RevPAR growth and only $3.3M of EBITDA in 2014. It would not be surprising if these two hotels were sold at some point in the next two years. The hotels were purchased by FCH for $140M in 2011 and would likely bring at least that much in a sale today. If the proceeds were used to further de-lever the balance sheet, the sale could represent a ~0.5x reduction in Net Debt/EBITDA. If the proceeds were used to acquire other properties, FCH could generate an incremental $7M of EBITDA on that reinvested capital (assuming a 14x acquisition of multiple).

• Dividend increase: FCH will soon redeem all of its Series C preferred shares. This will free up $0.09/common share which could potentially be used to increase the dividend. If the entire amount used to pay the annual preferred dividend was used to increase the common dividend, the common dividend would increase by over 50% to $0.25/share (the current annual dividend rate is $0.16/share). This would move FCH’s dividend yield closer to the peer average of ~3%, and could attract more dedicated REIT investors to the company’s stock.

Risks

• Lodging Cycle: For the past 4 years, the U.S. lodging industry has benefited from limited supply increases coupled with positive employment and consumer spending trends resulting in mid-to-high single digit annual RevPAR growth, with that trend expected to continue in 2015. The risk is that the lodging cycle is actually much further along than most investors think and RevPAR growth begins to materially decelerate over the next 12-24 months due to a combination of increased supply and stalled or decreased demand. This scenario would generate a significant headwind to FCH achieving its 2016 EBITDA and leverage projections and would likely result in lower multiples for hotel REITs and C-corps in general.

• Knickerbocker Ramp-up: One of the largest risks is underwriting the ramp-up of the Knickerbocker Hotel over the next 18-24 months. The hotel opened nearly a year behind schedule, and is attempting to ramp in a NYC market that is facing increased supply and is likely to be negatively impacted by decreased international travel due to the recent strong dollar. Our base case estimate is under management’s projection, but could still potentially prove to be too high. Underperformance in the Knickerbocker could prevent FCH from achieving its 2016 EBITDA projections.

• Interest Rates: REIT valuations are typically negatively impacted by increased interest rates, at least in the short-run. FCH will not be immune if REITs as a group sell off due to rising interest rates.  

Catalyst

Operational execution that results in achievement of management’s stated earnings projections

Strengthening of the balance sheet to a leverage profile more in-line with peers

Announcements of additional asset sales, acquisitions, and/or renovation projects

Announcement of a dividend increase