LaSalle Hotel Properties LHO E
December 18, 2008 - 3:29pm EST by
frankie3
2008 2009
Price: 11.06 EPS
Shares Out. (in M): 0 P/E
Market Cap (in $M): 450 P/FCF
Net Debt (in $M): 0 EBIT 0 0
TEV ($): 0 TEV/EBIT

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Description

Investing in a hotel stock seems risky right now but the ability to clip an 18% current yield in a well run hospitality REIT seems worth the risk based on my analysis.

 

The Security

LaSalle Hotel Properties, Preferred Stock Series E, 8% Coupon, $25 Par Value, Cumulative, Liquidation Preference, Redeemable at Par

Last Trade 11.06, Current Yield 18%

 

Investment Highlights

18% Current Yield

7.6X Debt and Preferred Forward EBITDA Mulitple

Preferred Dividend Coverage of 4.1X after Maintenance Capital Expenditures

Insider buying by CEO, CFO, President and COO, Directors, and Chief Accounting Officer.

High Quality Assets with High Barrier to Entry

20% Exposure to Washington D.C. market

Ability to hedge investment through common stock short

 

Company Description

LaSalle Hotel Properties (LaSalle) is a REIT which was formed in 1998 and owns 31 upper-upscale hotels in 14 markets in 11 states and the District of Columbia.  In total, it has about 8,400 total rooms.  Approximately 54% of its hotels are branded (Marriott, Hilton etc.) while the rest of independently branded.  The company has its highest exposure in terms of room count in the following cities:  Washington DC (20%), San Diego (15%), Boston (14%), and Chicago (13%).  LaSalle is structured as a REIT which enables them to not pay income taxes provided they pay out 90% of their taxable income to shareholders. 

 
Industry Fundamentals

Demand

There is no secret that the hospitality industry is deteriorating rapidly.  The economy is in recession.  Corporate spending is plummeting.  Business trips are being cancelled, and fewer business trips are being planned.  Consumer confidence is shot.  The consumer is totally pulling back from discretionary spending which includes vacation travel.   For hotel owners like LaSalle, this is an incredibly bad environment.  Revenues in the lodging industry will see a substantial decline in 2009 and 2010.  The revenue of hotel owners like LaSalle essentially rely upon the occupancy and the daily room rate charged at their hotels.  RevPAR is an industry term used to describe the product of the occupancy rate and the average daily room rate (for example a hotel running at 80% occupancy with an average room rate of $100 would have a RevPAR of $80).  RevPAR is used to assess the financial performance of a hotel property. Currently, the industry is seeing occupancy go down mid to high single digits and room rates beginning to soften.  Industy-wide, this is having the effect of decreasing RevPAR in the order of 7-15% in Q4 2008 and it shows early signs of similar year-over-year weakness in Q1 2009.  For 2009, RevPAR estimates are down 6-10% for the industry with the first 3 quarters remaining weak and Q4 benefitting from a weak Q4 2008 comp.  Newer and well- run hotels and hotels in urban areas typically see lower RevPAR decline.  Demand should be weak for the foreseeable future. 

Supply

On the supply front, more hotels have been built over the last few years as room supply has increased 2-3 percent.  Offsetting the growth, was the high cost to construct new hotels.  Urban markets, which LaSalle is concentrated, typically sees less supply growth.  Future supply growth is estimated to be muted for years to come.

 

 

LaSalle’ Ability to avoid big Industry RevPAR declines—Avoiding Major Revenue Decline

 

1)      Quality Well Run Hotels.  LaSalle owned hotels have an strong reputation in the industry for being in excellent condition and well run.  Nicer and better run hotels usually perform better in a slower economy,

2)      Good Time to Be in D.C.  20% of their EBITDA comes from the Washington D.C. market.  Presidential inauguration years typically see a strong uptick in RevPAR in Q1.  In a year where there is heavy turnover in the Presidential administration or Congress, the strength in these markets tends to extend to Q2 or Q3.  In addition to turnover, the Washington, D.C. market may benefit from an expansion in the government or government spending as more visitors come to the city.  2009 should see a strong boost from these factors.

3)      Urban Hotels are better protected from recession.  40% of LaSalle Hotels located within the city in a metropolitan area.  Guest are willing to pay a premium to stay in the urban core.  Urban hotels have consistently outperform industry-wide RevPAR growth. 

4)      Independently Branded Hotels Outperform.  Nearly 50% of LaSalle’s hotels are independently branded (i.e. not Marriott, Westin, Hilton etc.).  These hotels outperform because they office a unique unbranded experience.  RevPAR is higher for LaSalle’s independents.

 

 

LaSalle’s Ability to Deal with Lower RevPAR—Maintaining Profitability on Lower Revenue
 

There are several aspects to LaSalle’s business which will enable it to deal with lower RevPAR trends. 

1)   1)  They’ve done it before.  In 2001, RevPAR dropped over 12% while EBITDA margin deteriorated just 260 basis points.  They did this largely by reducing costs and operating more efficiently.

2)   2)  Nearly 50% of LaSalle’s hotels are Independent Branded Independent hotels allow LaSalle to be more aggressive with cost cuts as opposed to branded because branded hotels have brand standards and are usually less flexible to cost cuts and service levels.

3)   3)  Cost Cutting will be taken to a new level.  Cost cutting in 2009 is the number one focus.  The 2001 cost cuts will be mild compared to what the company has planned in 2009.  For starters, the company plans to cut workforce 20% at the hotel level.  Personnel costs consist of nearly 50% of operating expenses at the hotels.  Brand owners such as Marriott and Hilton are on-board with cost cuts more today than they were in 2001 in terms of relaxing standards at the branded hotels.

4)   4)  Efficiency initiatives at full force.  In additional to personnel reduction, all hotels have been evaluated and there are numerous  cost saving measures which can add up ( for example reducing the hours of restaurants or food service, reducing/eliminating complementary services, shrinking menu size, reducing energy usage etc.)

 

 

 

LaSalle’s Liquidity  

 

LaSalle currently has $963mm in Debt and it consists of $221 million drawn on a senior unsecured credit facility (with a capacity of $450mm) and $742mm of secured debt (secured by 12 hotels which comprises 58% of the company’s EBITDA).  The effective borrowing rate on the credit facility is 1 month libor plus 80 basis points (currently 1.50%) which is attractive.  LaSalle has 2 potential events in 2009 surrounding its debt which should be fairly easily managed.  First, they have $70mm in loans coming due.  The average rate on these loans were over 5% and these loans will most likely be repaid out of the credit facility.  The second issue is to deal with the potential tripping of the leverage covenant in the credit facility which stands at 6x.  Currently the company is running at 4.5X but the company may bounce up against in late 2009 if adjusted EBITDA drops to the $160mm level which is far below my 2009 estimate.  I believe that this will not be an issue if it should happen because of LaSalle’s ability to seek waivers or margin adjustments.  Furthermore, LaSalle is in the fortunate position of having 19 of its hotels or 42% of its EBITDA ($86mm on $205mm in EBITDA) unencumbered.  The company can issue mortgage loans against these assets and have plenty of liquidity.  In today’s market you can borrow 50% of the value of the hotel on a secured basis.  Using an 8X EBITDA multiple as a value this would enable the company to borrow $344mm on a secured basis at a rate somewhere in the neighborhood of Libor plus 400-500.  Before any desperate act the common dividend would be eliminated saving about $40mm per year.  This may occur early next year.  As last resort, LaSalle could also try to sell assets or equity.  The bottom line is that I believe there are many levers that can be pulled before a cut in the preferred.

 

Commitment to Paying the Preferred Dividend
I believe that management is committed to paying the preferred dividend and would only cut the dividend as a last resort.  I believe the company would  exhaust all efforts to work with their lenders before the preferred dividend cut.  There are several reasons for this rationale:
 
1)   1) The company relies heavily on the preferred market as a part of its capital structure and would not want to tarnish this avenue of financing.  The company has $368mm of preferred outstanding versus $963mm of debt, so the preferred is significant.
 
2)   2) The preferred is cumulative.  If they skip a payment the company would have to pay it back eventually.
 
3)  REITs are required to pay out 90% of income to equity holders or else they are taxed.  As I analyze below, the company should be more than profitable enough to cover the preferred dividends of $27mm.
 

Cash Flow Analysis and Valuation

 

In 2007 the company earned $217mm in EBITDA on RevPAR of $148, this year the company should earn about $205 million in EBITDA on an average RevPAR of $146/night.  For 2009, I estimate that RevPar will decrease to about $135/night or 7.5%.  This $11/per day decline in RevPAR should result in about $35mm decline in room revenues ($11*8400 rooms*365 days).  Offsetting the lower revenues will be cost cuts.  As I mentioned above, the company plans to cut as much as 20% of workforce.  Since workforce represents about 40-50% of hotel operating expenses or $130-150mm dollars, this would result in a savings of $26-30mm.  This would help offset the $35mm decline in room revenue.   The company would also see declines in their food and beverage business in 2009.  In 2008 they will make about 60 million in food and beverage profit.  I conservatively estimate that this profit will drop 20% to or $12mm in 2009.  The net of this simple analysis is that I see a $17 to $21mm decline in 2009 EBITDA, which brings would bring 2009 EBITDA to $184mm to 188mm.  To be conservative, I estimate 2009 EBITDA to come in at about $175mm. 

 

$175mm in EBITDA will allow will provide $109mm of cash flow (175 in EBITDA less 45.7 in interest less 20 million in capital expenditures) to be available for distribution to preferred and common shareholders after interesting and capital expenditures.  This provides over 4X cushion to the preferred shareholders who receive $26.8mm in annual dividends.  This cushion is substantial and provides a lot of downside protection.

Simple Valuation

At $175mm in EBITDA, the debt ($963mm) plus preferred ($369mm) multiple is at 7.6 which is a cheap multple for a high quality lodging company.

 

Ability to Hedge
 
One of the benefits of investing in the preferreds is that you can hedge a worse-than-expected outcome by shorting common stock.  With the common trading 60% off its recent lows and yielding just 9% it is not a bad entry point to start a hedge.
 
 
Several Preferred Stocks to Choose From
 
It is worth noting that there are several LaSalle preferred stocks to choose from: B,D,E,G.  They trade inefficiently despite having the same features (with the exception of dividend rate).  While I am aware that some hospitality bonds are trading at mid teen yields and provide higher seniority to preferred, they can be equally illiquid and do not trade on an exchange.
 
Risks
 
The risks to this investment is that fundamentals deteriorate worse than expected.  This risk can be lessened by shorting the common stock.  In addition spreads on corporate bonds may continue to expand which has an effect on the preferred market.  Preferred Stocks are also really illiquid.

Catalyst

Further Insider Buying,
Common Dividend Cut,
Corporate Bond Spreads tightening,
Company executing on plan to reduce costs.
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