Service Properties Trust

Good 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.

Good morning. Joining me on today's call are Tard Hargraves, 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 SDC's present beliefs and expectations as of today, May 8, 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 FCC, which can be accessed from our website at svcREIT.com or the FCC'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 SFO, and adjusted EBITDA RE. Reconciliations of these non-GAAP financial measures to net income, as well as components to calculate ASFO, are available in our financial reporting package, which can be found on our website. And 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.

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 transient 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 REF PAR declined 3.5% year-over-year. When excluding the 23 active renovations, ADR declined 0.7% and occupancy declined 0.2%, leading to a REF PAR 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 at RAPFAR 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 select service hotels continue 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 REF PAR 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 REF PAR year-over-year. Consistent with a trend from previous quarters, our longer-term extended stay occupancy, stays of seven-plus nights, has been declining due to the loss of non-repeat project-based room nights. While synesthesis actually pivoted to shorter-term stays of 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 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. Sinesta 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 Sinesta full-service hotel revenues were from loyalty program members, up 3.5 percentage points from 2023. Other ongoing Sinesta initiatives include a focus on driving ancillary revenues at the hotel, 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 soccer 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 and suites in suburban Minneapolis for an aggregate sales price of $6.2 million. We continue to market 22 Sinesta hotels with a book value of $160 million. The sale process is well underway and we're working with potential buyers to negotiate terms. In conclusion, we're 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 in 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.

Thanks, Todd, and good morning. Starting with our consolidated financial results for the first quarter of 2024, normalized FFO was $21.1 million, or $0.13 per share, versus $0.23 per share in the prior year quarter. Adjusted EBITDA RE 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 leave until $28.9 million, a decline from the prior year, but in line with our guidance rates provided last quarter. By service level, hotel leave through 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-core Q2 REVPAR of $95 to $99 in Hotel Ibiza in the $80 to $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 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 in our properties during the first quarter. We currently expect full-year capital expenditures of $300 to $325 million, up from our previous guidance range of $250 to $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 Senesta 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 20 cents per share, which we believe is well covered, representing a 51% normalized FFFO payout ratio for the 12 months ended March 31st, 2024. That concludes our prepared remarks. We're ready to open the line for questions.

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 2. At this time, we will pause momentarily to assemble our roster. Our first question is from Brian Mayer with B Reilly Securities. Please go ahead.

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?

Good morning, Brian. Thanks for the question. Yeah, a lot of it is just pace of projects. And 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 in 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. So 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. So 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.

Would you consider some or all of that $50 million a pull forward from what you would have spent in 2025? Some of it, yes. Yes. Okay. And when we think about the Hyatt renovation disruption, can you talk about when you think that 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.

Sure, I can take that one, Brian.

Good morning.

So the Hyatts, 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. Yeah, per key it's around $40,000. Yeah, $40,000. Yeah, and it's rooms, common areas, facades. It's a pretty intensive renovation. Those hotels haven't been renovated in a while, so we expect to see a pretty significant pickup

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

Yeah, from a Sonesta standpoint, it depends on the chain scale and the brand. The Simply Suites at the lower end is $30,000 to $35,000 per key and could be upwards of $50,000 a key for some of the bare 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've as we look at different chain scales and different needs when the last refresh happens.

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

And just two more for me. What kind of uplift are you looking for in RevPAR? roughly speaking, from the Hyatt renovations and the Sinesta 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 REF PAR uplift would be. Can you share with us what you're thinking there?

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 know, you're not going to get that same lift from more routine stuff that is just, you know, maintenance type capital. But, you know, there are various ROI projects built into our program and, you know, the amount of money we're putting in, we expect a significant lift that will, you know, high single digit EBITDA returns with the longer-term post-renovation periods. We finished nine semesters 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 ramp-up period afterwards, we're seeing those returns that we had forecasted. Okay, thank you.

Thank you. The next question is from Dori Keston with Wells Fargo. Please go ahead.

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 just, I'm not sure if you feel the SEC portfolio would participate as much given limited group exposure in the renovation headwinds.

That's a great question, Dory. Thank you. You know, 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.

Okay. And as you wrap up negotiations on the 22 Sinestas, 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?

Sure, Dori. The marketing process, so just to clarify, we have gone through multiple rounds of bidding on the hotels. We're 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 their negative EBITDA for the most part. They need CapEx, so local operators are coming in and 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. 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.

Okay. And then my last one is just on trucking trends. You've talked about the normalization of trends, and therefore it makes sense your rent coverage is coming in post-pandemic. But for context, like 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.

Right. It remains to be seen. It's a good... The commentary is... We agree with that commentary back in... 2017, 18, 19, the coverage for those assets was probably closer to 1.8 or 1.9 times. And then 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 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.

Okay. Thank you so much.

No problem. The next question is from Tyler Bittori with Oppenheimer. Please go ahead.

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 to 85 of hotel EBITDA, you know, 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? What needs to happen for you to really see some margin improvement and margin growth?

Hey, Tyler. Good morning and thanks for the question. Of But, you know, 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 height 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. These are some of our stronger seasonal periods. We're going to try to limit Rooms that are on our servers, so it's tough to fully quantify and 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 in our hotels. We're doing that through various initiatives, including the CapEx program. So that's the 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.

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 Sinestas. 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 on the – it's tough to get a good comp on the select service portfolio because so many were out of – We're 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 4 extended stay business of more than seven nights. In some cases, you can get 30 to 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 Senesta, are very focused on.

Okay, great. So in terms of the Senesta brand, I think you cited 30% of stays in the quarter were loyalty members. I think it's 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, you know, just kind of an update on how Synestes is resonating in the marketplace for travelers.

Right. And the number was about 26%, I believe, for the full service hotels. And it's a little bit lower on the focused service hotels. But we are seeing increases there. I think the full service, we saw 300 basis point increase year over year. So we are really seeing the adoption, especially on the Semesta and Royal Semesta 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, is 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 loyalty, through the loyalty program. So, you know, Semesta is still at this size, is a relatively newer, younger company. So, you know, we're seeing things move in the right direction, and we are seeing that brand adoption in some of the numbers.

Okay, great. And then last question for me, I obviously know debt 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 we sit today, can you rank order, you know, kind of what looks most attractive to you in terms of handling those maturities?

Hey, Tyler, that's a great question. You know, we continue to monitor the debt markets and we are going to continue to be proactive on our debt maturities. You know, as we've demonstrated, we've got multiple options using SBC'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. Okay. That's all for me.

Thank you.

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

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

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