Diamondrock Hospitality Company

Good day, and thank you for standing by. Welcome to the Diamond Rock Hospitality Company third quarter 2025 earnings conference call. At this time, all participants are in a listen-only mode. After the speaker's presentation, there'll be a question and answer session. To ask a question during the session, you'll need to press star 11 on your telephone. You will then hear an automated message advising your hand is raised. To answer a question, please press star 11 again. Please be advised that today's conference is being recorded. I would now like to turn the conference over to Brani Quinn. Please go ahead.

Good morning, everyone, and welcome to Diamond Rock's Third Quarter 2025 Earnings Call and Webcast. Joining me today is Jess Donnelly, our Chief Executive Officer, and Justin Leonard, our President and Chief Operating Officer. Before we begin, let me remind everyone that many of our comments today are not historical facts and are considered to be forward-looking statements under federal securities laws. As described in our filings with the SEC, these statements are subject to numerous risks and uncertainties that could cause future results to differ materially from what we discussed today. In addition, on today's call, we will discuss certain non-GAAP financial information. A reconciliation of this information to the most directly comparable GAAP financial measure can be found in our earnings press release. Turning to our results, corporate adjusted EBITDA in the third quarter was $79.1 million and adjusted FFO per share was $0.29, each ahead of our expectations. Free cash flow per share for the trailing 12 months, defined as adjusted FFO less CapEx, increased approximately 4% to 66 sets per share. Comparable RESPAR declined 0.3%, exceeding our expectation of a low single-digit decline, with each month of the quarter performing slightly better than expected. RESPAR outpaced both our weighted average star class and our comp sets in the quarter. Occupancy was flat year over year, and ADR declined 0.4%, both again slightly better than expected. Looking at our revenue segments, business transient led the way this quarter with almost 2% growth, while leisure transient declined 1.5% and group room revenue declined 3.5%. All year long, we had been highlighting the difficult group comparisons our portfolio would face in the third quarter, largely due to last year's Democratic National Convention in Chicago in August, as well as fewer citywide conventions in Boston. Despite this headwind, both of our hotels in Chicago were able to drive RevPar growth in the quarter. Despite the slight decline in RevPar, our out-of-room revenues increased 5.1%, resulting in total RevPar growth of 1.5%. Total RevPar grew in both our urban and resort portfolios. Food and beverage was once again a bright spot, both on the top and bottom line. F&B revenues increased 4%, with banquets and catering up almost 8%, while outlets were down modestly. Last quarter, we highlighted that our food and beverage margins expanded by 105 basis points. This quarter was even stronger, with F&B margins expanding by 180 basis points, aided by our continued efforts in reengineering menus and focused staffing. Other contributors to the increase in out-of-room revenues in the quarter included spa, parking, and destination fees, which were each up over 10%. Total hotel operating expenses increased 1.6%, resulting in only a three basis point EBITDA margin contraction, and hotel adjusted EBITDA growth of 1.4%, which to date is an industry-leading result. Wages and benefits, which represent almost half of our total expenses, increased to just 1.1%. Now to highlight the resorts of our urban hotels and our resorts for the quarter. Our urban portfolio, which accounts for over 60% of our annual EBITDA, achieved RevPAR growth of 0.6% in the quarter. Total RevPAR growth was 150 basis points stronger at 2.1%. As expected, August was our softest month and September was our strongest, with 6.1% RevPAR growth, showing gains in both occupancy and rate. The strongest RevPAR growth in the quarter was achieved by our hotels in Salt Lake City, New York, Atlanta, and Chicago, which helped to offset some of the renovation disruption at the Palomar and Phoenix. Turning to our resorts, RevPAR declined 2.5%, but total REVPAR increased 0.4% on 4% growth in out-of-room revenues. Excluding our Sedona hotels under renovation and Havana Cabana, where we made the decision to accelerate a capital project during a lower occupancy period, resort REVPAR declined just 0.4%, and total REVPAR increased an even stronger 1.7%. We continue to see a bifurcation in resort performance, with the higher ADR resorts outperforming those with lower ADRs. We expect that performance variance will continue to benefit our luxury resorts for the foreseeable future. Although the top-line trends of resorts have received elevated focus, we believe it is most important to focus on bottom-line results. Despite a 2.5% decline in RevPar in our resorts this quarter, EBITDA margins expanded by over 150 basis points with wages and benefits flat and total expenses down 1.5%. Said differently, our resorts made more money in Q3-25 than they did in Q3-24 on roughly the same amount of revenue. Before turning to the balance sheet, I'll make a few additional comments on our group segment. Group room revenues across the portfolio declined 3.5% in the quarter, with room nights down 4.5% and rates up over 1%. We faced tough comparisons, particularly in August. However, our hotels were quite successful in converting short-term leads to in-house groups. During the quarter, we booked 38% more groups for the balance of the year than we did the same time last year. Looking to 2026, our group pace is up in the mid to high single digits, and we entered the fourth quarter with almost 60% of our 2026 group revenue on the books, on pace towards the 70% we typically start with each year. Moving on to the balance sheet. Early in the quarter, we successfully refinanced, upsized, and extended the maturities under our senior unsecured credit facility, the proceeds of which were used to pay off our last two mortgage loans. Our portfolio is now fully unencumbered by secured debt. All of our debt is fully prepayable without fees or penalties, and with extension options, our earliest maturity is in 2029. Importantly, we have recast all of our debt to market rates, thus eliminating the overhang of below-market maturities on our FFO per share growth for the next several years. Inclusive of interest rate swaps, 30% of our debt is fixed rate and 70% is floating rate, a notable advantage in this declining interest rate environment. We have paid a quarterly common dividend of $0.08 per share to date this year and expect to declare an additional stub dividend for the fourth quarter. At the midpoint of our updated guidance, our current dividend to FFO per share payout is approximately 30%, as compared to just under 50% in 2019. as we continue to utilize a portion of our net operating losses to offset our taxable income. During the third quarter, we utilized our free cash flow to repurchase 1.5 million common shares at an implied cap rate of approximately 9.7%. Year-to-date, we have repurchased 4.8 million common shares for $37 million, or $772 per share on average. We anticipate ending the year with over $150 million of cash on hand and continue to view the repurchase of our common shares and or the redemption of our 8.25 Series A preferred shares to be highly attractive uses of capital in this environment. Before turning the call over to Jeff, I'll wrap up my comments with our updated 2025 guidance. We are maintaining the midpoints of our REVPAR and total REVPAR guidance while tightening the ranges. This revision implies a slight decline at the midpoint in the fourth quarter. However, in light of the continued success our team is having controlling expenses, we have raised the midpoint of our adjusted EBITDA guidance by $6 million to $287 to $295 million and raised the midpoint of our adjusted FFO per share guidance by $0.03 to $1.02 to $1.06. With that, I'll turn the call over to Jeff.

Thank you, Bryony, and thank you all for joining us this morning. I want to start by congratulating our hotels and our team at Diamond Rock for their hard work and ingenuity to deliver another quarter of results that exceeded expectations. In the last month, our portfolio has been awarded several prestigious honors, a handful I'd like to share here. Cavallo Point was recognized with two Michelin keys. The Gwen was honored with one. and Lake Austin Spa Resort was again named the number one destination spa in the United States by Condé Nast. Well earned, and congratulations to the teams for these rare achievements. While we have unwavering pride for every Diamond, Star, TripAdvisor rank, and top-meeting hotel owner, and the demanding work that goes into delivering the service to earn those awards, our North Star at Diamond Rock remains driving outsized free cash flow per share. To us, it is simple. We are in the business of making money for our investors and driving outsized free cash flow for share growth has, over time, historically resulted in outsized total shareholder returns. The accolades are not the end game, but they are an aspect of delivering on our promise to shareholders. At Diamond Rock, we strongly believe in the alignment of interests, so 100% of our officers' performance-based long-term equity incentive awards are tied to relative total shareholder returns. and common equity is a component of every employee's compensation. We believe in being efficient with our shareholders' money. In that regard, our G&A per owned hotel is nearly 45% below our peer average. It's one of the many ways we work to preserve capital. I'm going to focus my comments today on the strategy behind our differentiated CapEx program, the current transaction environment and how we intend to participate in it, our view on the remainder of 2025, and lastly, I will provide some context around our outlook for 2026. The strategy behind our CapEx program has become a key discussion point with investors and analysts as they lean into what differentiates Diamond Rock versus our peers. Between 2018 and 2024, we executed four strategic up-brandings, two un-brandings, and nine lifecycle renovations, yet spent approximately 9% of revenues on CapEx. In the last three years, we have spent just 7% of revenue on CapEx, while peers have spent 10.5%, an over 300 basis point spread. In dollar terms, that difference is over $100 million, or almost 50 cents per share on our stock. We are often asked how we can target annual CapEx spending at 7% to 9% of revenue when our peers repeatedly choose to spend 10.5% to 11% of revenue, and some even up to 14%. First off, With only 5% of our hotels brand managed, we have a competitive advantage of exerting more control over the scope and timing of renovations. As owner, we are in the best position to determine the balance between operating performance, value creation, and capital expenditure, not the brand manager. We are making capital decisions that will drive our outperformance and maximize our total share of the return. They are playing a different game. They're paid off the top line, understandably focused on brand standards, but less concerned with an owner's ROI. So how is it we keep our capex spending so efficient? It's important to mention that hotel brands typically mandate room renovations every seven years. We work hard to elongate that cycle and reduce the costs of renovations when undertaken. How do we elongate the cycle? Strong REVPAR index and bottom line profits evidence your product remains competitive. Performance matters. With it, we can justify a lighter and less frequent renovation. An extra two years on our renovation cycle is a 28% reduction in our average annual expenditures. How do we reduce the cost of a renovation? Our hotels on average are newer, so they're more code compliant with fewer surprises behind the walls. Our internal design and construction team plans our renovations at least two years in advance to target precise timing to minimize profit disruption. The longer planning window gives us time to fine tune and negotiate the scope. Supply chain is monitored. We analyze how improvements can increase labor productivity and boost profitability. Every single fixture, surface covering, and piece of furniture is reviewed for their cost, design, and durability. We assess what components can be kept and what can be refined. Our Kempton Palomar in Phoenix is a prime example. This is the number one hotel in the downtown market and we recently completed the hotel's first room renovation since opening in 2016. at a cost of just $21,000 per key, and it looks terrific. In our view, if the asset still looks fresh, competes effectively, and is operating efficiently, then we do not need to renovate every seven years. It's simply not a prudent use of our shareholders' capital to play a role in someone else's design war. To be clear, we are not anti-brand. Branding is a choice, and in the right circumstances, brands deliver exemplary performance. Instead, I would say we are pro-flexibility. The way we have chosen to invest in our portfolio preserves capital for investment and is translated to FFO per share and free cash flow per share outperformance. Based on the midpoint of our raised guidance, our 2025 free cash flow per share would be 2% above our 2018 level, while peers averaged 30% below. Now this isn't to say that we don't like a strong ROI project. We do. They can provide a great risk adjusted return. Take our recently completed the cliffs at Loberge, which is now fully integrated into our adjacent property, Loberge to Sedona. In the first full quarter post-renovation, the cliffs realized a 65% ADR increase. As we look more broadly at the market, we are incredibly pleased to see that the cliffs REVPAR index increased to over 130 from a level of 108 last year. Importantly, over that same period, L'Auberge de Sedona maintained its REVPAR index at over 160 within its own luxury comp set, meaning one hotel is not taking from the other, but together have become one stronger integrated resort. The group sales team at L'Auberge has been busy. The group revenue pace is up approximately 25% in the fourth quarter and up 55% in 2026. Standardizing product quality and combining the hotels has created a stronger group channel than either hotel enjoyed on its own. As a reminder, we spent $25 million on this renovation and remain quite comfortable this ROI project will achieve a 10% yield on cost at stabilization. We are hosting a tour of the integrated La Berge ahead of Dallas REIT World, and we look forward to showing those in attendance what a Diamond Rock ROI project looks like while experiencing the unparalleled hospitality of La Berge. With respect to the transaction environment, we continue to underwrite acquisition opportunities, mostly group-oriented hotels, urban select service hotels, and resorts. While we had our eye on a few potential candidates this past quarter, we did not feel the ultimate pricing was defendable after considering realistic CapEx needs versus where our shares are trading. In general, we see upper-upscale resorts with asking cap rates in the 7% and 9% range, but inclusive of near-term CapEx needs, the all-in cap rate was closer to 5% to 7%. Similarly, the ask for luxury hotels remains in the 5% to 7% range or about 4% to 6% all in. At that pricing, our strong preference is to reinvest in the luxury and upper upscale hotels Diamond Rock already owns through share repurchases. On the disposition side, we continue to have active conversations around the disposition of a handful of our assets, and we expect to remain active in the market in the coming year. We have nothing to share at this time, but we believe we will see elevated capital recycling in the next 12 to 18 months compared to our history. Now, to our outlook for 2025, as Bryony noted, we are raising the midpoint of our adjusted EBITDA guidance range by 2% and raising the midpoint of our FFO per share guidance by 3%. Our new guidance reflects our better than expected results in the third quarter, and a slightly moderated expectation for the fourth quarter, predominantly due to the impact of the federal government shutdown. To look forward, it helps to look back at how we got here. We knew about a year ago that our third quarter comp would be difficult, and we aggressively worked to chip away at that deficit. Heading into the third quarter, our group revenue pace was down 9.6% from the prior year, yet we exited the quarter around 600 basis points better. Our operators pushed hard to drive profitable short-term group business. On the transient side, our revenues were essentially flat and in line with our expectations. Making our way to the bottom line this past quarter, I was incredibly pleased with the results our operators and asset managers delivered. Our team is driven to be innovative in their efficiency and productivity efforts, and we were successful in that execution once again. When you look back at our fourth quarter last year, You will note our REF PAR and total REF PAR were up in the mid-5% range, making the fourth quarter our toughest revenue comparison of this year. Our playbook for Q4 remains the same as it was in the third quarter, identifying new strategies to drive revenues and grinding away to realize expense efficiencies. It's our team's tenacity, from Diamond Rock's asset managers to our hotel's teams, that results in exceeding expectations and driving free cash flow per share. The federal government shutdown has increased uncertainty with respect to short-term group pickup, attrition, and on-time transient guest arrivals. In this regard, we have seen our group revenue pace for the fourth quarter take a small step backwards from October to November. As I mentioned earlier, we have slightly moderated our fourth quarter forecast in our 2025 guidance to recognize that the impact of the shutdown is building. Our guidance assumes the shutdown is resolved in short order and travel resumes its normal cadence. Looking ahead to 2026, it is difficult not to be excited about the trajectory of the lodging industry, and specifically for Diamond Rock. The industry's tailwinds are well known at this point, with easier comparisons created by Liberation Day, the country's longest federal government shutdown, the holiday calendar, the United States' 250th anniversary, and an improvement in net inbound-outbound international visitation. I'd like to take a few moments to focus specifically on tailwinds unique to Diamond Rock. First, our renovations this year are expected to negatively impact our 2025 REVPAR growth by approximately 75 basis points, creating a built-in tailwind to start 2026. We have previously highlighted our expectation that the ROI project at the Calista-Lobayers should drive an incremental 25 to 50 basis point REVPAR tailwind in 2026 on its way to a 10% yield on cost. Second, we have the highest exposure to FIFA World Cup games based upon the importance of games, per a recent analyst report. We expect compression around these games to be material and create a compelling rate story for Diamond Rock next summer. Third, in 2026, we have a solid base of group and contract business, which typically accounts for 35% of our total demand, with group pace up in the mid to high single digits. We expect to be able to tell you our hotels achieved new highs for group revenue sequentially in 2024, 2025, and 2026. Top line growth does not mean much unless it makes its way to the bottom line as free cash flow. We are among the very few full-service lodging REITs to achieve free cash flow per share growth since 2018, and we expect to widen that disparity versus our peers next year. 2026 is around the corner, but there's still much work left to do in 2025. We look forward to seeing many of you at conferences and tours over the next few months to update you on our progress. Thank you for your time this morning, and we are happy to answer your questions.