8 Rebounds in the Hospitality Sector

07/03/2012 9:00 am EST


George Putnam

Editor, The Turnaround Letter

Some stocks in this sector (including some good REITs) have regrouped, and are looking very promising after scraping the bottom for a few years now, observes George Putnam III of The Turnaround Letter.

The hotel industry has had a long, slow recovery from the 2008-09 recession, but that recovery may be picking up steam.

Many hotel stocks, after rebounding from very depressed levels in late 2008 and early 2009, have gone essentially sideways for the last two years. We think that may be about to change, and have selected eight potential turnaround plays in the sector.

Occupancy has been growing slowly over the last few years, but there has been little new hotel construction, and not much is expected for the next several years. Hotel developers have been slow to launch new projects with memories of the recession still fresh, and those who have wanted to break ground have had difficulty obtaining financing. As a result, rates for hotel rooms are beginning to rise significantly.

Moreover, during the recession, many hotels cut costs in a variety of areas and those efficiencies are boosting the bottom line as revenues rise.

Ashford Hospitality Trust (AHT)
This is a REIT that focuses on upscale hotels, with the bulk of its assets in Top 25 markets in the East Coast, West Coast, and Texas. It stands out because it was able to buy back nearly one half of its outstanding shares during the recession at just over $3 while many peers were issuing dilutive equity.

The company has a fair amount of debt, but management has been actively shoring up the balance sheet, and there are no major maturities until 2016. As a result, management has sufficient resources to capitalize on market opportunities, and the dividend looks reasonably secure.

Chatham Lodging (CLDT)
This company has, since its IPO in 2010, developed a portfolio of hotels in the upscale, extended-stay market. About three-quarters of its properties are in the Northeast and along the California coast. Its public offering in 2010 gave the company the resources to complete renovations when occupancy was still low, thereby getting more bang for its buck.

Recent results have been strong, including above-average per room revenue growth. The stock trades well below its 2010 IPO price and at an attractive long-term valuation.

Diamondrock Hospitality (DRH)
This company has a strategy focused primarily on premium full-service hotels, with 26 hotels located in large cities and destination resorts.

First-quarter results were solid, with strong earnings, bookings and market-share gains. The New York and Boston markets were particularly robust. And the balance sheet is solid, with no corporate debt, and so the dividend looks safe. At today’s levels, the stock is just below its 2005 IPO price.

Felcor Lodging (FCH)
This company owns hotels in 22 states and Canada that are mostly upscale properties in urban and resort markets. The company is still a turnaround-in-progress.

It is selling properties in order to pay down debt and renovate or redevelop other properties. While there is definitely risk here, recent insider buying is a good sign.

Host Hotels & Resorts (HST)
One of the older hotel-resort operators, having begun operations as part of Marriott in 1927. Results have improved, including a strong first quarter, but the company is still selling assets, particularly airport properties. It is also restructuring the balance sheet with debt and equity offerings.

In addition to its US properties, Host has hotels and joint venture interests abroad that should provide good diversification over the long term.

MHI Hospitality (MDH)
A smaller REIT specializing in renovating and re-branding troubled hotel properties. All of its properties are located in the Mid-Atlantic and Southern US

The recession was hard on MHI, leading the company to eliminate its dividend in order to bolster its financials. But its fortunes have improved in recent quarters. The dividend was reinstated in 2011, a line of credit was paid off, debt maturities have been extended and its Tampa property was freed from encumbrances.

MHI is small, but its stock has substantial gain potential.

Strategic Hotel & Resorts (BEE)
This company has the most upscale focus of the hoteliers discussed here. Its 17 hotels and resorts, which include brands such as Fairmont, Four Seasons, and Ritz Carlton, are found in high-end markets, mostly in North America but also select international locations.

This premier positioning worked against the company during the recession, as customers became more cost-conscious. As with many in the industry, management was forced to eliminate dividends, both common and preferred.

The preferred dividend will be reinstated soon, but common dividends are less certain. Management is making solid progress in shoring up the balance sheet, and the stock should do well as travelers begin to spend more.

Sunstone Hotel Investors (SHO)
An operator of primarily upper-upscale properties in larger urban markets. The recession pushed Sunstone into a consolidation mode that eventually led to its deeding eight properties back to its lenders and the elimination of the common dividend.

While leverage remains a bit high, management is well on track to getting the balance sheet on sounder footing. With its improved financials, Sunstone was recently able to acquire the Wyndham Chicago hotel from Blackstone Group. As part of the deal, Blackstone ends up as a 5% shareholder of Sunstone.

The shares, trading below their 2004 IPO price, are well priced for long-term gains.

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