ACR - How Do RLJ Lodging Trust's Preferred Shares Compare To Others?

2023-03-11 03:37:37 ET

Summary

• In this article, we investigate RLJ Lodging Trust's convertible preferred shares, RLJ.PA.
• After a brief overview of the company, we dig into the financials to gauge safety of the preferreds.
• Then we'll merge our analysis with recent analysis of preferreds from two commercial mREITs: ACRES Commercial Realty and TPG RE Finance Trust.
• Look down to find tables comparing RLJ-A, ACR-C, ACR-D, and TRTX-C.

Comparing preferreds from across different companies can be a good way to gauge relative value. So today we are comparing RLJ Lodging Trust's preferred shares, RLJ.PA, to preferreds from two commercial mREITs: ACRES Commercial Realty Corp. ( ACR ) and TPG RE Finance Trust ( TRTX ). All three of these companies are real estate investment trusts or REITs though that should not confuse readers into thinking these companies operate similarly. Only two of them do.

Both ACR and TRTX are balance sheet lenders meaning they are invested in senior loans on commercial real estate property. This differs from RLJ Lodging Trusts' portfolio of hotels that they own and operate directly. As balance sheet lenders, ACR and TRTX could make a loan to RLJ to finance acquisition of a new property or a renovation of an existing one.

Another way of interpreting this is that ACR and TRTX operate more of a debt portfolio while RLJ is managing a set of properties, hotels specifically, to generate income. For the curious, I've done deeper coverage on ACR's preferred shares as well as TRTX and their preferreds . We'll take the time to merge that research and analysis here in comparison to the RLJ.PA preferred security.

RLJ Lodging Trust: A Company Overview

There's a certain kind of aesthetic that this hotel investment company is going for. It looks something like this.

So envision Quality, Prestige, $$ when you think of their " premium-branded, rooms-oriented, high-margin, focused-service and compact full-service hotels. " The portfolio consists of 96 hotels with ~21,200 rooms which are operated under a constellation of well-known brands like Mariott, Embassy Suites, Hyatt Place, and Wyndham.

Robert L. Johnson is the namesake of RLJ Lodging Trust as he founded the company back in 2011. Some may recognize Johnson as the co-founder of Black Entertainment Television or BET. Today Mr. Johnson remains active with the company as the Chairman of the Board for RLJ and he owns around 1% of the common stock.

Recently RLJ has seen headwinds from the COVID-19 pandemic effectively stopping business for a time in 2020 and impacting the entire hotel sector. Despite these headwinds the company has pursued a growth strategy in recent years and actually bought more properties as seen here and here .

The Financial Health of RLJ Lodging Trust

With another recession either imminent or already upon us it seems that RLJ is likely to see pressure with a slowing economy. It's a worrisome sign for the company which has seen about $123 million flow out of the company since 2018 mainly due to financing costs.

When we look at the balance sheet side of things the trend over the last five years reveals declining total equity value and cash on hand while debt remained level.

These are not encouraging trends heading into a worsening macro-situation. Yet when we look at things from the perspective of the preferred equity the picture perhaps is a bit better. For one we can acknowledge that stock equity covers preferred equity by 562% meaning the preferreds seem well secured in the capital stack relative to the common. We can also see that the current cash on hand of $481.3 million is greater than preferred equity value of $366.9 million.

Adjusted FFO per diluted common share was reported for 2022 at $1.36 or $221 million. This was a notable increase (616%) from AFFO of $0.19 in 2021 and suggests that there has been some recovery here since 2020. Over the longer term we can calculate average annual AFFO to be $167 million over the last five years with only the initial pandemic environment of 2020 causing losses.

Preferred dividends are $1.95 per share annually and with around 12.9 million shares outstanding that is an annual expense of about $25 million. Compared to annual average AFFO of $167 million, this dividend is covered over six times at current levels. And that's on top of the $0.32 per share paid out annually on the common stock.

With around 163 million common stock outstanding that equates to $52 million in common stock dividends. Terms on the preferred required that dividends must be paid out in full to the preferreds before a common dividend can be paid. This means that in a cash crunch situation RLJ could retain this $52 million by cutting the common stock dividend - and in so doing could pay the preferreds for two more years from that savings alone.

RLJ-A has an ask price of writing at $24.20 which amounts to a 8.2% dividend yield. From the above data it seems that this yield should be covered moving forward through funds from operation. If there are liquidity issues then cash could be freed up from the common stock dividend. These things suggest to me a decent degree of safety with the preferred.

A Preferred Analysis: RLJ-A, ACR-C, ACR-D, and TRTX-C

Now that we've established a baseline understanding of RLJ Lodging Trust overall, let's turn to comparing RLJ-A to other REIT preferreds. For comparison we are looking at ACRES Commercial Realty Corp's two preferred (ACR-C and ACR-D) and the fixed rate preferred from TPG RE Finance Trust (TRTX-C).

To start we'll compare some baseline operating data for the issuing companies.

From this table some things jump out at me.

1. ACR has the lowest SE/PE coverage here with also the lowest amount of Cash/Equity %. Both of these suggest that the preferreds are more at risk if equity value erodes.

2. Compared to both ACR and TRTX, RLJ has a much safer debt profile with a debt-to-equity ratio a magnitude lower than both ACR and TRTX.

3. Earnings coverage is greatest for RLJ and lowest for ACR. And it's much lower for ACR.

While each company reported positive earnings in 2022 we can see that the quality of those earnings in relation to the preferreds is much different. Simply on the basis of each company's financial standing it looks as if RLJ is in the best shape. With a good chunk of cash on hand, low debt, and high SE/PE coverage the company looks able to maintain dividends to their preferreds without impairing the business.

Financial health is not the only thing to consider though. We must also understand the current valuations and yields that are being offered. All of the preferreds are cumulative meaning that even if the dividend is not paid out it is still accrued. Beyond that there is a bit of structural nuance with each issue. Here are some of the key details:

First thing to note is that the RLJ-A preferred shares are non-redeemable meaning they will never be called. Instead, they are convertible into common stock. Initial conversion is enabled if the common shares trade above $89 for 20 days. RLJ Lodging Trust's common stock has not traded above $20 in the last three years which suggests that it's highly unlikely these will be converted anytime soon.

Of the two preferred shares from ACR, one of them is a fixed-to-floating preferred. What this means is that on the 1st call date the rate changes from the 7.875% fixed coupon to one which adjusts with interest rates. Depending on one's view of the future, this preferred offers unique interest rate features. Readers can find a deeper dive on both of these issues here .

Turning to the table of data above we can see that RLJ-A offers a below-average yield compared to the group. Yet if we contextualize this within the financial health of each of these companies, the higher yield on the ACR and TRTX issues seems to reflect their greater leverage risk. The marginal increase in yield that RLJ-A owners could reach for seems unnecessary and perhaps would put one at more risk of capital impairment.

One caveat here is if investors believe that interest rates will remain higher for longer. In this case, the fixed-to-floating shares may be attractive if one is comfortable with the leverage risk at the company. I produced a table in the other article referenced which shows the potential impact on this dividend moving forward. When the rate starts floating it changes to 3-month LIBOR plus 5.927% with an 8.625% floor, the original coupon rate. The table below contextualizes what the dividend yield might be depending on where rates end up.

Again, keep in mind that this potential for a higher rate does not happen until July 2024, so whatever rates are then will be determinative. The implied dividend yield is based on ACR-C price of $21.80 - the current ask for the issue as of writing.

Analysis in Summary

Compared to preferred issues from two other REITs, the RLJ-A issue looks like an attractive hold option. While RLJ Lodging Trust's business remains pressured by macroeconomic changes and a looming recession, preferred owners can rest easier knowing that preferred equity is covered by stock equity over 5x and that AFFO covers the dividend by over 8x.

If average AFFO over the last five years reflects a baseline for the future then the preferreds of RLJ-A seem well-covered. The main risk that I see here is in relation to rising interest rates. If interest rates continue to be raised, which seems likely, then in the next 1-2 years the price of these preferreds may adjust downward somewhat. Yet, if we take a longer term perspective the shares are offering an 8% annual yield with little risk to capital impairment.

And over the very long term, the conversion element of the preferreds may come into play. But I wouldn't count on it.

For those who are interested in more of a play on rising interest rates, a deeper investigation into ACR-C shares may be warranted. Just know that the debt profile for ACR is significantly more risky than that of RLJ.

For further details see: