PEB - Pebblebrook Hotel Trust: Low Yield And High Debt

2023-10-26 09:00:00 ET

Summary

• Hotel demand has stabilized, but labor costs are outpacing revenue increases.
• Pebblebrook Hotel Trust owns a small portfolio of 47 hotels, including mostly full-service resorts and urban lifestyle hotels.
• The company pays an extremely low dividend Yield, and has significant indebtedness problems.

My personal odyssey in REIT investing began with an article about REITs in the Motley Fool. The author of that article, whose name I do not now recall, recommended two REITs: Pebblebrook Hotel Trust ( PEB ) and Retail Opportunity Investments ( ROIC ). Not great advice. Today, I take an in-depth look at Pebblebrook.

Sector selection is the most important factor in REIT investing, so we begin by looking at the Hotel REIT sector for clues.

According to Hoya Capital,

hotels provide some of the better inflation-hedging properties of any REIT sector due to their ultra-short-term "lease" terms typically measured in days rather than months or years and exhibit the lowest level of interest rate sensitivity of any property sector.

While these would have been very important factors to consider in the recent past, the current environment of low inflation and peaking interest rates will not likely provide a tailwind for Hotel REITs.

Travel is a key macroeconomic factor affecting hotel demand. TSA Checkpoint volume for October, 2023 to date is up 10.8% YoY (year over year), and fully recovered beyond pre-pandemic levels, standing 4.1% up from October, 2019, providing a significant tailwind. International inbound flights were up 17% YoY in September, though still down from 2019 levels, and fewer than outbound flights . Meanwhile, gasoline prices , which were as much as 27% lower this summer than last, have returned to 2022 levels in October.

Although STR reports a slight YoY decline (-0.3%) in occupancy rates, to 66.0% in August, ADR (average daily rate) continued its climb at +1.8% YoY to $153.60, and RevPAR (revenue per available room) also increased YoY by 1.5%, to $101.35. These are stable and healthy signs. Overall , occupancy is down slightly (-1.4%) from 2019, but ADR is up 16.4% and RevPAR is up 14.0%, so it is safe to say that Hotel industry demand has fully recovered from COVID, and appears stable and healthy going forward.

At the same time, labor costs are up 4.9% from 2022, outpacing RevPAR growth, and hotel EBITDA per available room is off by (-11.6%), so it's not all sunshine and roses.

Importantly, booking.com's travel forecast for 2024 calls for more travel to escape the heat, which favors coastal and other water-proximate locations, and more travelers are just looking to live in an alter ego, so they seek more unique experiences.

Meet the company

Founded in 2009 and headquartered in Maryland, Pebblebrook Hotel Trust ( PEB ) is a small-cap, at approximately $1.56 billion, owning 47 properties in 13 U.S. markets, totaling over 12,000 rooms, balancing business and leisure customers evenly.

Pebblebrook focuses on:

• luxury, full service hotel and resort properties
• in or near urban markets
• in major United States gateway cities.

PEB's average room rate of $320 is the highest of any U.S. Hotel REIT, according to Hoya Capital Income Builder.

As you can see from the map above, PEB assets are concentrated in coastal areas, and near water.

PEB management classifies its holdings into 3 segments:

• Urban lifestyle properties (42% of NAV), which offer unique and immersive experiences,

• Unique lifestyle resorts (41% of NAV), and

• Urban major brand hotels (17% of NAV), which are the more traditional hotels with major brands, such as Hilton and Hyatt.

Over the past few years, Pebblebrook has sold some of its smaller, more transient-focused properties, and invested in redeveloping its lifestyle properties to appeal more to group travel, increasing its group segment to about 30%, up from 25%.

Consistent with the hotel industry as a whole, occupancy in PEB properties is down significantly (-12%), but ADR (+45%) and RevPAR (+27%) are up, compared to 2019 levels.

Growth metrics

Here are the 3-year growth figures for FFO (funds from operations), and TCFO (total cash from operations).

Source: TD Ameritrade, Hoya Capital Income Builder, and author calculations

Like all REITs, Pebblebrook suffered major declines in revenue and cash flow in 2020, when FFO/share and cash from operations both went into negative territory. In about the middle of 2021, the company began a comeback, and 2022 was pretty good in that regard, but revenue and cash flow through 2022 were still well below 2019 levels, resulting in double-digit 3-year average losses.

Meanwhile, here is how the stock price has done over the past 3 twelve-month periods, compared to the REIT average as represented by the Vanguard Real Estate ETF ( VNQ ).

Source: MarketWatch.com and author calculations

PEB shares outperformed the VNQ in the feeding frenzy of 2021, but have fared a little worse in the two years of decline since then. Investors who bought shares three years ago are sitting on losses of (-1.6)% per year, while investors in the VNQ have seen share price erode at (-3.7)%.

Since its inception in 2009, PEB shares have lost 39% of their value. This company has not been a good long-term investment.

Balance sheet metrics

Here are the key balance sheet metrics. PEB's balance sheet is not bond-rated. The debt ratio and Debt/EBITDA are both on the high side.

Source: Hoya Capital Income Builder, TD Ameritrade, and author calculations

The company reports its Net Debt/EBITDA at 6.4x, up from 5.7x a year ago.

PEB is carrying $2.4 billion in debt, at a weighted average interest rate of 4.3%. Of that total, a whopping 22% is held at variable rates, currently averaging 7.5%. Yikes.

The $2.4 billion in debt is largely front-loaded, with more than 25% coming due next year, followed by 19% in 2025, and 31% in 2026. Weighted average maturity is less than 3 years.

Dividend metrics

Pebblebrook's dividend Yield is almost nonexistent, at 0.31%, and like the company's revenues, it has not yet recovered from the pandemic. By contrast, Hotel REITs as a whole yield almost exactly the same as REITs overall, though with dividend growth rates that are still a bit tattered. Pebblebrook's near-zero payout ratio results in a much-too-safe Dividend Safety grade of A+.

Source: Hoya Capital Income Builder, TD Ameritrade, Seeking Alpha Premium

Dividend Score projects the Yield three years from now, on shares bought today, assuming the Dividend Growth rate remains unchanged.

Valuation metrics

Pebblebrook is priced like the average Hotel REIT, at 8.7x FFO '23, and much cheaper than the average REIT overall.

Source: Hoya Capital Income Builder, TD Ameritrade, and author calculations

PEB management estimates the company's NAV at $29.50 per share, but Hoya Capital Income Builder's consensus estimate comes in at just $22. Even with the more conservative estimate, however, the company is still selling at a steep discount to NAV.

Here are the numbers the company uses to arrive at its NAV estimate:

Then, using the estimates of total value, NAV per share is calculated as follows:

The mid-point comes in at $29.50, in a range from $27.00 to $32.00.

What could go wrong?

Other vacation and travel lodging options, such as AirBNB and Vacasa, are gradually taking market share from hotels at the moment. If this trend continues, all Hotel REITs will struggle.

With so much exposure to variable interest rate debt, any further rate-raising by the Fed can cause a large increase in cost for Pebblebrook, cutting into profitability.

Investor's bottom line

REITs have gotten very cheap, with high Yields, on average, and most will do well over the next 2 years. I don't think Pebblebrook will keep pace, however. Its combination of low Yield and high indebtedness make it unattractive to me. I rate PEB a Sell.

Pebblebrook Hotel Trust reports Q3 results on Thursday, October 26.

Opinions about this company vary widely. Zacks rates it a Buy, and The Street advises Hold, but Ford Equity Research recommends Sell, and TipRanks rates the company extreme Underperform.

Of the 14 analysts covering PEB, 12 say Hold, and 2 say Strong Buy. The average price target is $16.92, implying 29% upside.

As always, however, the opinion that matters most is yours.

For further details see: