INN - Summit Hotel Properties: Post-Pandemic Recovery Continues

2023-05-26 10:49:07 ET

Summary

• The company reported its 2023 Q1 earnings, improving on virtually all metrics.
• Management declared a 50% increase in its quarterly dividends, though the payout ratio remains low.
• Shares are currently trading at a discount to book value.

Introduction

I last covered Summit Hotel Properties (INN) a few months ago, after the company had released its FY 2022 earnings. In my article , I observed that the company was gradually recovering from the effects of the pandemic, and noted that its shares were likely to be undervalued. With the release of the company's Q1 2023 earnings earlier this month, I decided to re-evaluate the company to see if my investment thesis remains the same.

Business Model

Summit Hotel Properties is a hospitality REIT focused on the select-service segment. In comparison to the full-service and luxury segments within the lodging industry, select-service hotels have a leaner, more efficient operational structure with fewer amenities. This translates into several advantages for the company, such as lower capital requirements for maintenance, more consistent cash flows and most importantly, higher operating margins. This allows the company to allocate its capital to acquire more hotels compared to if it was focused on the full-service or luxury segments.

As of 31 March 2013, the company has a geographically well-diversified portfolio. Its portfolio comprises 103 hotels, with over 15,000 rooms spread across 24 states. Of these 15,000 rooms, 86% of them are situated in the top 50 metropolitan statistical areas (MSAs), areas with a high population density. Additionally, virtually all (99%) of the company's hotels operate under prominent brands such as Marriott, Hilton, Hyatt and IHG.

Q1 2023 Earnings

For the first quarter of 2023, the company reported a net loss of $0.05/share, a significant improvement compared to the loss of $0.12/share reported during the same period last year. While the company remains in a net loss position, it continues to show an operating profit, with the main contributing factors to its loss stemming from the preferred dividends. The company's improving performance is evident in various key metrics, such as its highest average daily rate (ADR), surpassing even pre-pandemic levels. Quarter-on-quarter, the company saw a growth of over 11% in its ADR. Additionally, the company also saw an increase of 19% in its revenue per available room (RevPAR). While leisure demand remained robust, the company's overall performance also benefited from the resurgence of other demand segments such as business transient and group demand, signifying a recovery in the industry as a whole and not just one specific segment.

Moving on to the company's adjusted funds from operations (AFFO), the company reported an AFFO of $0.22/share, a nearly 30% increase compared to the $0.17/share reported in the first quarter of 2022. The company's strong performance resulted in management announcing a 50% increase in its dividend, raising the quarterly dividend from $0.04/share to $0.06/share. Furthermore, the company maintained its outlook for 2023, anticipating a range between $0.92/share and $1.05/share. This demonstrates management's confidence that even in a worst-case scenario, demand will at least match 2022 levels. The company is gradually progressing towards pre-pandemic levels, where its AFFO ranged between $1.25/share and $1.35/share.

Dividend

As mentioned above, the company announced a 50% increase in its quarterly dividend to $0.06/share. With the current share price of $6.40, this gives the company a forward dividend yield of approximately 3.75%. It should be noted that despite the substantial dividend increase, the company's AFFO of $0.22/share comfortably covers the declared dividend. Moreover, the low payout ratio of 27% indicates the company has significant room increase its dividends further if management wishes to. In fact, the AFFO for the first quarter of 2023 alone is sufficient to cover almost all of the dividends for the year.

While it is uncertain whether the company will continue to increase its dividends this year, the current payout ratio suggests that the existing dividend is secure. Its low payout ratio should reassure investors regarding the sustainability of the dividend, leaving room for potential increases in the future. To provide some context, the pre-pandemic quarterly dividend was $0.18/share.

Valuation

From a valuation perspective, the company is currently trading at a discount to its book value. According to Morningstar, the company's price-to-book (P/B) ratio is currently at 0.74, implying a discount of 26%. Historically, before the pandemic, the company generally traded at a premium to book value, with its P/B ratio reaching as high as 1.53 in 2016. While it is certainly not realistic to expect the company to reach such a significant premium in the near future, if ever, the current valuation provides potential investors with a margin of safety in my view.

Conclusion

The release of the company's results for the first quarter of 2023 show that the company is continuing its recovery from the pandemic, as observed from its improved performance in various metrics. The company continues to trade at a discount to its book value, while its dividend is well-covered and has the potential to be increased further. Put together, this makes it an attractive opportunity for potential investors who may wish to enter before the hospitality industry recovers fully.

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