INN - Summit Hotel Properties: Swap The Commons For The 7% Yield Preferreds

Summary

• Summit is paying out a 7.7% yield to owners of its preferreds who also stand to realize a 14.4% yield to call.
• Dividend pay-outs to common shareholders remain at a fraction of their pre-pandemic average.
• This has come against dual beats for FFO and revenue for the lodging REIT's last reported fiscal 2022 fourth quarter.

Summit Hotel's ( INN ) dividends have been curtailed for three years now with the lodging REIT last declaring a quarterly cash dividend of $0.04 per share , in line with its prior payout and for an annualized 2.08% yield. The current peppercorn distributions have been in place for three quarters following a total suspension since the early days of the pandemic where stay-at-home orders brought business travel to a halt to bring about the near-collapse of the industry.

The near-term want of Summit's common shareholders is for the now reinstated payout to start to move up more markedly and claw back what was a pre-pandemic quarterly payout of $0.18 per share. Whilst this early pandemic dividend suspension was mirrored by other lodging REITs, a growing number of these REITs like Braemar Hotels & Resorts ( BHR ) and RLJ Lodging Trust ( RLJ ) have begun raising their pay-outs. This move up would be especially welcome with Summit's last reported earnings for its fiscal 2022 fourth quarter seeing a broad improvement of its core operating metrics from revenue per available room and FFO.

Dual Beats On Revenue And FFO

Summit is a $909 million REIT with a portfolio comprised of 15,334 rooms spread across 103 properties and 43 markets across the US. These were concentrated in the Sun Belt which constituted 62% of properties and with 9,432 rooms.

Whilst Marriott forms the largest percentage of Summit's portfolio at 52%, the portfolio also includes a range of distinctive brand offerings including Holiday Inn, Hilton, and Hyatt across a number of hotel types.

Summit's recently reported earnings for its fiscal 2022 fourth quarter saw revenue come in at $172.3 million , an increase of 61.2% from the year-ago quarter and a beat by $3.12 million on consensus estimates. This growth was partly driven by pro-forma RevPAR which increased by 17.9% to $109.01 versus the year-ago quarter. The quarter was also boosted by a year that saw cumulative acquisitions of just under $1 billion, with management focusing on hotel types with higher average RevPAR. The REIT would also make investments in a number of luxury camping, or glamping, properties.

Fourth quarter funds from operations came in at $0.25, a beat by $0.05 on consensus estimates and growth from $0.14 in the year-ago quarter. This set the backdrop for guidance that FFO for fiscal 2023 will come in at $0.92 to $1.05, versus an FFO of $0.94 for fiscal 2022. The REIT is penciling in a 5-year RevPAR compound annual growth rate of 12% from fiscal 2021 to fiscal 2026, suggesting FFO performance could come in at the top end of its range.

Whilst Summit continues to trade at a discount to book value, its book value has been trending lower in recent years and stabilizing this would form the base case for a long-term position. Book value per share for the fourth quarter came in at $8.98, up from $8.91 in the year-ago comp but down sequentially from $9.13 in the third quarter.

A 7.7 Yield On Cost With The Series F Preferreds

Summit's 5.875% Series F Cumulative Preferred Stock ( INN.PF ) pays out an annual coupon of $1.46875 for a 7.7% yield on cost. Hence, simply swapping out the commons for these would allow for a 3.7x increase in the yield derived from a position in the REIT. Such a move would also reduce overall risk and opens up the potential of outperformance on a total return basis with higher dividend accrued from the preferreds enhancing the compounding effect. The preferreds are currently trading at $19.16, a 23% discount on their par value, to open up another avenue of returns.

The discount has widened in recent weeks on the back of stock market angst around inflation remaining sticky, but preferred shareowners are looking towards this discount being closed in the medium to long term. The Series F has no maturity date but will be up for redemption on August 12, 2026. Summit could choose not to fully redeem these at its call date and allow them to trade in perpetuity. However, this is a move that would depend on the currently elevated Fed funds rate subsiding.

I think it would also be difficult to justify fully redeeming the Series F if the common dividend pay-outs were still truncated versus pre-pandemic averages. Critically, the cumulative preferreds have never had their quarterly distributions suspended with the common shareholders essentially subsidizing the preferreds owners with their initial loss of dividend income. The yield to call expected if Summit does redeem in 2026 would be 14.4%, a level of return that the commons would struggle to match. Hence, the preferreds form the better choice here.

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