Apple Hospitality REIT, Inc. (NYSE:APLE) Q3 2023 Earnings Call Transcript

Apple Hospitality REIT, Inc. (NYSE:APLE) Q3 2023 Earnings Call Transcript November 8, 2023

Operator: Greetings and welcome to the Apple Hospitality REIT Third Quarter 2023 Earnings Call. At this time, all participants are in a listen-only mode. [Operator Instructions] As a reminder, this conference is being recorded. It is now my pleasure to introduce your host Kelly Clarke. Please go ahead.

Kelly Clarke: Thank you and good morning. Welcome to the Apple Hospitality REIT’s third quarter 2023 earnings call. Today’s call will be based on the earnings release and Form 10-Q, which we distributed and filed yesterday afternoon. Before we begin, please note that today’s call may include forward-looking statements as defined by federal securities laws. These forward-looking statements are based on current views and assumptions and as a result, are subject to numerous risks, uncertainties, and the outcome of future events that could cause actual results, performance or achievements to materially differ from those expressed, projected or implied. Any such forward-looking statements are qualified by the risk factors described in our filings with the SEC, including in our 2022 annual report on Form 10-K and speak only as of today.

The Company undertakes no obligation to publicly update or revise any forward-looking statements, except as required by law. In addition, non-GAAP measures of performance will be discussed during this call. Reconciliations of those measures to GAAP measures and definitions of certain items referred to in our remarks are included in yesterday’s earnings release and other filings with the SEC. For a copy of the earnings release or additional information about the Company, please visit applehospitalityreit.com. This morning, Justin Knight, our Chief Executive Officer; and Liz Perkins, our Chief Financial Officer, will provide an overview of our results for the third quarter 2023 and an operational outlook for the remainder of the year. Following the overview, we will open the call for Q&A.

At this time, it is my pleasure to turn the call over to Justin.

Justin Knight: Good morning and thank you for joining us today. We are incredibly pleased with our performance year-to-date. A steady recovery in business transient and continued strength in leisure demand drove comparable hotels third quarter RevPAR growth of more than 7% as compared to the third quarter of 2019, our highest quarterly comparable hotels RevPAR growth since the onset of the pandemic. Despite more challenging year-over-year comparisons, during the third quarter, we achieved improvements in occupancy, ADR, and RevPAR. Third quarter 2023 comparable hotels ADR increased by 1%. Occupancy was up 2%, and RevPAR improved by 3% as compared to the third quarter of 2022. Continued top line growth enabled us to achieve third quarter comparable hotels adjusted hotel EBITDA of $132 million, a 1% improvement over third quarter 2022.

Positive trends have continued, and based on preliminary results, comparable hotels occupancy for the month of October was 78% with continued growth in ADR. Given the strength of our performance as we approach the end of last year, top line comparisons will become increasingly difficult as we continue through the fourth quarter. Still, overall travel trends are favorable. Leisure demand remains elevated to pre-pandemic levels, and steady improvement in business travel demand continues to bolster midweek occupancies. We have adjusted our annual guidance to reflect portfolio performance through the first nine months of the year, top line performance through October, and the recently completed and announced acquisitions. Expense growth, which was elevated as a result of general inflationary pressures and a competitive labor environment, moderated somewhat in the latter portion of the quarter as we lapped periods where we saw significant growth last year.

Through continued rate growth and disciplined cost controls, we achieved a comparable hotels adjusted hotel EBITDA margin for the quarter of 37%, down 110 basis points to third quarter 2022. We are fortunate to be partnered with some of the best operators in the industry who, together with our experienced asset management team, work to share best practices, monitor real time performance and focus on-site efforts to maximize profitability at our hotels without sacrificing service, cleanliness, or overall guest satisfaction. Our outperformance since the onset of the pandemic is a tribute to the combined efforts of our corporate team and our managers, and it’s a testament to our strategy of investing in a broadly diversified portfolio of high quality, rooms focused hotels with low leverage, which has enabled us to maintain the strength and flexibility of our balance sheet, positioning us to be acquisitive within the current transaction environment.

We have acquired four hotels since the beginning of the year, with three additional hotels under contract for purchase and are actively underwriting additional opportunities. In October, we acquired a Courtyard, a recently renovated Hyatt House and a corresponding parking garage in downtown Salt Lake City for a combined total of $91.5 million. We are pleased to expand our presence within the business friendly downtown Salt Lake City area, which has seen significant economic growth and positive demographic trends in recent years and is poised for continued expansion. These hotels sit adjacent to one another and are located directly across the street from the Delta Center within walking distance of the Salt Palace Convention Center, and convenient to Temple Square, the Utah State Capitol, the University of Utah, Salt Lake City International Airport, numerous performing arts venues, and multiple key areas.

Salt Lake City’s diversified economy offers a wide variety of business and leisure demand generators and includes software development, hardware manufacturing, and information technology firms, as well as defense, oil and gas, transportation, tourism, healthcare, and financial service industries among others. In October, we acquired the recently built Residence Inn Seattle South, Renton for $55.5 million. Renton is well known for its proximity to downtown Seattle and Bellevue as well as its strong business environment that spans aviation, aerospace, manufacturing, technology, life science, and health care. The hotel is less than 1 mile from Boeing’s Renton production facility, known for its assembly of the Boeing 737 family of commercial airplanes.

And from a leisure perspective, the hotel is located across from the southeastern shore of Lake Washington and convenient to the Seattle Seahawks’ headquarters and training facility, Tukwila Station, and the Seattle-Tacoma International Airport. We continue to have one existing hotel under contract for purchase for a total of approximately $37 million, the Embassy Suites, South Jordan Salt Lake City, which we anticipate acquiring by year-end. This hotel is part of a transit oriented mixed use development with two Class A office buildings located just off Interstate 15 in the Silicon Slopes region of the Salt Lake City metropolitan area, just 20 minutes south of downtown Salt Lake City, with a variety of amenities nearby, including Utah Transit’s SoJo Station North and South serving an 83 mile corridor with connections to downtown Salt Lake City and the Salt Lake City International Airport, South Jordan Towne Center, and South Valley Regional Airport.

South Jordan is home to a diverse range of businesses, including technology, biotech, healthcare, education and retail, in its near several key areas. The 192 room hotel opened in 2018 and has market leading meeting space at over 8,000 square feet. The combined purchase price for the recently acquired Salt Lake City and Renton assets together with the Embassy Suites in South Jordan represent a blended 8% cap rate on trailing 12-month financials through September of this year after an industry standard 4% FF&E Reserve. We believe each of these assets has embedded upside and will be a meaningful contributor to our overall portfolio performance. We also have two hotels under contract for purchase that are currently under development, the Embassy Suites in downtown Madison, Wisconsin for a purchase price of $79 million and the Motto in downtown Nashville for $97 million.

We anticipate acquiring the Madison Embassy in mid-2024 and the Nashville Motto in 2025, both following completion of construction. Since the onset of the pandemic, we have strategically transacted in ways that have refined and grown our portfolio. We have completed approximately $253 million in hotel sales and have invested approximately $736 million in new acquisitions. On a trailing 12-month basis, the 14 hotels acquired since the pandemic and owned for at least a full year have produced an unlevered yield of approximately 9% after capital expenditures. Importantly, we have completed these acquisitions while maintaining the strength of our balance sheet with estimated post acquisitions debt levels still below 3.5 times trailing 12-month EBITDA.

We continue to underwrite numerous potential opportunities and remain intently focused on maximizing total returns for our shareholders through strong operating fundamentals and portfolio growth when conditions are optimal. With our tremendous transaction experience, our available balance sheet capacity and our deep industry relationships, we are well positioned within the current marketplace. Supported by our strong operating performance, we continue to lead our peers in post-pandemic dividend payments. During the quarter, we paid distributions totaling $0.24 per share. Based on Monday’s closing stock price, our annualized distribution of $0.96 per share represents an annual yield of approximately 5.7%. Together with our Board of Directors, we will continue to monitor our distribution rate and timing relative to the performance of our hotels and other potential uses of capital.

As we approach year-end, the fundamentals of our business remain favorable with continued strength in demand and limited near-term supply growth. As has been the case for several quarters, nearly half of our hotels do not have any new supply under construction within a 5-mile radius, providing us with the ability to meaningfully benefit from incremental demand. And we believe our recent acquisitions further enhance our portfolio and position us for continued outperformance. Our strategy was designed to create an asymmetrical risk profile, mitigating downside risk while providing significant opportunity for upside. Our portfolio of upscale rooms focused hotels is broadly diversified across a wide variety of markets and demand generators. Our hotels are franchise with industry leading brands managed by some of the best management companies in the industry and provide a strong value proposition with broad consumer appeal.

Underlying the strength of our portfolio is a balance sheet with low leverage and financial flexibility, a consistent reinvestment, an effective portfolio management strategy, and dedicated corporate team with extensive industry experience. While we have reason to be optimistic about the trajectory of our industry and our portfolio specifically, I’m confident we are well positioned to continue to outperform and maximize shareholder value in any macroeconomic environment. It is now my pleasure to turn the call over to Liz for additional details on our balance sheet, financial performance during the quarter and updated annual guidance.

Liz Perkins: Thank you, Justin, and good morning. We are pleased to report another strong quarter for our portfolio of hotels. Comparable hotels total revenue was $356 million for the quarter and over $1 billion for the first nine months of the year, up 4% and 9% as compared to the same periods of 2022, respectively. Continued strength in leisure demand and recovery in business travel during the quarter enabled us to achieve comparable hotels RevPAR of $123, a 3% increase over third quarter 2022, with ADR of $159, up 1%, and occupancy of 77%, up 2% to third quarter 2022. Year-to-date through September, comparable hotels ADR was up 5% and occupancy was up 3% with RevPAR up 8% compared to the same period of 2022. Leisure travel continued to be strong during the quarter, with weekend occupancies of 82%, up 1% compared to the third quarter of 2022.

In addition, we continue to see improvement in business demand, supporting average weekday occupancies of 75%, an increase of 2% year-over-year. While weekday occupancies are ahead of 2022 for the quarter, there still remains upside opportunity relative to pre-pandemic weekday occupancy levels. Midweek occupancies have continued to strengthen over the last three weeks in October, while shoulder night and weekend occupancies remain strong, supporting the resiliency of leisure demand. In terms of same-store room night channel mix, brand.com bookings remained constant at 40% quarter-over-quarter. OTA bookings increased slightly to 13%. Property direct bookings were steady at 25% for the quarter. And while GDS bookings decreased seasonally from 17% during the second quarter to 16% in the third quarter, GDS room night volume was up 2% quarter-over-quarter.

This channel mix speaks to the powerful direct bookings our brands command, the strong property direct sales efforts our properties maintain in the field, our ability to leverage OTAs when beneficial, and the continued recovery of business demand. Looking at third quarter same-store segmentation as compared to the second quarter, VaR remained strong at 33%. Driven by seasonality, other discounts increased from 28% to 30%. Group decreased slightly from 15% to 14%, which is still slightly elevated to the same period in 2019. And the negotiated segment was 17% of our mix, up slightly to the same period in 2022 but remains lower than 2019, which we believe represents continued upside. Turning to expenses, total payroll per occupied room for our same-store hotels was under $38 for the quarter, up slightly to the second quarter of this year.

Year-over-year comparisons eased as we moved through the quarter with September same-store total payroll up just 4% compared to September 2022. Contributing to the improvement was an 18% reduction in same-store contract labor as a percentage of wages as compared to the third quarter of 2022. While we expect fourth quarter year-over-year growth to also moderate given the meaningful increases in the back half of 2022, we anticipate that higher wages for full and part time employees and higher utilization of contract labor will continue to result in elevated cost per occupied room relative to pre-pandemic levels. Hotel margins during the quarter were also impacted by travel and registration costs associated with brand conferences. We will continue to balance productivity and efficiency initiatives with our efforts to train and celebrate associates and to uphold a positive work environment conducive to attracting and retaining top talent.

These efforts better position us to support the high levels of service, cleanliness and maintenance necessary to sustain rate growth and maximize the long-term profitability of our assets. A focus on property level cost controls amid a challenging labor and inflationary environment enabled us to achieve comparable hotels adjusted hotel EBITDA of approximately $132 million for the quarter and $382 million for the nine months ended September 30th, up 1% and 6% to the same periods of 2022, respectively. Comparable hotels adjusted hotel EBITDA margin was strong at 37.1% for the quarter and 37.2% year-to-date through September, down 110 basis points and 90 basis points to the same periods of 2022, respectively. With expense comparisons having eased somewhat as we moved into the back half of the year as anticipated, this reflects a 50 basis-point improvement quarter-over-quarter and quarterly margin comparisons to 2022.

As we have stated on past calls, we believe that long-term margin expansion for the industry and for our portfolio will largely be conditioned on our ability to grow rates. So, with inflation figures coming down and hotels more appropriately staffed, we expect near-term growth in operating expenses to moderate relative to the significant increases we have seen in past quarters. Despite the continued inflationary environment, adjusted EBITDAre for the third quarter was $122 million and year-to-date was $346 million, up 3% and 7% to the same periods of 2022, respectively. MFFO for the quarter was $104 million and year-to-date was $294 million, up 1.5% and 6% as compared to the same periods of 2022, respectively. Looking at our balance sheet, as of September 30, 2023, we had $1.3 billion in total outstanding debt net of cash, approximately 3.1 times our trailing 12-month EBITDA with a weighted average interest rate of 4.3%.

Total outstanding debt, excluding unamortized debt issuance costs and fair value adjustments is comprised of approximately $285 million and property level debt secured by 15 hotels, and approximately $1.1 billion outstanding on our unsecured credit facilities. At the end of the quarter, our weighted average debt maturities were four years. We had cash on hand of approximately $35 million, availability under our revolving credit facility of approximately $650 million and approximately 80% of our total debt outstanding was fixed or hedged. As previously discussed, in July, we entered into an amendment of our $225 million term loan facility, which extended the maturity of the existing $50 million term loan by two years to August 2025 and align the maturity date with the other term loan in the broader $225 million facility.

We continue to be grateful for our supportive and longstanding lender relationships, as further demonstrated by this recent amendment. As of September 30th, we have approximately $106 million of debt maturing in the next 12 months, consisting of one $85 million term loan and a mortgage loan of approximately $21 million. We plan to pay for these coming debt maturities using funds from operations, borrowings under our revolving credit facility and/or new financing. Acquisitions completed subsequent to the third quarter were funded using cash on hand and availability on our revolving credit facility. As Justin highlighted in his remarks, we continue to be well positioned with pro forma debt to trailing 12-month EBITDA of less than 3.5 times, including the recently acquired acquisitions and closing on the South Jordan Embassy, and we have ample liquidity on our line of credit to pursue accretive opportunities.

Shifting to our outlook. With top line performance exceeding our expectations through the third quarter and with continued strength in preliminary numbers for October, we have narrowed our RevPAR guidance range and increased the midpoint by 50 basis points. We now anticipate comparable hotels RevPAR growth to be between 5.5% and 7.5% for the year. We have made similar adjustments to our EBITDAre guidance, narrowing the range by increasing the lower end to $423 million and decreasing the high end to $440 million. Given continued inflationary pressures on expenses, we have adjusted our comparable hotels adjusted hotel EBITDA margin guidance by holding the low end at 35.4% and reducing the high end by 70 basis points to 36.3%. We expect net income to be between $167 million and $189 million.

We continue to expect capital expenditures to be between $70 million and $80 million for the year. Our updated comparable guidance includes properties acquired and announced for acquisition before year-end as if the hotels were owned as of January 1, 2022, excludes dispositions since January 1, 2022 and excludes one non-hotel property, our New York asset, Hotel 57, where hotel operations have been leased to a third-party. We are encouraged by recent trends and the strength of fundamentals for our business. And while our updated guidance reflects some ongoing macroeconomic uncertainty, October top line performance for our portfolio showed continued strength in both business and leisure demand for our hotels, and expense growth has moderated in recent months.

A continuation of current trends would position us to perform above the midpoint of our guidance. As we approach the end of 2023, we are pleased with our performance and confident we are well positioned for the coming year. Our differentiated strategy has proven resilient through economic cycles. Our balance sheet is strong with ample liquidity, which we will continue to use opportunistically to pursue accretive transactions. Our assets are in good condition, with consistent capital investments ensuring that we maintain a competitive advantage over other products in our market. And we believe the fundamentals of our business are sound, with favorable supply dynamics allowing us to benefit from incremental demand. That concludes our prepared remarks.

Justin and I will now be happy to answer any questions that you have for us this morning.

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Q&A Session

Operator: [Operator Instructions] Our first question comes from Austin Wurschmidt with KeyBanc Capital Markets. Please go ahead.

Austin Wurschmidt: So Liz, can you just help us understand what the revised guidance assumes for hotel EBITDA margin change on the comparable 220 hotels or when you kind of adjust out that the impact that the new acquisitions had to the revised range for adjusted hotel EBITDA margin?

Liz Perkins: At the midpoint, the revised guidance, if you’re just looking at the existing comp and not the new acquisitions subsequent to quarter-end, the difference is about 50 basis points. So, we get a 30 basis-point benefit on an absolute basis from the new acquisitions.

Austin Wurschmidt: So, that gets you down in the 150 basis-point range at the midpoint on that revised range for that comparable pool, just to be clear?

Liz Perkins: 140.

Austin Wurschmidt: 140. Okay. And so margins are down 90 basis points year-to-date through the first three quarters. So basically, you saw some improvement in the year-over-year margin change in the third quarter. You’re expecting a little bit of a step back in the fourth quarter, but it sounds like you don’t expect some of that growth to bleed into ‘24, because I believe you said that expenses should continue — expense growth should continue to moderate in the quarters ahead. Is that fair?

Liz Perkins: That is what we believe will happen, or that’s certainly what we’re hopeful will happen. And based on what we saw, especially in September, if we continue to see year-over-year comparisons like we saw in September, we could outperform the midpoint of our range. I think we looked at the full quarter, which included a tough comp in July, some improvement in August and then more meaningful improvement in September from a margin perspective year-over-year and an expense growth perspective year-over-year as well. And I think we saw the latter quarter trends throughout the fourth quarter and into next year. That would be more positive than the midpoint of our guidance. But considering that one month doesn’t make a trend with September and I think we opted to be more cautious, more conservative.

But we’re certainly pleased with what we’ve seen most recently, both with the improvement that our team has made with the management companies and their focus and efforts around contract labor and productivity. I mentioned in my prepared remarks that we have seen some improvement there. We’re pleased with that. We’re certainly hopeful that that will continue. They’re really doing a great job and have continued to maintain higher productivity levels despite the challenges, and wages have started to moderate year-over-year as we anticipated. So, I think we’re hopeful. One of the things that impacted us in the third quarter, was, we had some favorable real estate taxes in prior quarters that was helping to offset the increase in insurance premiums, and we had some uninsured loss deductibles that hit in the third quarter that we hadn’t had.

So, we’ve had some favorable experience relative — or to offset some of the insurance premium increases and that we didn’t have that benefit in the third quarter. We carried that negative drag through the fourth quarter into the guidance. That may or may not happen.

Austin Wurschmidt: And then just last one on the guidance, just to clarify. I mean, how much hotel EBITDA contribution do you from the acquisitions that are set to close this year?

Liz Perkins: If you look at, I think it’s page 16 on our earnings release, you can see the add back for pre-ownership EBITDA for the new properties. That would include Cleveland, which we closed on at the end of second quarter. If you annualize that, it’s probably around $16 million.

Operator: Our next question comes from Floris van Dijkum with Compass Point.

Floris van Dijkum: Thanks for the color on the cap rates. I’m curious, Justin, obviously, you guys have been active. I like the update on how your acquisitions have fared so far and how the yield has been pretty attractive. As you look out, do you expect your investment activity to be one-offs, or how is the market looking for larger transactions as well? And how do you think about — are there going to be opportunities on the troubled refinancing of portfolios in your view? And would you participate in those kinds of investments?

Justin Knight: So, I’ll start and work my way backwards. I think, to your last point, would we consider, or participate in some of the various types of investment that you highlighted. I think, certainly, we are active in the marketplace. I highlighted in my prepared remarks that we continue to be active in underwriting additional potential acquisitions, and that includes the mix of individual one-off assets and small and medium sized portfolios. Because of where the debt markets are right now, we’ve seen less activity at the large portfolio level, meaning fewer large portfolios being brought to market, but that could change. And, I think we have consistently underwrote those as well. From a preference standpoint, generally, our preference is to pursue individual assets.

And we’ve found that we can be incredibly competitive in that space. Certainly, the landscape has changed slightly. And when we look at total transaction volume, that has not meaningfully increased, but our share of the total transaction volume has. And I think that’s a firm indication of our ability to transact in a market that has become more challenging for some of our — some of the groups that we are competing with, when we look back 12 months or so. I think on a go-forward basis, we anticipate a continued steady stream of potential deals that we will have an opportunity to underwrite. I think you highlighted in your question a portion of those are likely to be brought to market, because of financing issues or overall liquidity issues with the sponsor.

That is an area that we’ve been very successful recently. And as we continue to move into next year, we do anticipate the continued pressure from the brands around capital investments, should bring incremental assets to market as well. But I think incredibly pleased with the opportunity set that we’re seeing now with pricing for those assets and with our ability, based on the flexibility that we have because of the strength of our balance sheet, to be active in a market that’s become more challenging for many of the other groups that would be interested in acquiring assets.

Floris van Dijkum: If I can add one more follow-up or other. I know that your business is typically not viewed as being group dependents, you mentioned, I think, in your remarks or Liz did, 14% of your demand is group, it’s certainly a lot lower than some of your full service peers. But how do you think about the convention calendar. I note that your largest exposure to a market is San Diego. San Diego’s convention calendar, I believe, looks very good. How much of a benefit will flow through to your properties in your view? Maybe give a little bit of a backdrop in terms of how your exposure to group might be bigger than what people think it is.