HEDGEYE EDGE
Now that the dust has settled on Q3, our postmortem review suggests there’s still little upside for full service hotel REIT stocks. On the contrary, with the recent strength in the stocks due to a relief rally and a market rip, we see an opportunity to re-short some of them as they face what could be a challenging few quarters ahead. On the surface, the stocks may appear cheap and could be seen as beneficiaries of “recovery” tailwinds. However, business transient has stopped “recovering” short of 2019 volumes and may be getting worse, while leisure travel is decelerating. At the same time, costs are rising, and margins may be under pressure.
There may come a time when we shift course, but the hotel REIT industry should be contracting when it comes to EBITDA growth, not recovering. The industry still faces a demand problem, so supply bull cases don’t yet resonate in our view. With macro issues still looming, RevPAR facing some seasonal headwinds, and potential earnings shortfalls upcoming, we’re looking for short entry points.
Our top REIT short remains PEB followed by PK and then XHR. We’re not universally negative, though. RHP would be a name to consider on the long side but with the recent rally we suspect there will be better entry points. RHP’s fundamentals can play through fairly independent of the FS REIT issues, but the stock will unlikely be immune. Read on as we walk through what we deem to be key pieces of analysis for assessing the health of the hotel REIT industry.
key points | headwinds out number remaining tailwinds
EBITDA expectations in some of our favorite REIT short ideas – PEB, PK, and XHR – for ’23 and ’24 have come down more than 10-15% from last year’s summer peak. Although 6 out of 7 of the hotel REITs “beat” Q3 estimates, the balance of the year and 1H’24 looks uneven. Lower than expected Q4 guidance from half the REITs suggests the future trajectory is far from certain. We’re not buying any of the hype and given the operating leverage to a shaky RevPAR foundation, macro headwinds, and in certain cases, high financial leverage (PEB), the risks remain high for these companies. Here are the core tenets of our negative thesis for most of full service hotel REITs.
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RevPAR: October’s “pop” notwithstanding, the trend in RevPAR growth remains rangebound across the US and should slow from here. This is far and away the biggest catalyst for lower earnings, valuations, stock prices. For corporate demand proxies, there’s been little incremental growth from trend (biz market weekday RevPAR, urban weekday, etc.
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Hedgeye’s Macro driven RevPAR Model implies deceleration into Nov-Dec, and then again in 1H’24. See more HERE
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Seasonally, group & calendar shifts have been a big driver of incremental RevPAR growth in Sep & October. Group’s contribution fades in Nov-Jan and should be down 600-800bps relative to Sep-Oct.
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Tough leisure comps remain in place – especially around the holiday season should result in little incremental growth – see HST’s comments on this.
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Leisure competition is only intensifying – outbound, cruise, alternative accommodation are competitive factors that are not going away, they’re picking up and travel patterns are normalizing.
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REIT RevPAR Underperformance: REITs continue to underperform the broader US Full Service market. The normalization period has yet to occur, and we don’t think it will anytime soon. Geographic concentration and importantly, customer concentration to keep REIT RevPAR recoveries on a delay.
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Deferred CapEx Catalyst Not Played Out: Underperformance on top and bottom line is in part driven by the deferred spend from ’20 – ’22 for the industry. The ability to regain share won’t come until late ’24 and ’25.
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Margin Trends & Estimates: Continued margin pressure expected as amenities and staffing continue to ramp back up with the return of group and corporate and the pushback among leisure guests. Non-labor costs also remain a headwind and work through the P&L’s for at least another few quarters.
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Macro & Valuations: Macro headwinds to remain firm through at least the next few months (Quad 3/4) which is a negative for sentiment & demand. Valuations on revised numbers and higher stock prices don’t suggest a favorable entry point in many of the FS REIT stocks – given catalysts we see a valuation haircut. < 10x EBITDA is not unreasonable for the FS REITs.
Industry p&l trending the wrong direction
The charts below highlight the hotel REIT underperformance and shaky top and bottom line outlook. RevPAR decelerated in Q3, and the gap between the industry and the REITs widened to >1,000bps. We expect this underperformance to continue, but even if the performance gap narrows to the industry… the tailwind of industry growth is now in the rearview and more deceleration is coming per our tracking model.
Turning to costs and margins, on balance, owners did an OK job managing through the ADR deceleration and sticky core cost growth. When looking under the hood and reading the industry tea leaves, we see a challenging setup whereby costs should continue to exceed incremental revenues in the coming quarters, keeping a lid on margins. There’s still a staffing catchup to be had against a backdrop of higher unit costs and demand mix shift (both in customer and in RevPAR growth components) pose headwinds to margins. The industry as a whole hasn’t provided much in the way of ’24 guidance but our base case would entail another year of degradation and below consensus production.
Absent a major change in the macro and corporate demand, the industry faces many more headwinds than tailwinds, at least for now.
downside to earnings & stocks
Admittedly, our negative call on the hotel REITs does not have the same magnitude of earnings downside as it did at this point last year. However, earnings downside remains and the implied MSD RevPAR growth and stable margins among our closely followed REITs of PEB, PK, XHR, and HST, appears overly optimistic. We’ll take the under on current ’24 EBITDA expectations and see downside ranging from 3-6% across those names. On top of the earnings downside, slowing RevPAR and GDP should keep a lid on valuations and sentiment.
Among our top shorts of PEB, PK, and XHR, we see downside of 10-20% in the stocks and potentially more downside on a move toward the lower end of the valuation ranges (9-9.5x) EV/EBITDA.
