HEDGEYE EDGE
Now that the dust has settled on Q4, our postmortem review is highlighted by big moves in the hotel REIT stocks coupled with little moves in the underlying estimates and RevPAR growth data. Indeed, much of the hotel and lodging complex has been on a tear of late as the risk of recession gets priced out of the stocks and the potential for acceleration gets priced in. At this juncture, however, we’re not sure investors should be ready to underwrite much in the way of material acceleration into their models. In fact, given the recent track record for RevPAR and the backdrop for stickier OpEx growth, there could be a greater risk of earnings misses in the near term as opposed to beats. From current vantage, given the softer RevPAR growth we expect for the coming months, we don’t see much opportunity for earnings revisions to inflect positively. So, with earnings revisions likely capped and valuations now well off their lows, the risk / reward and trade look skewed to the downside.
Given the alternatives across GLL, we’ll continue to view the FS Hotel REITs with a bearish bias with PEB, PK, XHR featured on our Best Idea Short list. Read on as we walk through what we deem to be key pieces of analysis for reassessing the health of the domestic hotel REIT industry in ‘24.
key points | STACKING UP THE POSITIVES & NEGATIVES
EBITDA expectations in some of our favorite REIT short ideas – PEB, PK, and XHR – for ’24 had come down more than 10-15% from the ’22 peak, so while there’s less earnings downside, there still is one. Certainly, relative to alternatives across GLL. Is there another 10% downside to '24 EBITDA estimates? No, but downside remains, and from a sentiment perspective we see more headwinds vs tailwinds as move into the Spring. Here are our core positives and negatives impacting most Full Service Hotel REITs. Yes, there are more positives vs prior installments of this note, but negatives still outweigh the positives.
(+) More so than before there’s potential for RevPAR acceleration in 2H, starting in July when comparisons get the easiest for the industry.
(+) With recession off the table, the macro headwinds of the last 12-18 months are probably in the rearview. Corporate profits should grow this year, supporting at least a comparable level of business travel (still below ’19 on a volume basis).
(–) Significant headwinds still in place for RevPAR through at least the early Summer – expect RevPAR to be range bound / slow until then
(–) Comparisons, while easier in 2H, do hold some risk for the FS industry as the contribution from Group really picked up in Q2-Q4 last year. This dynamic presents much tougher comps and puts pressure on Transient (especially Biz transient) to deliver incremental growth.
(–) RevPAR growth for the last few quarters has materially lagged Nominal GDP growth… we’re not betting that those dynamics revert anytime soon. This was an ongoing relationship before Covid as well – calls into question the secular issues ongoing in hotels.
(–) Hotel REITs still underperforming their market-weighted growth – deferred CapEx from prior years is still taking a toll across many hotel REIT portfolios. Headwinds to remain in place for ’24.
(–) Cost growth matching RevPAR growth… Even if RevPAR midpoints are achieved, OpEx growth will offset those gains and there will be minimal EBITDA growth.
DATA tracking
Despite the move in the stocks in the YTD, there has been little in the way of accelerating data or “green shoots” to speak of – especially if we remove Las Vegas (a market no REIT is really exposed to). In some spots, early February data did show improvement but not enough to materially alter the QTD. On balance, business transient trends, while recovering, are not accelerating from Q4 and the forward-looking indicators we track suggest the setup for March and April won’t be a whole lot different than what we have seen in the YTD. Can the stocks and investors stomach that dynamic and keep looking to the back half or will the data need to start delivering? We’re betting on the latter, and within that bet, we expect there to be some shortfalls.
Industry p&l’S show muted progress
The Q4 results were mostly in line to slightly better than expectations after sluggish '23 created a low estimate bar for Q4. Annual guidance offered little reason to change our company models and for consensus estimates the takeaways are similar. In the aggregate, there’s very little change in estimates across the Full Service REITs. Keep in mind that guidance ranges for HST, PK, XHR, PEB, DRH, and SHO, on average, were within 0-1% of the consensus estimate bar prior to the prints. Again, recessions and negative RevPAR and P&L implosions are off the table, but the upside risk of material estimate revisions seems relatively low at this stage in the year.
The charts below highlight the trajectory of hotel REIT RevPAR growth as well as the industry revenue and cost performance on a “POR” basis. FS REIT RevPAR growth narrowly accelerated in Q4 relative to Q3, but the gap between market level weighted performance and the Full Service industry remained wide, at ~400bps and ~150bps, respectively. Given the easier comparisons for the REITs, we expect this underperformance to narrow in the coming year, but our view of the industry remains on the cautious side.
Turning to costs and margins, owners did an OK job managing through the ADR deceleration last year amid 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. Guidance ranges imply another year of challenges on the cost side. Our own modeling points to a setup where RevPOR < CostPOR for much of ’24. Historically, this is not a time to aggressively buy / own hotel REIT stocks. Rather it’s time to be selective and more balanced / underweight.
CONCLUSION
Our negative call on the hotel REITs has evolved over the last few years, with the first iterations stemming from our expectations for a much more elongated recovery, followed then by an expectation for RevPAR disappointments, and then by elevated cost growth and normalizing margin trends. Remember those margin goals and “optimization” targets that were tossed around in ’21? We do. Margins are going to be down YoY in ’24 and outside of RHP and HST, margins remain a far cry from pre-Covid levels. Our call moving forward is predicated on a combination of softer RevPAR growth putting Q1 prints at risk + April performance keeping guidance and estimate revisions in check. Beyond the near term, we still see earnings downside to the lower ends of the guidance ranges, and worse for some.
Among our top shorts of PEB, PK, and XHR, we see downside of ~20-25% in the stocks and potentially more downside on a move toward the middle to lower end of the valuation ranges.