A Fresh Look At Service Properties Trust Before Q4 Earnings – Service Properties Trust (NASDAQ:SVC)

We wrote about Service Properties Trust (SVC) back in November of last year where we focused on the dividend. This REIT presently pays out a forward dividend of $2.16 per share which presently equates to a dividend yield of 9.53%. SVC announces its fourth quarter and final year numbers at the back-end of this month. In this article, we will take a closer look at SVC’s valuation. Remember, the strong calling card for investors at present is that robust dividend yield. Suffice it to say, if SVC’s valuation is below its long-term historical averages at present, it may set-up an attractive potential long-play here.

To get a good read on how cheap/expensive this REIT is at present, we will take a look at a number of SVC’s valuation metrics. Service Properties Trust reported $0.95 in funds from operations in the third quarter. This means the FFO per share over the past four quarters comes in at $3.31 per share. SVC is expected to report $0.89 in the final quarter of the year. If the trust does this, it would mean that $3.70 per share was earned from funds from operations in 2019.

When we divide this number into the current share price of $22.65, we get a P/FFO ratio of 6.12. This number looks attractive, not only compared to SVC‘s former valuations but also compared to the average in this sector (17). The forward multiple is even more attractive as earnings are FFO are expected to rise by a small single-digit percentage in 2020.

We touched on the increasing debt load in SVC back in November pre-Q3 numbers. Out of all the metrics discussed in this article, SVC’s debt to equity is most likely the least attractive of SVC’s valuation metrics. Over a trailing 12-month average, this trust’s debt to equity ratio comes in at over 250%. This is well north of the sector’s median of 96%. However, the difference does not look as large versus the industry when we use the popular debt to EBITDA ratio which comes in at a far more respectable 8.56 (not far behind the industry’s 6.24). The issue here though is how SVC’s debt metrics have been trending. Over the past 10 years for example, SVC’s debt to EBITDA has increased from 3.73 to a current 8.56.

In terms of how sustainable the dividend is, the reported dividend payout ratio is just over 57%. This ratio is taken off the projected FFO of $3.75 in 2019 against the present dividend payout of $2.16 per share. Remember SVC still has to come good on that FFO number for the payout ratio to come in under 60% for 2019. While this number is attractive in the REIT industry, we must also look at the underlying trend. For example, the dividend has grown by less than 2% on average per year over the past 3 years but the payout ratio (calculated off FFO) continues to rise.

Why is the above important? Well, we speak a lot about dividend growth in our commentary. The reason being is that growth protects the purchasing power of the investor. Furthermore, it fosters confidence with respect to future projected FFO growth.

We also write a lot about risk/reward in our commentary. Furthermore, SVC’s valuation metrics at present have all the hallmarks of being a potential value play. Its earnings, assets, sales and cash flow are very cheap compared to the industry at large. The skeleton in the closet as mentioned is the firm’s debt-load.

If we look at the technical chart, we can see that buying volume has been steadily increasing since August of last year despite the lower lows. Usually, the volume trend offers a good read on where the share price is headed over the near term. Maybe the fourth quarter numbers will confirm the bullish technicals.

Therefore, to sum up, smart money seems to be giving SVC the benefit of the doubt at present despite sluggish growth. The smart play here seems to be to start with an initial position (with a hard stop) and then add when shares are once more convincingly higher than the 200-day moving average. Suffice it to say, we may play this REIT going into earnings.

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Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

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