Service Properties Trust: Hotel Portfolio Profits Now Picking Up Steam (NASDAQ:SVC)

Intro

The chart below clearly demonstrates the ramifications of how shares of Service Properties Trust (NASDAQ:SVC) were impacted by the pandemic in the initial innings of 2020. Shares of the REIT literally fell off a cliff back then, then made a strong recovery before finally topping out in June of 2021 at a level well below the REIT’s pre-pandemic highs. Management of the trust however had to retain capital at the time back in April 2020 and did so by cutting its dividend from $0.54 per quarter down to a mere $0.01 per quarter.

In saying the above, the technicals have been showing signs of improvement which is encouraging for long-term investors who have decided not to sell this name. Although shares of Service Properties Trust will ultimately need to take out that downcycle multi-year trendline before we could confirm a fresh bull market in this trust, what we do have is higher yearly lows and a crossover of the trust’s 10-week moving average above its corresponding 40-week. Suffice it to say, given the recent reinstatement of the dividend (which yields almost 10%), any sustained rally in Service Properties Trust from its present level would mean excellent forward returns for investors.

Despite the return of the quarterly dividend (currently standing at $0.20 per quarter), the 9.65% forward dividend yield is only significant if it indeed can be sustained. Therefore, by looking at SVC’s balance sheet leverage as well as its forward-looking earnings expectations, we can get a good read on whether the current payout is viable or not.

Encouraging Payout Ratios

Firstly to SVC’s projected earnings going forward. Funds from operations are expected to come in at $1.42 per share in fiscal 2022 and $1.69 in fiscal 2023. This means the forward dividend payout ratio (working off an annual payout of $0.80 per share) comes in at 56% & 47%, respectively, for this year and next year. This is encouraging along with the fact that the $0.36 FFO estimate for the fourth quarter has actually risen in recent months. This bodes well both for the dividend and share price accordingly.

High Leverage

Earnings are one thing but if a REIT is too leveraged, meeting the dividend payment can become impossible especially if SVC needed to borrow at much higher fixed interest rates than 5% for example. We calculate the debt-to-market capitalization ratio by dividing SVC’s debt by the sum of its debt and shareholder equity. At the end of SVC’s third-quarter earnings report, long-term debt came in at $5.74 billion. Moreover, 165.5 million common shares multiplied by the current share price of $8.34 gives us shareholder equity of $1.38 billion.

Therefore, the trust’s debt-to-market capitalization comes in at approximately 81%. Although the elevated ratio demonstrates that the trust is being principally financed by debt, management has been eating into that debt load, and shares remain in an upward curve. Suffice it to say, it will be very interesting to see how management deals with its most near-term maturities ($500 million approx) which expire in the Summer of next year.

Diversified Portfolio

Whereas SVC may not look like an interesting play due to its leverage on one hand, what it does have is cash-producing assets which remain much higher in value (more than $9 billion of unencumbered assets) than the company’s debt load. Suffice it to say, when trading conditions stack as they have been doing recently in SVC’s hotel portfolio, for example, this REIT can outperform which is actually what we saw in SVC’s most recent third quarter.

SVC’s retail net lease properties provide the foundation for the REIT in that not a lot of money needs to be spent on these cash-producing assets (low capital expenditure outlays). Then, on the hotel side, management is focused on assets that are geared toward guests having lengthy stays as higher margins invariably come as a result. Management continues to sell hotels that are not performing from a RevPAR (Revenue Per Available Room) perspective. Therefore, if current operating conditions remain in fiscal 2023 and management can continue to double down on what is working in its portfolios, then SVC could definitely take advantage of the operating leverage it has at its disposal.

Conclusion

The recent reinstatement of SVC’s dividend was a vote of confidence that the REIT is on an upward path. Although highly leveraged, if trading conditions align for the trust (especially on the hotel side), we can see shares rising significantly higher here. Let’s see what Q4 brings. We look forward to continued coverage.