Alika Obrazovskaya
Sonder Holdings Inc. (NASDAQ:SOND) is in the hospitality business, operating and managing a portfolio of properties catering to leisure, business and family travelers.
Its share price has taken a dive since January 2022, when it traded at a 52-week high of $10.88 before collapsing to its 52-week low of $0.901 in mid-July 2022. Since then, it has recovered some, finding a higher bottom, but still struggles to break out above the $2.50 per share mark.
While total costs and operating expenses were up over 50 percent year-over-year, the company’s primary focus going forward is to become free cash flow positive in 2023.
In this article we’ll look at some of the latest numbers from its earnings report and the steps the company has in place to reach its free cash flow goal. We’ll also look at whether or not potentially worsening economic conditions will be a significant headwind for the company as we head toward 2023.
Some of the numbers
Revenue generated in the third quarter was $125 million, up 85 percent year-over-year, which was attributed to a 43 percent increase in its live portfolio, ending the quarter at about 9,000. The company had approximately 18,900 units in its portfolio at the end of the reporting period. The other catalyst for the increase in revenue was RevPAR increasing by 25 percent to $158.00.
For readers that may not know, RevPAR, or revenue per available room, is one of the more important metrics used in the industry to evaluate performance.
Based upon forecasts, the company expects RevPAR to continue to benefit from growth in urban travel from projections the industry will recover to 2019 levels by in the middle of 2023.
As far as those expectations go, I look at it as a best-case scenario under current economic conditions and the strong possibility they’re likely to worsen in the first half of 2023, and possibly further out.
If the recession goes deeper for longer, I don’t think there are any doubt consumers and business will cut back on travel spend. Under that scenario, SOND’s goal to be free cash flow positive in 2023 would have to be pushed further out.
As for average daily rate (ADR), it climbed a modest 3 percent to $189.00, while occupancy rate was up to 84 percent.
Going on to free cash flow, that was a negative $39 million in the third quarter, although an improvement over the negative $45 million last year in the same quarter. Free cash flow margin was up in the third quarter, coming in at negative 31 percent against the negative 66 percent in the third quarter of 2021. It also was better than the negative 37 percent in free cash flow of the prior quarter.
Looking ahead, free cash flow will be the primary metric for investors to use in order to gauge the progress the company is making in the quarters ahead. If it’s able to attain its free cash flow goal next year, it’s going to be a powerful, positive catalyst that should drive the share price of the company up nicely.
On the other hand, if economic conditions worsen to the point of having an impact on travel and lodging spend, the company’s share price will either fall further than it is today, and/or continue to trade in a consolidate fashion until the economy improves and demand grows. At this time I think it could go either way in 2023. At the end of the third quarter the company had $317 million in cash and $167 million in long-term debt.
Full-year guidance for 2022 is for revenue to surpass $455 million, which would be an increase of 95 percent year-over-year, with the Q4 2022 accounting for more than $129 million of that. Concerning free cash flow in the second half of 2022, guidance is for it to be better than negative $70 million, which means the fourth quarter would improve over the negative $31 million in free cash flow in the third quarter of 2022. From the recent cash flow numbers, the company is showing, at least for now, that it has the ability to continue to increase free cash flow on a consistent basis.
Free cash flow strategy
On its earnings call, CEO Francis Davidson laid out the company plan to improve free cash flow in order to become free cash flow positive in 2023. It involves four “levers.”
The first of these involves cutting cash costs by about $85 million on an annualized basis. In June 2022 SOND initiated a restructuring plan that will bring about almost $55 million in annualized savings in comparison to the first quarter of 2022. For the most part, the benefit of this will be seen in 2023.
Approximately $30 million in savings will come from lowering preopening costs and CapEx connected to units going live. That will also enhanced by the company signing only units that require lower costs to go live in the future.
Second, SOND is going to cut back on the number of planned signings in the short term, with the idea of focusing on units it has previously contracted with. In other words, it’s going to draw from its existing, overall portfolio of almost 19,000 units.
While the number of new signings in the near term will be lower than before the introduction of its free cash flow positive plan, the company noted that with its current unit supply it would be able to increase revenue to about twice the level it stands today, even if RevPAR improvements were level with where they are at this time. Third, the company has committed to only signing new units that are “100% capital-light deals.” Most of the new units signed in the third quarter met that criteria, and in the fourth quarter it’s expected to reach its goal of 100 percent. The fourth lever to boost free cash flow is via rapid payback RevPAR initiatives. Taking into account its fixed landlord payment, an incremental increase in RevPAR results in a significant increase in its cash contribution margin. One successful program it has instituted that has been growing is in regard to corporate travel. The number of accounts there has grown from 100 last year in the fourth quarter, to 600 at the end of the third quarter of 2022. It was also up from the 400 in corporate travel accounts it had in the prior quarter.
It is working on offering several other programs that will increase RevPAR, and ultimately free cash flow in 2023 and beyond. The company wants to achieve this without raising more capital while maintaining a strong cash position.
Based upon its success in improving free cash flow in the last couple of quarters, along with the initiatives listed above, it appears the company does have a very good chance of being cash flow positive in 2023.
The one caveat I would add is I think it may be too optimistic concerning the impact of the economy on the hospitality industry, and for that reason, there’s a chance SOND will have to wait a little longer to reach its free cash flow goals if businesses and consumers start cutting back on spending.
Conclusion
The share price of SOND has been trading in a tight range after it bounced off its 52-week low, and will probably continue to do so until the company proves it can improve free cash flow on a consistent basis. So far it has done so, but it’ll have to be done on a quarterly basis until it becomes free cash flow positive.
Assuming it’s able to execute its strategy, I believe the market will reward the stock as it approaches being free cash flow positive.
I like the idea that it can tap into its existing portfolio of contracted units to bring them live. That way it can focus on signing up only low-cost units that will be more profitable for the company in the long term. Not only that, but it’ll allow the company to continue to grow revenue as it cuts costs.
The major unknown in the short term will be the impact of the recession on the spending habits of consumers and businesses. The depth and length of the recession will determine how much that will have an effect on SOND’s performance in 2023.
Even though data from third-party sources point to the sector recovering to 2019 levels in 2023, I’m not convinced they’re taking into account the potential impact of a severe recession, if that’s how it plays out.
With that in mind, I think SOND is taking the right steps to improve shareholder value, but investors should consider that it may take more time to execute its free cash flow improvement plan than currently believed.
But after taking such a big hit on its share price and trading below $2.00 per share, along with its visible portfolio of contracted units and the flexibility the company has there are bringing them live, it looks to me that even if there are some headwinds that keep its share price subdued, it’s strongly positioned to generate consistent growth in the years ahead.
And even if it takes longer to achieve its cash flow positive goal, cutting back on costs, combined with its cash liquidity, should allow it the time it needs to successfully execute its strategy
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