Braemar Hotels: turn a risky 1% return into a safer 8-9% return

Thomas Barwick

Background

Braemar Hotels & Resorts (NYSE: BHR) is an externally managed hotel and lodging real estate investment trust that owns and operates hotels in the United States. BHR primarily invests in luxury hotels and resorts with high revenue per available room (“RevPAR”), which stands for RevPAR at least twice the US national average RevPAR for all hotels, as determined by Smith Travel Research.

BHR has 14 hotel properties primarily located in US urban and resort areas with favorable growth characteristics resulting from multiple demand drivers. They directly own 12 hotel properties and the remaining two hotel properties through an investment in a consolidated majority-owned joint venture.

BHR is advised by Ashford LLC, a subsidiary of Ashford Inc. (AINC), through an advisory agreement. Asset management functions include acquisition, renovation, financing and disposal of assets, operational accountability of managers, budget review, capital expenditures and property-level strategies versus to the day-to-day management of hotel properties, which is carried out by hotel managers. BRH does not directly operate any of its hotel properties; instead, they employ hotel management companies to operate them under management contracts. On November 6, 2019, Ashford Inc. completed its acquisition of the hotel management business of Remington Lodging.

Under hotel management agreements for BHR’s hotel properties, they pay a monthly hotel management fee equal to the greater of approximately $15,000 per hotel (increased annually based on consumer price index adjustments ) or 3% of gross revenues, or in certain cases 3.0% to 5.0% of gross revenues, plus annual incentive management fees, if applicable. These management agreements expire from December 2023 to December 2065, with options for renewal.

The majority of hotels are classed as a “resort” hotel, and cater to vacationers and tend to be located near attractions. BHR properties are operated under most major brands, including Ritz-Carlton, Marriott (MAR) and Hilton (HLT). This is a competitive advantage because there is only so much space around an attraction. Resort properties generally achieve a higher RevPAR and have shown a much stronger rebound since March 2020 than their urban counterparts demonstrating segment resilience.

August 2022 Investor Presentation

August 2022 Investor Presentation (Braemar Hotels & Resorts)

August 2022 Investor Presentation

August 2022 Investor Presentation (Braemar Hotels & Resorts)

Like most hotel and lodging companies, BHR hasn’t fared very well during COVID, although its profitability hasn’t declined as badly as most of its peers. By July 2022, occupancy rates at resort and urban properties had returned to pre-pandemic highs of 70%. Resort properties were showing 80% occupancy in January 2021, during omicron’s closures.

Chart
Data by YCharts
Braemar Hotels & Resorts

Braemar Hotels & Resorts (August 2022 Investor Presentation)

BHR appears to be on track to top its pre-pandemic numbers for at least fiscal 2022, as TTM’s EBITDA in June 2023 exceeded 2019 annual EBITDA by 29% due to its ability to demand higher prices and rising occupancy levels.

August 2022 Investor Presentation

August 2022 Investor Presentation (Braemar Hotels & Resorts)

Risks

The biggest concern is the leverage used by the REIT, as there is currently $1.2 billion of mortgage debt outstanding on its properties, which puts the net debt/EBITDA TTM at 5x. It’s not weak when it comes to REITs, but it’s quite conservative when compared to other hotel REITs.

August 2022 Investor Presentation

August 2022 Investor Presentation (Braemar Hotels & Resorts)

The biggest concern is that all debt is senior secured by the hotel properties and aside from the convertible senior notes which are only 7% of the debt, 93% is floating rate. Floating rate debt is not what you want to see as an investor when a cyclical REIT is heading into a period of rising interest rates and possible recession.

BHR posted a weighted average interest rate of 4.3% as of June 30, 2022 and paid $18 million in interest charges on its debt. This as LIBOR rates averaged below 1% in the first half of 2022, and given that LIBOR is now around 3.06% and with signaling from the FED to raise rates by 1.25 bps. additional percentage before the end of the year, it would not be unreasonable to expect interest charges to double in the second half of the year for BHR.

Braemar Hotels & Resorts

Braemar Hotels & Resorts (August 2022 Investor Presentation)

Month/LIBOR

Month/LIBOR (Global rates)

The Fed is preparing to raise rates to 4.5-4.75% by next year and 14% of the debt matures before 2023 YE and 48% before 2024. Therefore, we could see the charges more than double by 2023 YE from their current levels.

BHR has hit all-time highs in Average Daily Rates (ADRs) throughout 2022, which is arguably the result of “pent up” demand to go on vacation, which is a luxury most don’t have. were unable to enjoy during the pandemic. With a recession looming, disposable income will likely decline and dampen the high ADRs and RevPARs that were achieved in 2022.

Investment thesis

I can’t even begin to predict how badly BHR’s finances will be affected by rising rates and a short-term recession. However, I think the 2019 results provide a conservative run rate to start from. He is cautious because the ADR for that year was around 30% lower than what we see today. Additionally, BHR only had 3,711 suites to complete that year as they ended the second quarter of 2022 with 3,971,260 less, as they have since acquired the Dorado Beach Ritz-Carlton and Mr C Beverly hotels. Hills.

Revenue $487,614
EBITDA (25% margin) $121,904
Interest charges ($50,000)
Sustaining CAPEX ($9MM annualized Q2) ($36,000)
Preferred dividend payment ($14,734)
Annual FFO $21,170
Diluted shares outstanding 91,939
FFO/share $0.23/share

BHR will still have over $20 million to spend on debt repayment and with $318 million in cash and cash equivalents they should be able to repay maturing debt through 2024 without having to cut the dividend by $0.01/share. In this conservative scenario, it would trade at 18x ​​P/FFO, which would still put it at a discount to Pebblebrook Hotel Trust (PEB) and RLJ Lodging Trust (RLJ).

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Data by YCharts

BHR has two publicly traded preferred shares for those who want an even better return than the common offers and added security by being higher in capital structure and cumulative. The 8.25% Series D Cumulative Preferred Shares (NYSE: BHR.PD) takes precedence over all classes or series of common shares and future junior securities of the Company. The Series D Cumulative Preferred Shares have no maturity date but are redeemable at $25/share after November 2023 and have a redemption yield of approximately 14.80% at their current price of $23.50/ stock. The current yield is 8.78%. If you add back $14.7 million in annual preferred stock dividends, the FFO hedge is greater than 2.40x on common and preferred stock dividends.

The other issue is the Series B 5.50% Cumulative Convertible Preferred Share (NYSE: BHR.PB) which is not callable. At the current price of $14/share, a 44% discount to par, it has a juicy yield of 9.8%. It also has a somewhat favorable conversion option at a conversion rate of 1.3372. The stock price of common stock will need to exceed $10.50/share for the conversion to have value, but it could get there at the current rate as the price/share exceeded that amount in 2019. BRH has a forced conversion but the common stock price is expected to exceed $20.57/share for more than 45 consecutive days, which seems highly unlikely in the current environment and the BRH has not traded at such highs since 2014. Likely reason for the high par discount is the perceived risk is slightly higher than Series D due to its subordination in capital structure and therefore the market believes it should have a higher return to reflect. If we add $4,232 million in Series B stock payments back to the FFO hedge on preferred dividends and ordinary dividends, that would be over ~4.0x.

Chart
Data by YCharts

Series M and E are not publicly traded and therefore not discussed.

Conclusion

The likelihood of slower economic activity combined with higher interest rates will likely slow free cash flow in the near term, combined with large debt maturities in the three years from 2023, i do not see a significant increase in the common stock dividend in the near term.

Preferred shares, on the other hand, represent excellent income opportunities. Series D has more security by taking priority over other series and common stock and would be less likely to experience a dividend cut. The extra security only has a cost of 102 basis points in yield. The Series B Shares have greater potential for long-term capital gain due to the conversion feature and are expected to trade at a lower discount to par if the Series D Shares are called.

Management’s interests are aligned with those of shareholders as they hold 8.4% of the outstanding shares, which is high for a hotel REIT, providing greater confidence that prudence will be exercised to increase returns to shareholders.

August 2022 Investor Presentation

August 2022 Investor Presentation (Braemar Hotels & Resorts)

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