Earnings Call Transcript - APLE Q2 2022

Operator, Operator

Greetings. Welcome to Apple Hospitality REIT Second Quarter 2022 Earnings Call. Please note, this conference is being recorded. I will now turn the conference over to Kelly Clarke, President of Investor Relations. Thank you. You may begin.

Kelly Clarke, President of Investor Relations

Thank you, and good morning. Welcome to Apple Hospitality REIT's Second quarter 2022 earnings call. Today's call will be based on the earnings release and Form 10-Q, which we distributed and filed yesterday afternoon. Before we begin, please note that today's call may include forward-looking statements as defined by federal securities laws. These forward-looking statements are based on current views and assumptions, and as a result, are subject to numerous cause actual results, performance or achievements to materially differ from those expressed, projected or implied. Any such forward-looking statements are qualified by the risk factors described in our filings with the SEC, including our 2021 annual report on Form 10-K and speak only as of today. The company undertakes no obligation to publicly update or revise any forward-looking statements, except as required by law. In addition, non-GAAP measures of performance will be discussed during this call. Reconciliations of those measures to GAAP measures and definitions of certain items referred to in our remarks are included in yesterday's earnings release and other filings with the SEC. For a copy of the earnings release or additional information about the company, please visit applehospitalityreit.com. This morning, Justin Knight, our Chief Executive Officer; and Liz Perkins, our Chief Financial Officer will provide an overview of our results for the second quarter of 2022. Following the overview, we will open the call for Q&A. At this time, it is my pleasure to turn the call over to Justin.

Justin Knight, CEO

Good morning, and thank you for joining us. Performance across our portfolio during the second quarter continued to exceed our expectations. Second quarter RevPAR surpassed pre-pandemic highs, coming in at $119, up 40% compared to second quarter 2021 and up 4% compared to second quarter 2019. RevPAR was bolstered by strong rate growth. ADR for our portfolio was $153 for the quarter, up 27% to 2021 and up 8% to 2019. Occupancy for the quarter was strong at 78%, up 10% to 2021 and down only 4% to 2019. Positive business and leisure demand trends have continued into July with occupancy of approximately 77% for the month and rate continuing to grow and exceed pre-pandemic levels. We are encouraged by growth in weekday occupancies, which reached 75% for the quarter, indicative of the resiliency of business travel across our markets. Consistent with our expectations, leisure travel continues to be incredibly strong despite higher gas prices and an inflationary environment. Weekend occupancy was approximately 85% for the quarter, surpassing 2019 occupancy levels by 160 basis points. With stronger weekday occupancies adding to robust weekends, we are better positioned to more meaningfully move rates throughout the week and adjust our business mix to maximize profitability. For the quarter, weekday ADR was $148, and weekend ADR was $165. Strong recovery in rate helped to offset challenging labor and inflationary pressures. As a result, second quarter operations were significantly ahead of the same period last year with comparable hotels total revenue up more than 39% relative to the second quarter of 2021. We achieved comparable hotels adjusted hotel EBITDA of $137 million, up 46% compared to the same period of 2021 and up 4% for the same period of 2019. We achieved comparable hotels adjusted hotel EBITDA margin of 40%, and up $100 million from operations was $111 million or $0.48 per share, in line with second quarter 2019 results. These outstanding results further validate our strategy of investing in a diversified portfolio of high-quality, branded, rooms-focused hotels with low leverage and are a testament to the tremendous efforts of our corporate and on-site management teams. Our portfolio includes 219 hotels and provides exposure to a wide variety of demand generators and industries. Our hotels are generally located in business-friendly markets that offer attractive cost of living and popular leisure and entertainment venues, which appeal to a variety of small and medium-sized businesses as well as large corporations. Our rooms-focused hotels aligned with industry-leading brands and managed by best-in-class offerings have the ability to produce robust operating margins and profitability. The strength of our balance sheet further contributes to the long-term stability and optionality of our platform. In July, we refinanced our primary unsecured credit facility, further bolstering our already strong liquidity position. We greatly appreciate the support of our lenders, their conviction in our strategy, and their continued confidence in the underlying fundamentals of our business. We continue to actively underwrite and explore dozens of opportunities for acquisitions of assets in 2022, with transactions likely over the coming months. The 12 hotels we have purchased since the onset of the pandemic contributed meaningfully to our year-to-date outperformance, exceeding our original underwriting during the first six months of the year by over $3.2 million in hotel EBITDA. Future acquisitions will be consistent with our strategy of investing in high-quality, rooms-focused hotels located in strong RevPAR markets with attractive cost structures and meaningful growth potential. We were fortunate to have entered the pandemic with a relatively young and well-maintained portfolio. As a result, we're able to strategically reduce renovation spend to preserve capital in 2020 and 2021. During the first six months of 2022, we invested approximately $17 million in capital expenditures and anticipate spending a total of $55 million to $65 million during the year. Through our scale, ownership of branded rooms-focused properties over more than two decades, we have significant experience in determining the most effective scope and timing of our investments to ensure minimal disruption to property operations and maximum impact for every dollar spent. As of June 30, 2022, we had approximately $345 million remaining under our share repurchase program. We will be opportunistic in using this program where we see market dislocations that create opportunities to buy our portfolio at a meaningful discount. We also intend to continue to return capital to our investors through monthly dividends, and based on Wednesday's closing price, the annualized distribution of $0.60 per common share represents an annual yield on a monthly basis. Our strategy was designed to create an asymmetrical risk profile, mitigating downside risk while providing meaningful opportunity for upside. We remain confident in the resiliency of travel and our ability to drive strong results and maximize shareholder value in any macroeconomic environment. With nearly every operating business travel and new supply at historically low levels, we are incredibly optimistic about the future of our business. Before I turn the time over to Liz, I just want to take a moment to thank those that I touched on in my earlier remarks. Liz, I'll now turn the time over to you for additional details on our balance sheet, operations, and financial performance during the quarter.

Elizabeth Perkins, CFO

Thank you, Justin, and good morning. Top line performance for the second quarter grew sequentially by months with total portfolio revenues for June up approximately 28% compared to the prior year and in line with June of 2019. RevPAR growth for the quarter was driven primarily by ADR, which improved 27% and 8% compared to the same period in 2021 and 2019, respectively. Occupancy was up significantly compared to 2021 but came in approximately 4% lower than the second quarter of 2019. Preliminary results for July show continued strength in demand with occupancy of 77% and continued growth in rate. While July occupancy was down 6% compared to 2019, this was largely due to lower business demand over the Fourth of July holiday. Our portfolio is now producing top line results above pre-pandemic levels even without a full recovery in business travel. As we look forward to midweek occupancy driven by further recovery in business travel, we expect this to push our operating performance even higher. Recent performance reflects both continued strength in leisure and a meaningful recovery in business demand. April, May, and June weekend occupancies were 83%, 86%, and 85%, respectively. Weekday occupancy improved significantly over last year and the first quarter of this year, with April and May weekday occupancy at 74% and 73%, respectively, both down less than 8% compared to 2019. Weekday occupancy improved further in June to 78%, only 6% lower compared to June of 2019. With growth in weekday occupancy, weekday ADR meaningfully improved, moving from $142 in April to $155 in June, now exceeding 2019 weekday rate levels. As we assess our demand segments and business transient trends, we observe that travel patterns are beginning to normalize, with 56% of our portfolio producing RevPAR above pre-pandemic levels during the quarter and improvement in demand impacting nearly every market. The strong demand segments primarily include universities, healthcare, and manufacturing. In terms of expenses, total for the quarter was roughly in line with the first quarter and up 5% compared to the second quarter of 2019. Low unemployment and rising occupancies have continued to exert pressure on labor. Second-quarter results were impacted by higher wages for full and part-time employees, training costs, and higher utilization of contract labor to meet short-term needs. While we anticipate that a portion of the elevated expenses will be temporary, we are focused on balancing product and maintenance standards to support strong employee morale and low turnover to maximize long-term profitability. Excluding payroll, same-store rooms expenses continued to be well controlled and were down by 4% per occupied room compared to 2019 for the quarter. Strong rate growth and effective cost control despite the challenging labor environment resulted in hotel EBITDA of approximately $137 million and a comparable adjusted hotel EBITDA margin of approximately 40%, up 10 basis points compared to the second quarter of 2019. Following similar trends, MFFO also improved sequentially each month and was approximately $111 million or $0.48 per share for the second quarter, up 74% compared to the second quarter of 2021 and in line with the second quarter of 2019. Looking at our balance sheet, as of June 30, 2022, we had $1.4 billion in total outstanding debt, approximately 3.7 times our trailing 12 months EBITDA with a weighted average interest rate of 3.6%. The $1.2 billion credit facility is comprised of a term loan of $275 million available with a delayed draw option and a revolving credit facility of $650 million with an initial maturity date in July 2026. Through the refinancing of our primary credit facility and the repayment of 9 secured mortgages, we achieved key balance sheet objectives of managing and staggering our debt maturity, increasing access to liquidity through upsizing our revolving credit facility, and increasing the unencumbered pool of assets in our portfolio. As for our outlook for the remainder of 2022, we remain confident in the broader industry recovery and the performance of our portfolio specifically. Second quarter performance exceeded our internal forecast. We anticipate that midweek occupancy will continue to grow, which should enable us to further increase RevPAR for our portfolio.

Neil Malkin, Analyst

Yes. First one, can you either of you talk about midweek or BT opportunity from here? Maybe you could start by reviewing Q2 and then into July. And then there is a sentiment that group will recover ahead of BT; how do you see that side of the business shaking out and what are your expectations for the next several quarters in terms of BT holistically in the portfolio?

Elizabeth Perkins, CFO

Sure. We had started to see more sequential and consistent improvement in business transient, looking at a couple of different points, GDS as a percentage of our mix and then a room segmentation perspective, looking at our negotiated both local and corporate negotiated accounts. Room segmentation for corporate and local negotiated combined is in the low 20% range, about 20-21% for the quarter, pretty much where we were before the pandemic for corporate and local negotiated. For GDS, we improved to 15% in the quarter. This reflects more traditional corporate-negotiated hotels that are exceeding 2019 levels. There's still a significant amount of our portfolio that has room to grow in both the corporate and leisure segments. We continue to see meaningful upside as some markets remain slower to return. Overall, as more markets start approaching and exceeding 2019 levels, we've gained pricing power, allowing for opportunities on the rate side as that business travel returns.

Justin Knight, CEO

Yes, and importantly, Neil, we've continued to see progressive improvement month-over-month on the business transient side of our business. And that's showing up in our mid-week occupancies. Tuesday and Wednesday for the entire quarter those days were up about 80% from an occupancy perspective. While we continue to have room to improve on the business side, we are seeing continual improvement in that area and anticipate that business travel will continue to improve through the back half of the year.

Elizabeth Perkins, CFO

Even if you look at July and what we've seen on Tuesday and Wednesday night in July, excluding that first week which was impacted by the 4th of July, we are continuing to see good growth.

Neil Malkin, Analyst

Great. Yes. Sounds good. And just thought you said something like, I think GDS is 15% versus 20% in 2019. That's around, what, like 75%? Is that like an accurate way to think about it? Like BT was 75% of '19. Again, just trying to understand.

Elizabeth Perkins, CFO

Yes.

Neil Malkin, Analyst

Okay. Great. Other thing for me, Justin, I think you touched on it briefly, but one of the things you guys have always talked about, particularly since the pandemic is the balance sheet and the differentiated nature of it. Now that we have a more questionable financial environment with some macro uncertainty, do you feel like you're going on the offense or being more aggressive in terms of finding deals or opportunities to acquire? Can you shed some light on that?

Justin Knight, CEO

Yes, certainly. In my prepared remarks, I highlighted the fact that disruptions in the debt market have at least temporarily created more attractive buying opportunities for us. We anticipate that we will be net acquirers this year. We have been actively underwriting deals continuously since the onset of the pandemic and competing for deals largely with private equity players who are now meaningfully disadvantaged by increasing interest rates and lack of availability of debt, specifically in the CMBS market. As a result, we have seen deals that were tied up coming back to market, both individual properties and larger portfolios. We believe that we are in a good position to capitalize on potential dislocations in the market.

Dori Kesten, Analyst

Can you give a little bit more detail on the reasoning behind the increase in the size of the facility? Is it that it's more appropriate given the company today? Or is this really a read-through about future growth? Are there relatively large portfolios being marketed for sale today that are of interest to you?

Elizabeth Perkins, CFO

To answer the first part of your question, Dori, the upsizing of the facility was the result of a couple of unsecured transactions. The revolver upsize was strategic, both relative to the size of our company and the size of our average investment today, aiming to be nimble in any environment and grow strategically if the opportunity exists.

Justin Knight, CEO

In terms of portfolios, there have actually been, for some time, a number of attractive portfolios that have been marketed, several of which we were active in the bidding process around. Deals that had interest have come back to market, with sellers more willing to adjust the makeup of those portfolios, which enables us to better align our acquisitions with our existing portfolio strategy. While we believe that we will continue to pursue growth through a series of individual asset transactions, small portfolios are also a consideration.

Michael Bellisario, Analyst

Can you give us some more detail on what you've seen over the last 90-plus days in terms of pricing changes and expectations in pricing changes in cap rates? How would you characterize the differential between single assets and portfolio pricing?

Justin Knight, CEO

With a lack of available financing, portfolios are impacted more significantly from a pricing standpoint. Brokers are guiding to somewhere around a 10% discount to where values were prior to the disruption. However, the rapid recovery in operating performance allows sellers to achieve their objectives even at a higher potential cap rate. We are in ongoing dialogue with a number of potential sellers regarding individual assets and larger portfolio trades.

Michael Bellisario, Analyst

For higher-quality properties you might be interested in, prices have come back to you, but the cap rate is higher because of fundamentals improving in the past 6 months. Is that fair?

Justin Knight, CEO

That's correct. But I want to point out that until the deals trade, we can only provide directional commentary.

Elizabeth Perkins, CFO

For July specifically, we mentioned that July was 77% from an occupancy perspective, which compared to 2019 was down about 6%. However, excluding the Fourth of July week, we saw that gap shrink to only down about 3% from an occupancy standpoint relative to 2019. We typically see July ADR take a step back again from June, so rate growth into July will help offset the incremental impact of the Fourth of July week on overall RevPAR levels.

Chris Darling, Analyst

Does the fact that a larger swath of your markets are either at or above pre-COVID performance change where you look to allocate capital going forward?

Justin Knight, CEO

We have been looking into markets that have been slower to recover. Our appetite toward those markets depends on our long-term view of performance. Diversification remains a key component of our strategy, allowing us to add assets to our portfolio that create exposure to demand generators and yield opportunities. We have a broad vision for potential acquisitions based on this strategy and continue to look for opportunities in various markets.

Austin Wurschmidt, Analyst

Are there any markets you're specifically focused on for acquisitions to enhance that diversification? Have you explored opportunities on pre-purchase-type deals on development?

Justin Knight, CEO

We're active in discussions around potential developments. However, with the rising costs of construction and uncertainty around supply chains and labor availability, it’s more challenging to underwrite new development deals than it ever has been. We anticipate that new development deals will represent about one-fourth of our total acquisitions over time, but in the near term, we are more likely to pursue existing deals where there are fewer buyers competing with us. Thank you for joining us today. We are pleased with our portfolio performance over the past quarter and are optimistic about the future. As always, we encourage you to stay with us at one of our hotels. We look forward to speaking with you soon.

Operator, Operator

Thank you. This does conclude today's conference. You may disconnect your lines at this time, and thank you for your participation.