Earnings Call Transcript - SHO Q1 2025

Operator, Operator

Good morning, ladies and gentlemen, and thank you for joining us. Welcome to the Sunstone Hotel Investors First Quarter 2025 Earnings Call. I want to remind everyone that this conference is being recorded today, May 6, 2025, at 10:30 a.m. Eastern Time. I will now hand over the presentation to Mr. Aaron Reyes, Chief Financial Officer. Please proceed, sir.

Aaron Reyes, CFO

Thank you, Operator. Before we begin, I would like to remind everyone that this call contains forward-looking statements that are subject to risks and uncertainties, including those described in our filings with the SEC, which could cause actual results to differ materially from those projected. We caution you to consider these factors in evaluating our forward-looking statements. We also note that the commentary on this call will contain non-GAAP financial information, including adjusted EBITDAre, adjusted FFO and hotel adjusted EBITDAre. We are providing this information as a supplement to information prepared in accordance with generally accepted accounting principles. Additional details on our quarterly results have been provided in our earnings release and supplemental, which are available in the Investor Relations section of our website. With us on the call today are Bryan Giglia, Chief Executive Officer; and Robert Springer, President and Chief Investment Officer. Bryan will start us off by providing some commentary on recent developments and our first quarter operations. Afterwards, Robert will discuss our capital investment activity. And finally, I will review our first quarter earnings results and provide the details of our updated outlook for 2025. After our remarks, the team will be available to answer your questions. With that, I would like to turn the call over to Bryan. Please go ahead.

Bryan Giglia, CEO

Thank you, Aaron, and good morning, everyone. It was an eventful quarter that began with stronger-than-expected performance in January and February, driven by the Super Bowl in New Orleans and the inauguration in D.C. and then was partially offset by a pullback in government and leisure demand in select markets in March as the macroeconomic outlook became more mixed. Our first quarter EBITDA and FFO came in just above our expectations as better out-of-room spend, solid cost controls by our operators and savings at the corporate office offset softer room revenue growth. I'll provide some additional details on our first quarter operations shortly, but first, I am happy to announce the next chapter of the Sunstone growth story with the debut of the Andaz Miami Beach, which began welcoming guests on May 3. While the road to opening was met with numerous permitting and approval delays, the doors are now open and guests can experience an exceptional Miami Beach resort. I was on property last week, and the finished product looks great and is well positioned to deliver on our underwriting and provide earnings growth for the next several years. This is a significant component of our layered approach to growth, which will add to the success we have experienced with the conversions of the Westin D.C. Downtown and the Marriott Long Beach Downtown, the acquisition of the Hyatt Regency San Antonio Riverwalk and the capital we have deployed into the purchase of our common stock. We expect to continue our balanced and nimble approach to capital allocation and to utilize our strong balance sheet and future asset recycling to drive growth in FFO and NAV per share. Now shifting back to our quarterly results. We were pleased with how the portfolio performed relative to our expectations despite the incremental volatility we began to see later in the quarter. The inauguration drove outsized growth in Washington, D.C. with our recently renovated hotel generating a 24% increase in RevPAR during the quarter. Additionally, in New Orleans, our 2 hotels grew RevPAR by a combined 25% on strong performance from the Super Bowl, even with the cancellation headwinds from a rare snowstorm that hit the area in January and negatively impacted what was slated to be a high demand period in the city. Outside of this event-driven business, we saw sustained strength in group demand and continued growth in business travel. In San Francisco, we generated RevPAR growth of 9% as the result of a better citywide calendar and increased levels of commercial activity in the downtown area. Our performance in San Francisco is encouraging as we have meaningful opportunity for additional earnings recovery there as growth in the city has lagged other major markets, but has an increasingly positive outlook for the coming years. After having a great 2024, trends in Boston remained strong into the first quarter with solid performance at our well-located Marriott Long Wharf. The better-than-expected performance in most of our urban and convention markets was partially offset by more subdued market-wide transient demand in San Diego. While first quarter results in San Diego were less robust, the outlook for the remainder of the year is more encouraging with solid growth expected in the second quarter, followed by the recapture of lost business from the labor activity that occurred in the third and fourth quarters of last year. Overall group and business transient demand was strong in the first quarter. Despite some pockets of softness primarily related to government business, good first quarter production and positive group pace across the portfolio would point to stability in these trends for the remainder of the year. On the transient side, we were encouraged by growth in midweek demand. This is an indicator that corporate America continues to travel, a trend that is supported by increased return to office and the greater levels of activity we are seeing in the business districts of our urban markets. Within our resort portfolio, we saw softer-than-expected performance in Wailea as all inventory comes back online on the West side and the island continues to recover from the fires. Our Wailea Beach Resort's premier location as the closest property to the water on what is arguably the best strip of beachfront land in the country gives us confidence that we will navigate through this short-term choppiness and return to growth in the coming quarters. This period of transition as the Kaanapali submarket reopens will be a long-term positive for the island as it will ultimately bring the return of more guests and drive additional airlift into Maui. Our updated outlook assumes that we face a softer demand environment in Wailea for the next couple of quarters as Kaanapali returns to normalized operating levels. Group production at Wailea for all future periods was up nearly 20% in the first quarter relative to the prior year and gives us reason to be optimistic that sunnier days lay ahead for our resort. As we have shared with you before, investing in our portfolio remains a key component of the Sunstone story. We saw the benefits of this in the first quarter with our recently renovated and converted Marriott Long Beach Downtown, which posted a solid 145% increase in RevPAR. While we expect to continue to benefit from outsized growth in Long Beach for the coming quarters, we will now also see the contribution from the Andaz Miami Beach in the second half of the year, which will deliver our next layer of growth that will extend into 2026 and beyond. The growth generated from these conversions is not limited to the immediate year following completion. Inauguration aside, we continue to see the Westin D.C. downtown establish itself as a premier group and business transient hotel, driving incremental cash flow as it approaches its third year following renovation despite a near-term slowdown in government demand. While we were encouraged by many of the trends we saw in the early months of the year, operating fundamentals moderated as the quarter progressed, driven primarily by increasing macroeconomic uncertainty and declining business and consumer confidence. While this has led to lowered expectations in a few markets for the middle part of the year, we are seeing more stable trends in other areas and steady booking volumes across most of the portfolio for the latter part of the year. Given the increased volatility, the uncertainty regarding economic policy changes and the greater variability in the range of possible economic outcomes for the year, our forward visibility has become more limited. As a result of these factors, we are adjusting our full year outlook to better align with current trends. The updated outlook that Aaron will discuss shortly is based on information available to us today, but is subject to change, both negatively or positively based on how future macroeconomic developments impact lodging demand. Our current outlook reflects the revised opening date for the Andaz and assumes continued weakness in government-related business, no meaningful change to the imbalance of international travel and a more subdued demand environment in Wailea for the coming quarters before resuming growth later this year. Given the lack of visibility and overall economic volatility, we are extrapolating these trends forward, which could prove to be a conservative approach if the environment stabilizes sooner than expected. That said, our capital recycling and investment efforts are still delivering sector-leading growth. This is a direct result of our layered approach to recycling capital, investing in our portfolio and returning capital to our shareholders. As you saw in our earnings release this morning, we repurchased $21 million of stock at a blended repurchase price of $8.90 per share. Repurchasing our shares at these levels equates to a highly compelling multiple on our earnings and results in significant value creation. Given our strong balance sheet and the earnings contribution we anticipate from our recent investments, we are well positioned to generate incremental shareholder value by opportunistically repurchasing our shares. Given the current discount to NAV, we will look to recycle additional capital into share repurchase, potentially through additional asset sales. To sum things up, despite a more volatile operating environment than we expected at the start of the year, we continue to execute on our strategic objectives in the first quarter. We are advancing the page in the Sunstone growth story with the opening of the Andaz Miami Beach and the continued growth from our other recent investments in Long Beach and Washington, D.C. We will further advance our capital recycling strategy by utilizing our available balance sheet capacity and future asset sales to thoughtfully grow our FFO and NAV per share as we move further into the year. And with that, I'd like to turn the call over to Robert to give some additional thoughts on our capital investments. Robert, please go ahead.

Robert Springer, President and Chief Investment Officer

Thanks, Bryan. We are very pleased to have the Andaz Miami Beach open and expect the resort will be a fitting addition to Mid-Beach which is defining itself as the more elevated and sought-after destination of Miami Beach. In addition to the amenities that are available today, over the coming months, we will introduce Olazul, a members-only beach club, which will operate from a historic home in the resort's backyard. Later, the resort will also debut The Bazaar by Jose Andres, which we expect will further increase the appeal of the property and serve as a dining destination for local residents and guests from nearby hotels. Elsewhere across the portfolio, we have recently completed a rooms renovation and lobby refresh at the Wailea Beach Resort and are in the process of creating two additional residential style oceanfront villa units following the positive reception we received from those that came online at the end of last year. In San Antonio, we will begin renovating the meeting space in the third quarter. We expect to move efficiently through this project and be complete by the end of the year. Part of what appealed to us in acquiring this hotel is the opportunity to reprogram the lower lobby level to take advantage of the new development activity happening next door at the Alamo Visitor Center and Museum. We are still in the planning stages of this effort, but look forward to updating you as we progress. In San Diego, we are in the final planning stages for a renovation of the meeting space at our Hilton Bayfront and expect to be in a position to begin work late in the year. We will complete the meeting space update in phases, resulting in minimal disruption, which is included in our outlook. Corporate meetings are the core business of this very productive hotel. And by upgrading the space, we will enhance its ability to attract the best groups in the market. As we shared with you last quarter, we expect our capital investment activities for this year will be in the range of $80 million to $100 million. While there is still too much uncertainty to accurately assess the impact of the recent tariff announcements on our future capital projects, the largest components of our spend for this year relate to projects that were already underway at the start of the year and for which materials have largely been procured. While this certainly does not mean we are not at risk for cost inflation in certain areas, based on what we know today, we expect to be able to complete our planned activities for this year within our prior estimated range. Now turning to the transaction market. As we moved into 2025, we had higher hopes that the setup for the year would support a more robust transaction market. However, the uncertainty that has permeated the environment since that time makes finding and getting deals done much more challenging. As Bryan noted, recycling capital is a primary component of our strategy. And so despite the recent volatility, we continue to seek out opportunities to drive growth and create value through accretive transaction activity. We hope to have more to share with you on this front as the year progresses. With that, I'll turn it over to Aaron. Please go ahead.

Aaron Reyes, CFO

Thanks, Robert. As we noted at the top of the call, our earnings results for the first quarter came in ahead of expectations as stronger ancillary revenue, better hotel expense management and savings at the corporate level offset lower rooms revenue growth, which was driven primarily by a more challenging top line performance in March. Comparable rooms RevPAR increased 3.8% in the first quarter and total RevPAR grew 4.3%, contributing to an 80 basis point expansion in hotel margins. Adjusted EBITDA in the first quarter was $57 million and adjusted FFO was $0.21 per diluted share, which reflects a 17% increase from the prior year given the contribution from our recent investments in the portfolio with the added benefit of our accretive share repurchase activity. Our balance sheet remains strong with net leverage, including our preferred equity of only 4.5x trailing EBITDA. While our outlook has moderated, we still expect our leverage and balance sheet capacity to improve as we move through the year and benefit from the embedded growth in the portfolio. Subsequent to the end of the quarter, we exercised the extension option on our $225 million term loan. Together with the extension options we have in place on other debt, we don't have any maturities for the remainder of the year. As of the end of the quarter, we had nearly $150 million of total cash and cash equivalents, including our restricted cash. Together with capacity on our credit facility, this equates to nearly $650 million of total liquidity. Included in our earnings release this morning are the details of our updated outlook for 2025. As Bryan noted earlier, this revised projection is based on expectations and the information we have available today, but could be impacted either positively or negatively based on how the macroeconomic environment and business and consumer sentiment evolve from here. Based on what we see today, we expect that our total portfolio RevPAR growth will range from 4% to 7% as compared to 2024. This range reflects the early May opening of Andaz Miami Beach, which is a few weeks later than what was assumed in our prior outlook. For the balance of the portfolio, excluding Andaz, we now anticipate that RevPAR will increase between 1% and 4%. With these revised top line growth projections, we now estimate that full year adjusted EBITDAre will range from $235 million to $260 million, and our adjusted FFO per diluted share will range from $0.82 to $0.94. Despite the headwinds from the more volatile operating environment, the midpoint of our updated outlook for EBITDA and FFO would still equate to healthy annual growth rates of 8% and 10%, respectively, and is a direct result of our recent portfolio investments. As it relates to some of the quarterly assumptions that comprise our updated full year outlook, we would expect our total portfolio RevPAR growth to remain in the low single-digit range for the second quarter before increasing more meaningfully in the third and fourth quarters, driven by increased contribution from Andaz Miami Beach, continued growth in Long Beach and the easier comparison from the impact of the strike in San Diego. In terms of the distribution of our EBITDA by quarter, based on the midpoint of our revised outlook, the first quarter contributed 23% of our expected full year total. As is typical for our portfolio, we expect the second quarter to be the largest contributor of the year at approximately 28% and the third quarter to comprise nearly 23%. This would leave the balance or approximately 26% in the fourth quarter, which is a bit higher for us than usual, but is when we expect to generate the bulk of the current year earnings from Andaz. As we noted in the 2025 outlook section of our press release, the remaining components of our full year projections remain unchanged from the prior quarter. Now shifting to our return of capital. In addition to the accretive share repurchase activity we have completed so far this year, our Board of Directors has authorized a $0.09 per share common dividend for the second quarter and has also declared the routine distributions for our Series G, H and I preferred securities. While we retain ample capacity for additional capital return, the full year outlook that was discussed earlier does not assume the benefit of any additional share repurchase activity. And with that, we can now open the call to questions. So that we are able to speak with as many participants as possible, we ask that you please limit yourself to one question. Operator, please go ahead.

David Katz, Analyst

I wanted to revisit the Confidante. The world has changed somewhat since its conception and launch. Could you discuss your current underwriting trajectory compared to where it was 12, 18, or even 24 months ago? What can we realistically expect in terms of returns next year?

Bryan Giglia, CEO

I'm not familiar with the Confidante, but I can speak about the Andaz. We're very excited that the hotel and resort are now open after a long journey. Given the approval process in Miami Beach, closing a hotel there and undertaking a major renovation is something we would reconsider, but we are pleased with our current position. When we assessed the hotel and the market, our initial projections for the Mid-Beach luxury market were lower than the actual outcomes in 2023, although we did see a pullback in 2024. The 2024 performance was still significantly better than we had anticipated, reaching around the 800-plus range. Our success here relies on offering a product that is competitive with other hotels, and having visited the resort, I can confirm that it truly meets that standard. We have a luxury resort equipped with upscale amenities, fine dining, and an adequate number of suites. We reduced the total number of rooms to increase the suite count, targeting a rate between the mid-500s to $600 for success, which is still achievable as the market remains above these rates. We are confident that despite the later opening, the final results will align with our expectations. With the hotel now operational and groups starting to visit, we are approaching the booking season for the fourth and first quarters. This hotel is projected to generate 60% to 70% of its EBITDA during these quarters. We are on track to capture that business. The resort's food and beverage offerings, including those from the Jose Andres Group, make us optimistic about hitting our targets by year-end and into 2026. Due to the delayed opening, we anticipate around $6 million to $7 million in EBITDA for this year, predominantly in the fourth quarter. Looking ahead to next year, we expect to return to the EBITDA growth patterns we had in mind earlier this year, aiming for a range in the high teens to 20s and continuing to grow over the next three years.

Dany Asad, Analyst

Aaron, I would like to revisit your updated outlook that you shared with us. Could you break it down for us? Bryan mentioned the Andaz now at $67 million. Can you explain how the view on Wailea has become more moderated, the changes with Andaz, and what remains in the core of the portfolio?

Aaron Reyes, CFO

Sure, Dany. Thanks for your question. I'm happy to explain. When we review the portfolio and connect it to the EBITDA and FFO adjustments from the quarter, we can categorize the changes into three main groups. First, the revised expectation for Andaz is now between $6 million and $7 million, which is about $2 million lower than our initial estimate based on the original opening date we mentioned in February. The second factor is the more challenging operating conditions in Maui, particularly as Kaanapali reopens and the island works to return to its pre-fire state. This accounts for approximately $4 million in forecast adjustments. Lastly, there's about $2 million in headwinds related to San Diego, reflecting a weaker transient market we observed in the first quarter and into the middle of this year.

Bryan Giglia, CEO

In San Diego, we experienced some short-term weakness in the first quarter, along with additional government-related challenges in other areas. We based our forecast on what the hotels provided and projected it further into the year until conditions stabilize. We believe this was a reasonable decision given the information available. There are many uncertainties right now, and if conditions change, it might appear more conservative. As we move into summer, despite the weaker dollar, we do not expect an increase in international travel, which is an opportunity for us with the weaker dollar. Overall, we aimed for a conservative yet realistic perspective, but in a quarter or two, we could see various changes, both positive and negative.

Duane Pfennigwerth, Analyst

Just a follow-up there, maybe two markets. Hawaii, what do you think held back the asset in the first quarter? And why do you think your at least near-term or 1Q commentary differs from one of the main peers with exposure to Maui? And then on San Francisco, obviously, a strong first quarter. How do you see that playing out over the balance of the year?

Bryan Giglia, CEO

In Maui, the R1 Hotel in Wailea operates within the luxury market, contrasting with Kaanapali, which is somewhat more affordable. We provide guests there with an excellent opportunity to enjoy a luxury resort experience at a slightly lower luxury rate. The main competition we face is from the Westside in Kaanapali, which offers a different, less luxurious experience. As business in Kaanapali begins to stabilize, we've observed positive trends in occupancy and airlift, which decreased by 20% last year but is now down by about 13%. Kaanapali is experiencing good fill rates, occasionally reducing their prices. If the price gap between our hotel in Wailea and Kaanapali widens, we may see some guests choosing to stay in Kaanapali instead. This is part of the natural recovery process in the market following the fire. Looking ahead, we anticipate these growing pains will continue for a quarter or so, but we are optimistic, especially with strong group bookings for the fourth quarter. Our room renovations, which initially caused some disruptions, have been completed, and we are committed to enhancing our luxury experience further. Our Olakino pool is currently the premier luxury pool experience in Maui, and the state is effectively promoting Maui as a tourist destination. By 2026, we expect double-digit growth in pace. Overall, as the year progresses, our hotel is set to return to normalcy and we aim to increase occupancy by about 10 points. Compared to competitors, there are advantages and disadvantages; larger hotels in Kaanapali could benefit more during this time. Additionally, hotels recently renovated often create a skewed performance in the following quarters. However, the positive news is that luxury demand remains strong, and as Kaanapali's occupancy improves, we will also benefit significantly. Regarding San Francisco, this market has faced challenges but is showing positive developments over the past year. We expect consistent demand for the remainder of the year, particularly from business travelers, with a strong transient business presence in our submarket. A decade ago, Union Square was the prime location, but now the Embarcadero and Financial District have become the preferred spots for business guests, particularly from Monday to Thursday. We can leverage our in-house meeting facilities to optimize occupancy. Moving forward, sentiment in the city is improving, office demand is rising in our specific areas, and we expect robust growth in pace for next year. Thus, we view San Francisco positively for several upcoming quarters into 2026 and likely into 2027.

Michael Bellisario, Analyst

Bryan, just sort of big picture question for you on strategy and value creation. And it sounds like you're inclined to shrink the portfolio a bit more with at least one asset sale, at least sort of based on how you guys framed it in the prepared remarks. But sort of 2 parts here for, I guess. One, how many more noncore hotels do you have or have you identified? And then two, maybe when do you consider a more opportunistic or larger sale like Miami to just more meaningfully move the needle to repurchase even more stock?

Bryan Giglia, CEO

Thank you, Michael. Regarding your first question about the number of noncore assets we have, I'm pleased to say we possess a strong portfolio. We're quite satisfied with it and have spent several years carefully refining our holdings to focus on exceptional assets. So, are there hotels that need to be sold? No, not necessarily. Our focus is on effectively recycling capital and determining the ideal timing to divest assets and reinvest the proceeds. We assess when our returns may begin to decline due to future capital requirements or stagnant growth. This is our approach to identifying assets for recycling. We will consistently evaluate opportunities to recycle assets, whether they are our smallest or largest. We compare current market values against our internal NAV, and if we can capitalize on opportunities in private markets, we will do so. We've successfully executed this strategy in the past. One advantage of being a company of our size is our ability to remain flexible; we have repurchased shares previously, and amounts can vary from quarter to quarter. This year, we have been active, and we believe the current value is compelling, so we intend to capitalize on that. Reflecting on last year, when our stock rebounded and acquisition opportunities arose, we made a significant acquisition in San Antonio at a very opportune time. However, soon after, we shifted back to repurchasing shares. We will keep looking for opportunities to recycle assets and assess the best way to allocate our capital. At present, it is clear our stock represents the best use of our capital, and we will continue to pursue this. Given current market conditions, we expect to be net sellers. While the transaction market is somewhat unstable now, we're noticing an improvement in the debt markets, which should facilitate more transactions in the future. For now, it seems reasonable to anticipate that we will be net sellers, and any resultant capital is likely to be used for buying back our stock.

Smedes Rose, Analyst

I wanted to maybe just follow up on that a little bit and kind of circle in on your Napa assets. It looks like the losses accelerated year-over-year, just wondering if you put that up to maybe the calendar shift that went on during the quarter? And maybe you could just talk to your overall expectations this year for those assets. And then certainly, kind of, Bryan, I mean, water cooler talk would suggest that those 2 properties would be on the short list potentially for recycling capital. And I'm just wondering, without addressing maybe potentially those, what are the conversations like for high-end luxury assets? I mean, are there buyers? Is there just big pricing discrepancy or buyers more on the sidelines at this point? Just any kind of discussion around that would be of interest.

Bryan Giglia, CEO

The first quarter in Wine Country, like any seasonal resort market, will always be the weakest. Our aim is to approach breakeven in that quarter, but profits are made elsewhere. Shifts of a few hundred thousand dollars year-to-year can be influenced by a single group. Together, the two resorts generated a couple of million dollars more in EBITDA last year and are expected to do the same this year. We are fine-tuning to optimize the group mix and have made significant progress. We are collaborating with brands and third-party consultants to reduce costs while maintaining guest satisfaction. These efforts are progressing positively. Regarding the disposition of luxury assets, they appeal to a small, focused group of investors who recognize their scarcity value and typically have longer hold periods and views on asset performance. We are consistently engaged in conversations about a significant portion of our portfolio because we have high-performing assets in demand. While luxury buyers are affected by debt markets and interest costs, these factors are additional considerations for valuation. A slowdown in transaction volumes across asset types also impacts this sector. However, our focus remains on recycling capital, which includes our high-end luxury assets and all items in our portfolio. We are keen to capitalize on private market values, especially considering our current stock performance makes it an attractive opportunity.

Chris Woronka, Analyst

This will be a follow-up on the Andaz Miami. I assume your revised outlook with EBITDA accounts for any rebooked customers that may work with Hyatt. The question relates more to the rest of the year, particularly Q4, given your expectations. What kind of visibility do you think you have? Can you provide a sense of what you expect at that asset regarding the booking window? If we compare it to other luxury resorts that usually have longer booking times, how do you anticipate that will develop throughout this year and beyond?

Bryan Giglia, CEO

Yes. Thank you, Chris. To address the first part of your question, when we had to relocate some customers, those costs are factored into our future EBITDA and FFO reconciliation. The booking window for our 287-room resort is quite different from San Diego. We are currently opening up and conducting site visits for corporate events, targeting industries such as finance, automotive, luxury apparel, and pharmaceuticals, as well as social events like weddings for the end of the year. As we approach the fourth quarter, the booking window is just starting to open now. Our opening date will not hinder our chances for a successful fourth quarter and the first quarter of next year. We expect our occupancy rates to be in the 30s and 40s percent in May and June, increasing to around 70% in November and December. The market rate during the summer is between $300 and $400 per night, while in the fourth quarter, it will be around $600 to $800 per night. We are well-positioned to capture that business and optimize our hotel revenue for the fourth quarter. Most of the site visits happening now are focused on securing bookings for the third and fourth quarters, and a bit into the first quarter. Thank you, everyone. We look forward to meeting with many of you at upcoming conferences. And for those that were able to see the Andaz during construction, we look forward to having everyone back and being able to tour the resort and see the finished product. Thank you.

Operator, Operator

This concludes today's conference call. Thank you for your participation. You may now disconnect.