I’m An Enthusiastic Shareholder In Park Hotels & Resorts

The typical Lodging REIT tends to have a market capitalization of anywhere from $1 billion to $2 billion and prior to the formation of Park Hotels & Resorts (PK), if you were a large-cap investor who needed liquidity, there was only one name in which you could invest, Host Hotels (HST).

Based in McLean, Virginia, Park was formed when Hilton Worldwide (NYSE:HLT) spun off most of its owned real estate into a separate public REIT. Park is the latest entrant into a sector long dominated by Host, which still dwarfs all other stock exchange-listed hotel REITs in terms of size. Park is the second largest publicly traded Lodging REIT:

Park is among the Top 25 largest REITs out of 130 REITs based on TTM Adjusted EBITDA and Park ranks among the Top 25 Largest REITs in the US:

Park Hotels owns a $9 billion portfolio of 67 large-scale, high-end hotels, including iconic properties stretching from coast to coast. Its trophy properties include the New York Hilton, which spans an entire city block in Midtown Manhattan; the landmark, 1,544-room Hilton Chicago Downtown, boasting nearly 200,000 square feet of meeting space; and the oceanfront, 2,860-room Hilton Hawaiian Village in Honolulu.

There is strong potential in the 35,000-room portfolio of upper-upscale and luxury hotels, and Park Hotels through acquisitions of like properties in leading hotel and resort markets, already has holdings in 14 of the top 25 U.S. hotel markets.

Park is one-brand concentrated right now, but the company says it "seeks brand and operator diversity over time." This is similar to what happened in 1993, after Marriott International (NYSE:MAR) spun off what is now Host Hotels.

Conrad Hilton, founder of Hilton Hotels said, “enthusiasm is a vital element toward the individual success of every man or woman”.

I decided to use the word “enthusiasm” to describe my convictions for owning shares in Park Hotels & Resorts and to provide you with my Q2-17 research report and bullish report on the high-quality Lodging REIT.

Photo Source

A Diverse Portfolio Of High-Quality Hotels

The pictures below illustrate Park's diversified exposure to attractive markets:

Around 74% of Hotel EBITDA comes from coastal markets, and 91% of Hotel EBITDA is from Top 25 Markets and resort destinations:

While Park lacks diversified brand affiliations, the company mitigates the risk by owning such a diversified portfolio:

Its portfolio's strong group positioning increases visibility into forward bookings and reduces operating volatility by enhancing the stability and predictability of revenue throughout the lodging cycle.

Top 25 Hotels: Group/Transient Mix: 31% / 63%. Park's strategy will be to "Group Up" and drive that mix up another 400bp to 35% Group demand. The portfolio contains 26 properties with over 25,000 sq. ft. of meeting space and 6 properties with over 125,000 sq. ft. of meeting space in top convention markets, generating robust corporate meeting and group business. Supply and demand trends favor large, group-oriented hotels for the foreseeable future.

Iconic Assets Valued at Well Below Replacement Cost

Park's assets are currently valued at a significant discount to replacement cost:

The REIT's focus is on building a portfolio of Upper Upscale and Luxury branded assets in Top 25 markets and premium resort destinations. It pursues larger-scale deals (assets and portfolios) that offer significant value-add opportunities.

The company seeks to diversify its brand (beyond Hilton) and operator mix to include other global manager / franchisors. Park will opportunistically recycle

capital, selling out of slower-growth, non-core assets and reinvest in higher-growth markets.

Less competition exists on larger transactions, as only a limited number of investors have access to the equity needed to pursue $250+ million single assets.

Consequently, the share of deals pre-empted and executed off-market increases in conjunction with deal size, thereby enhancing the price negotiation leverage for an eligible buyer. Park's balance sheet and operating platform are well positioned to execute these larger transactions.

The company intends to focus on owning hotels and resorts in the Luxury and Upper Upscale segments. Park focuses on recognizable products compared to independent hotels struggling to differentiate their offerings. Loyalty programs help to drive recurring sales, while lowering new customer acquisition costs. Hilton (~60 million members) and Marriott, including Starwood (NYSE:STWD) (~100 million members), have ~50% of sales stemming from customers within their loyalty programs.

Park has the ability to achieve increased direct-to-consumer sales, minimizing OTA / wholesale commissions and increasing revenue to the company. This means significantly lower distribution costs for the OTA business, given the negotiating power of brands.

Park can more effective compete against Airbnb (Private:AIRB), particularly with respect to frequent travelers, who appreciate the reliability and security of branded hotels.

Active Asset Management: Hands-on Approach

Hilton continues to manage the vast majority of Park's properties it spun off. Oversight of operations under Park creates a system of checks and balances that should eventually translate into higher profits.

Hilton, like most brand owners, doesn't have corporate oversight of property-level management to make sure they are maximizing profits for the owner.

Park is able to maximize each asset's full potential through a focused approach on revenue management and cost containment initiatives, while purposefully addressing capital needs, including ROI opportunities.

CapEx: Over $1.3 Billion Has Been Reinvested in Park's Hotels

Park has invested heavily to drive market share and ensure strong competitive positioning of its portfolio. The company continues to consistently renovate to adapt to evolving customer preferences and the latest technology.

Renovations have been focused on guestroom design, open and activated lobby areas, food and beverage and public spaces, and modernized meeting spaces. Park creates value through repositioning select hotels across brands or chain scale segments, and exploring adaptive reuse opportunities for highest and best use. (No major deferred maintenance.)

The Balance Sheet

Park is extremely well capitalized with $214 million of unconsolidated JV debt (pro rata). The company is targeting an investment grade leverage profile over time. It has a healthy fixed versus floating mix: 74% fixed / 26% floating.

Park has ample liquidity, with $183 million of unrestricted cash available as of 12/31/16 following the E&P dividend (cash portion of $110 million). In addition to cash, it has access to a $1 billion revolving credit facility, with minimal debt maturities.

There were no major changes to Park’s capital structure during Q2-17, with net leverage still running at just 3.8x and the company remains well- positioned from a liquidity standpoint with more than $1.2 billion available between the revolver

and available cash. Park is expected to refinance its largely CMBS debt to more traditional unsecured notes, as CMBS debt tends to be less flexible.

Buy Park And Don't Pass Go

Back in April 2017 I wrote on Park and I initiated a BUY recommendation. Since that time, shares have traded neutral:

Of course now Park has another quarter under its belt, and in Q2-17 the company announced adjusted EBITDA was $217 million, adjusted FFO was $173 million (or

$0.81 per share), both of which were slightly ahead of the company’s internal forecasts and consensus.

Portfolio performance was largely driven by continued strength across both Hawaii and Orlando; however, San Francisco proved to be materially worse than we expected, accounting for 190 basis points of RevPAR drag during the quarter.

Overall, across Park’s top 10 assets, hotel adjusted EBITDA fell 3.4% during the quarter, and margins were down 110 basis points, with 70 basis points of that decline related to the two assets in San Francisco. Excluding these two assets, EBITDA growth across the top 10 assets would've been 3.7%.

During the quarter, Park invested $49 million on capital improvements, nearly 80% of which was for guest-facing areas within the hotels, taking year-to-date CapEx spend to $86 million. More specifically, Park completed the third phase of guestroom renovations at the Hilton San Francisco, which included case goods, soft goods, and guest bathrooms for 389 rooms.

Park has elected to pull forward the final phase of rooms renovation at the hotel into Q4-17 from Q1-18 to better position the company with a fully renovated property for next year. Park expects approximately $700,000 of disruption in the fourth quarter, negatively impacting the hotels RevPAR by approximately 200 basis points for the quarter.

Net-net, Park’s impact to earnings is largely immaterial, the full year EBITDA guidance increases by $5 million at the low end of the range to $740 million, while the top end remains unchanged at $765 million.

With respect to FFO per share guidance, Park said it was increasing the range by just over 1% at the midpoint to $2.70 at the low end and $2.80 at the high end, with the bulk of that increase related to a change in the tax provision for the year.

Hawaii Excites Me

Park owns 2 hotels in Hawaii (4,104 Rooms) that generate ~23% of Hotel EBITDA.

Hilton Hawaiian Village is situated on a 22-acre ocean front property in Waikiki, the property has nearly 3,000 rooms spread across six towers. Occupancy runs a portfolio high of 94.6%, while margins run an impressive 37%. In 2016, the hotel won a Certificate of Excellence from TripAdvisor. Other notable facts: Over the last 5 years, 1,600 rooms have been renovated at a cost of $44mn, or $28,000 per room and over the last two years, invested $10mn renovating 100,000 sq. ft. of meeting space.

Hilton Waikoloa Village is a 62-acre oceanfront Waikoloa Beach Resort hotel on the sunny Kohala Coast of Hawaii and is home to 1,244 rooms and two championship golf courses. RevPAR growth was an impressive 14% in 2016 driven by strong in-house group demand including a resort buyout. Over the next 2.5 years, Park will transfer 600 rooms to Hilton Grand Vacations —Ocean Tower, shrinking its footprint, and ultimately making the hotel more efficient to operate. Over the last 5 years, 643 rooms have been renovated at a cost of $34mn, or $53,000 per room.

One of these days (very soon) I need to travel to Hawaii for a property inspection!

I’m Most Enthusiastic About This…

Park trades below the sector average FFO multiple of 10.3x, based on 2017 estimates (its peers include HST, Pebblebrook Hotel Trust (NYSE:PEB), and LaSalle Hotel Properties (NYSE:LHO)).

Here's a snapshot of Park's dividend yield compared with that of the peer group:

As you can see, it has an attractive dividend yield and also a modest AFFO payout ratio. Assuming a 65% to 70% FFO payout ratio and the mid-point of FFO guidance for 2017, the potential yield is 150bps above the Lodging REIT peers.

Park has the highest FFO growth forecasted, as illustrated below:

Park enjoys a size advantage (in the Lodging sector), as the company is able to enhance price negotiations by flexing its size and financial muscle. Its balance sheet and operating platform are well positioned to execute these larger transactions, and the company should be able to benefit from the continued consolidation within the lodging sector. Here’s a snapshot of the FFO/share forecaster:

Trimming PEB and increasing exposure in PK: I am maintaining my BUY recommendation on PEB and PK; however, I am trimming shares in PEB so that I can redeploy capital into PK. From a valuation lens, I consider PK the better buy today, and I believe that shares (in PK) will out-perform the peers over the next 12 months. Now you can recognize why I’m so enthusiastic to be a shareholder in Park Hotels & Resorts.