Park Hotels: Real estate investment trust with growth potential of 55.4%

Why do we like Park Hotels & Resorts Inc.?

Reason 1. Recovery of the hospitality industry

The Covid-19 pandemic and related restrictions on cross-border and local travel have dealt a devastating blow to the hospitality industry. However, pent-up demand and low-base effects have provided hotel companies with a recovery momentum that allows them to weather the current headwinds of tighter monetary policy and consumer spending compression relatively unscathed.

According to the US Transportation Security Administration, the number of travellers crossing the country's borders daily in autumn 2022 was 195.98 million, up 18% from a year earlier, but still 5.7% below the comparable period in 2019. Air passenger traffic also continues to grow steadily and in October narrowed the gap from 2019 to 5%.

Number of travellers crossing US borders; source: compiled by the author

About half of Park Hotels' EBITDA comes from three regions: Hawaii, San Francisco and Orlando, which are experiencing a steady recovery. In Hawaii, for example, passenger traffic in November 2022 was 827,670, up 15.6% from a year earlier, but still 5.2% lower than in pre-dawn 2019. The number of passengers at Orlando International Airport has increased by 49.3% in the past 12 months and at San Francisco Airport by 55.3%.

These trends have already had an impact on the performance of the hospitality industry. According to STR data, Revenue Per Available Room (RevPAR) at US hotels rose 14% on 2019 levels to $104.59 and Average Daily Rate (ADR) rose 16.8% to $155.63.

Main indicators of the hospitality industry; source: compiled by the author

However, the occupancy rate is still 2.4% lower than the pre-pandemic 2019 rate of 67.2%. In Hawaii, the figure reached 77.4% in Q3 2022 compared to 82.6% in 2019. In San Francisco, occupancy is 19% below pre-pandemic levels. Orlando has become one of the few "successful" cities, there the rate increased by 1.9% for 2019 to 73.6%.

In our view, the current hospitality market environment is providing companies with a significant tailwind. When occupancy returns to 2019 levels, overall hotel company performance will exceed pre-pandemic levels, as RevPAR and ADR are already higher than in 2019 and PwC forecasts that they will continue to grow in 2023.

Reason 2. Deleveraging as a growth driver

While the Nuveen Short-Term REIT ETF, which has wide exposure to hotel property trusts, has recovered most of its value, Park Hotels is still trading well below sub-annuity levels and at a significant discount to net asset value.

Thus, unlike most industry players, the company can provide its clients with comprehensive solutions that consider their needs at all stages and allow TELUS to consider changing trends as the firm evolves. The ability to provide complex solutions makes the company attractive to large enterprises that prefer to deal with a single supplier capable of offering a "package deal" and ensuring business continuity. As such, TELUS has a significant advantage over its competitors.

PK and Nuveen Short-Term REIT ETF dynamics; source: TradingView

The discount is due to Park Hotels' high debt burden. Investors are concerned about potential dilution of shareholder shares to meet creditors' demands. As of end-September, the company had total debt of $4.67 billion and net debt of $3.67 billion. In our view, high financial leverage should not be a problem for Park Hotels. Moreover, we expect the deleveraging and rebalancing of the balance sheet to increase the company's stock price.

First, the current cash balance is sufficient to cover all debt maturities up to and including 2024. If the company extends its credit line by $900 million until 2027, according to management's plans, it will be able to cover its 2025 obligations as well.

Debt maturity of Park Hotels; source: Company Presentation

Second, Park Hotels has suspended its dividend policy for 2020 and the current payouts are insignificant and more of a symbolic nature. The company is showing positive and growing cash flow, which will allow it to service its liabilities. It is worth noting that 98% of the firm's liabilities have a fixed rate of 5.04%, which minimises the impact of monetary policy on financial stability.

Third, the net worth of the company's properties (net of accumulated depreciation) is $8.29 billion. Net debt accounts for only 44.3% of net real estate value. It is worth noting that, under GAAP, Park Hotels depreciates properties using standard methods, while their market value increases over time. The gross value of the properties (excluding accumulated depreciation) is $10.95 billion, which is more in line with market values. Thus, net debt represents only 33.5% of the value of the property portfolio.

Reason 3. Buyback

Further supporting our view of Park Hotels' resilience is the fact that the company has repurchased $218 million worth of shares in the last nine months, thus realising the majority of the $300 million buyback programme approved in February.

Some investors would prefer to see a bond buyback. However, the company's weighted average cost of debt is significantly lower than its cost of equity, and given that Park Hotels trades at a discount to book value, a buyback at current prices has a high internal rate of return.

Financial indicators

Against the backdrop of a recovery in the hospitality industry, Park Hotels is showing steady improvement in operational and financial metrics. However, a number of metrics still remain significantly below pre-pandemic levels, providing the company with the potential for further recovery growth. The nine months of 2022 versus the comparable period in 2019 are shown below:

• RevPAR: $154.21 versus $178.73.
• Occupancy: 64.8% vs. 80.5%.
• ADR: $238.16 vs $221.89

The company's results for the past 12 months can be summarised as follows

• TTM revenue was $2.29 billion, a 67.9% increase on the 2021 results.
• Adjusted EBITDA increased from $142 million to $528 million. Adj. EBITDA margin increased from 10.43% to 23.09%.
• Net profit was $66 million compared to -$459 million at the end of the year. Net margin rose from -33.70% to 2.89%.

The financial results for Q3 2022 are as follows

• Revenue rose 56.5% year on year, from $423 million to $662 million.
• Adjusted EBITDA increased from $77 million to $158 million Adj. EBITDA margin increased from 18.20% to 23.87%.
• Net profit was $35 million compared to -$86 million a year earlier. Net margin increased from -20.33% to 5.29%.

Net income is not a fully representative measure of the performance of real estate investment trusts. GAAP/IFRS standards require all REITs to depreciate their properties over time using one of the standard depreciation methods, while the value of many investment properties increases over time. Funds From Operations (FFO) compensates for cost accounting methods that may not accurately reflect the true performance of a REIT.

At the end of the latest reporting period, TTM FFO was $261 million, compared with -$136 million at the end of the year.

As noted earlier, Park Hotels has a relatively high debt load. However, in our view, the high financial leverage should not be a problem for the company. Its total debt is $4.67 billion, cash equivalents and short-term investments account for $1 billion and net debt is $3.67 billion, which is 6.95x TTM Adj. EBITDA (Net debt/EBITDA — 6.95x). The interest expense coverage ratio is 2.13x.

Evaluation

Park Hotels trades at a discount to the industry average: EV/Sales — 2.84x, EV/EBITDA — 13.53x, P/FFO — 8.44x, P/B — 0.65x. In addition, the company has a better FFO yield than its peers: FFO yield of 11.8%.

The minimum price target from investment banks set by SMBC Nikko is $12 per share. Compass Point, on the other hand, values PK at $25 per share. According to the consensus, the fair market value of the stock is $18.50 per share, which implies a 46.5% upside potential.

Key risks

• A number of US cities are experiencing another spike in the incidence of Covid-19. Although we consider the likelihood of any restrictions to be extremely low, it is worth considering this risk when making investment decisions.
• The high debt burden makes Park Hotels more susceptible to external shocks. Whether it is the imposition of restrictions or reduced demand due to macroeconomic uncertainty, the company will find it much harder to get through tough times than its less indebted competitors.