Description

NOTE: We could not get the pictures from the company's presentation to paste into this document, so we've provided the below link to download the formatted PDF from Google Docs.

https://drive.google.com/file/d/0B4hSfOmlwIkybnNibmI1RC1hOHM/view?usp=sharing

Summary

We look at XHR as a 75/80 cent dollar rather than the 50 cent we hope to find. That being said we think the downside is relatively protected with a 4% yield / 46% pay-out ratio and the valuation is not demanding on an absolute basis (roughly 9% FFO/MC). On a relative basis XHR is underpriced to its comps (which are priced between 6%-8% FFO/MC). We believe XHR offers ~25% upside over the next few quarters with minimal risk of permanent capital loss.

Company

Spin-off

Xenia Hotel and Resorts (XHR) came public on February 4, 2015 as a result of a spin-off from Inland American Real Estate Investment Trust, a private REIT. Inland America was formed in 2004 and results since inception have been poor. The private REIT also faced multiple investigations from the SEC and state regulators.

The spin-off was marketed as a liquidity event for Inland American shareholders and a way to maximize value/access public markets. Concurrent with the spin, the Company launched a tender for up to 5% of the common shares outstanding with a range of $19-$21/share. The result of the tender was released on March 9, 2015 with only 1.6% of the company’s total shares tendered (out of 5% max) at $21, the top of the range. That only 1.6% was offered is interesting given the history of the REIT and the spin-off being a taxable event for its holders. Given that the shares were trading at the high end of the tender price it is possible people held off and just utilized the public markets rather than a tender to get their shares off. Even still the volume post spin has not been massive vs the roughly 112M share count.

XHR assets and performance

XHR is also a REIT and owns 46 hotel properties under a variety of flags including the following:

Here is another breakdown. Marriot, Hilton and Hyatt represent the majority:

Management touts its upscale/upper upscale presence but it’s worth looking at average daily rate (ADR) and revenue per available room (RevPar) to get a feel for what they can charge and their occupancy versus their peers. Here is a breakdown of ADR, occupancy and RevPar vs. their peers (these are not all perfect peers but represent the publically traded hotel REITs):

As we can see, XHR’s ADR is about 12% off the peer average and occupancy is slightly worse than average but not bad.

The Company purchased 22 hotels (6,572 rooms) since 2012 for a total cost of $1.68B. These newer hotels have increased RevPar which pretty dramatically changes the break-even rate. Here is a chart of the RevPar since the 2012-present acquisitions started.

Combined with the overall favorable hotel industry tailwinds and better properties, the Company has been able to bring up their ADR, occupancy and RevPar significantly since 2011. Number of rooms have doubled, ADR went up roughly 1/5 and Revpar was up roughly 1/3 due to increased ADR and occupancy rates.  That being said, we are not going to pretend these prices/room and breakeven rates are cheap.

Hotel industry

We went through each publically traded hotel REIT and they are all telling basically the same story. For at least two more years, demand should increase more than the increase in supply on the market. The typical research figures estimate around 3% annual demand growth vs. 2% supply growth…so it is not a massive gap. 

Given the lead times for new development it is hard to imagine everyone has the supply side of the equation wrong. Certainly the demand side could under-perform but we see no reason or significant likelihood of a quick and material drop.

With demand outstripping supply, occupancy should tick up and potentially allow the average daily rate (ADR) to increase. Either of these or the combination should allow revenue per available room (RevPar) to increase. This is reflected in every single publically traded REITs expectations for RevPar in 2015. Here are the figures:

We will provide additional detail around the comps below, but basically every company expects RevPar growth around 5%-7%. XHR is right in the middle. Depending on your inclinations, this is either a positive in that the industry as a whole has got it right and things should continue on nicely for the next couple of years or a negative in that when everyone thinks things are rosy bad things typically happen. We are in the middle camp of expecting the business to continue along okay but doubtful that all is wonderful. 

The Texas Question

We figure we’ll address the issue of Texas and its potential issues with the decline in oil prices here. The Company provides a simple map here that outlines its hotels by state.

There are seven hotels in Texas mostly concentrated around Dallas and Houston. This is out of 46 properties so to the extent there is a significant hit to Texas and a corresponding hit to hotel prices in these markets, it should not be earth shattering for XHR.

Management

We will focus mainly on the CEO in this discussion. Marcel Verbaas is the CEO of XHR and has been with the Company since 2007. Mr. Verbaas was previously the CIO for CNL Hotel and Resorts which was sold, arguably at the top of the market in Apr07, to Morgan Stanley’s Real Estate group and Ashford Hospitality Trust (AHT). Morgan Stanley took the seven crown jewels (JW Phoenix, JW Orlando, Grand Wailea Maui, etc.) where AHT took the remainder (51 hotels). Morgan Stanley ended up writing off these hotels and turning them over to its creditors which included John Paulson and the Winthrop Realty Trust. AHT arguably fared better in the deal however alongside the rest of the hotel sector in the recession they were priced for BK as well with their stock dropping down to 60 cents in Mar09. Given that he was CIO, not CEO we are not certain how much credit he would deserve for pushing this deal through near the height of the market. Overall it’s probably not a negative though.

From the most recent Form 4, Mr. Verbaas has a beneficial interest (granted not purchased) of 74K shares. These shares are worth roughly $1.6M currently vs a salary of roughly $550K. We would prefer to see more skin in the game, especially purchased equity.

The operating results over the last 4 years or so seem to be in line with the industry although nothing especially amazing pops off the chart at us. Likely the real mettle of the management team will be tested in the next down-turn / if they start to liquidate at all prior to that next downturn.

Valuation

Post tender, the company’s valuation is roughly as follows:

The Company expects to generate $285M in adjusted EBITDA and $222M in adjusted FFO (both midpoints). This puts the valuation of XHR at 12.8x EV/EBITDA and 8.84% FFO/NC. This is versus a peer group average of 14x EV/EBITDA and 7% FFO/MC.

Here is the detail of the Company’s peer group on these same metrics. XHRs closest comps in terms of debt profile and operating metrics (RevPar, ADR) are RLJ and SHO. Their average FFO/MC is roughly 7.8%.

Here is a quick matrix of XHRs 2015 valuation plus a year’s worth of dividends under the following scenarios:

Conclusion: XHR has a portfolio of high quality hotel assets and is trading at a discount to its peer group. The discount isn’t due to operational issues or poor management, but instead likely a result of this being a new spinoff, undiscovered by most market participants, no sell side coverage, and numbers not picked up in conventional databases such as Factset yet, etc. As the company gets a few quarterly reports under its belt and begins to get discovered by the Street, we expect the stock to trade up in line with its peer group in relatively short order. Even in a bearish scenario of 12% cap rates for these high quality properties, the downside is not all that great, and therefore we view the risk of permanent capital loss as low.

Disclaimer: This research report expresses our research opinions, which we have based upon certain facts, all of which are based upon publicly available information. Any investment involves substantial risks, including complete loss of capital. Any forecasts or estimates are for illustrative purpose only and should not be taken as limitations of the maximum possible loss or gain. Any information contained in this report may include forward-looking statements, expectations, and projections. You should assume these types of statements, expectations, and projections may turn out to be incorrect. This is not investment advice nor should it be construed as such. You should do your own research and due diligence before making any investment decision with respect to securities covered herein. The author and his clients have a position in this stock and may add, reduce or sell out of the position completely without informing readers.

Catalyst

• Quarterly reports that allow databases to pick up numbers so it shows up on screens
• Initiation of sell-side coverage