REIT HST Valuation


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HST\'s valuation

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  • Host Hotels and Resorts is a real estate investment trust specialized in hotels. HST has a market capitalization of $ 2.83 billion.
  • HST is the leading real estate company specialized in hotels. It owns 119 luxury full service hotels managed by strong brands such as Marriott (75%), Ritz-Carlton, Swissotel, Hyatt, Westin, Fairmont and Four Seasons. 61% of the revenues stem from the rooms, 30% from the food and beverage revenue and 9% from some services such as parking, golf course, spa, telephone… The hotels are mainly located in major US urban cities.
  • As a REIT, HST has to distribute at least 90% of its taxable income, their strategy is therefore to maximize their shareholder value by acquiring luxury hotels located in prime locations with barriers to entry. The also create value through aggressive asset management, especially during a crisis. They want to expand their leadership in the US and in top markets to take advantage of a greater geographic diversification and a greater scale. Finally, they own a lot of cash and are not too leveraged in order to stay flexible and seize future opportunities.
  • Concerning the management, they are all really experienced. The organizational structure enhances flexibility. Therefore, their expertise in lodging real estate, knowledge of real estate cycles and crisis as well as the flexibility in the company are main assets to weather the current storm.
  • Their main competitor is Lasalle Hotel Properties which is growing faster but HST remain the leader from far! Just have a look the market capitalization, revenues and assets to understand the scale difference. They have also a similar strategy of investing in major urban cities but HST is enjoying its size to diversify its portfolio and to invest in Europe and in Asia. HST has more general expenses disclosed a lower operating profit margin of 26% vs 33%. But its assets generate more revenues therefore its capital efficiency and return on assets are both much higher. LHO was growing at an annual rate of 30% between 2002 and 2007 while HST was growing at an 8% annual growth rate. It mainly stems from the difference of size and the desire for HST to optimize its capital allocation by rigorously choosing its investment opportunities. Last quarter, despite a similar liabilities/ assets ratio of 0.54, the current ratio of HST was 4.9 while the current ratio of LHO reached 0.8. This implies that HST is in a better position to weather the gloomy economic situation.
  • As you can see in the chart, HST is enjoying a high profitability despite a substantial volatility which stems from real estate cycles. The after tax operating margin stand at 16% while the ROIC is 8%. The recent results and forecast show that HST is in a challenging gloomy economic situation and a defavorable lodging real estate cycle. Because of the leading position in lodging real estate, its prime location luxury hotels in constrained major urban cities, the investments in Asia and in Europe, and the competitive advantages of HST (barrier to competition, experience curve, economies of scale), The adjusted ROIC should not sharply decline during the gloomy economic period.
  • HST has also a low financial risk thanks to its low leverage. Indeed its long term debt equity ratio amounts to 107% and its long term debt matures mainly after 2012. HST solvability is also really good thanks to the levels of its current, its important amount of cash and its significant operating cash flows. With low financial risks and important flexibility, HST is in a good position to weather the storm and to invest.
  • However, I have some concerns about the potential decrease in hotels value and the credit crunch. Indeed, REIT depends heavily on debt and on the value of their assets. HST is in a challenging economic situation and given the volatility of its profits, the stock price is really volatile. Hence the Merton model gives us a default probability of 8% within 6 months and its rating by Standard and Poor’s is only BB.   But finally, HST has a modest financial risk profile, is focused on prime location in constrained markets and is diversifying its portfolio. Finally, its cash flows statement is really good.
  • Here you can see that the operating cash flows and free cash flows are continuously increasing since 1998.
  • The quarterly cash flows are also good, the company is still investing (renovation), got an important financing before the worst period of the financial crisis. Their operating and free cash flows remain steady.
  • The average annual total return to shareholders is low with 2%. As you can see, with the real estate crisis, it has dramatically decreased since 2007. After the decline of 24% and 2% in 2001 and 2002, the annual TRS went around 40% two years in a row. The stock price has been strongly bitten and we can expect a rebound soon. Indeed, even if the operational environment will be still challenging, markets anticipate rebounds.
  • HST has clearly outperformed the SPY during Hotel real estate booming and significantly underperfomed during real estate crisis. The recent poor performance can be explained by the current real estate crisis. However, in case of a rebound, HST is expected to strongly outperform SPY.
  • it has also a greater annual volatility with an average of 35% (vs 19% for SPY). Like almost all the stocks, its volatility skyrocketed during the recent months because of the financial crisis. I do believe that this volatility will decline in the next weeks.
  • To valuate the company, I used the three stages model. The first stage is based on a recession scenario with high cost of capital and lower return on invested capital. The second stage is based upon a successful execution of HST with an expansion in Europe and in Asia. Finally the third stage is based on an average return on invested capital and cost of capital with a low growth. With that model, I found that the stock price is undervalued by 51%.
  • I also did a Valuation under a stress case. For that I decreased the return on invested capital, the revenues and the capital efficiency. I also made increase the cost of capital during the first and third stages. In so doing, the stock price is still undervalued by 1%.
  • Given the undervalued price, the leading position, the good profitability and the healthy financial condition of HST, I recommend to buy shares of HST   With the latest stock price, HST is even more undervalued
  • REIT HST Valuation

    1. 1. Real Estate Investment Trust specialized in hotels (1993) $2.83 B of market capitalization 02/16/2009
    2. 2. Profile Leader in the lodging real estate sector 119 luxury and full service hotels managed by strong brands (Marriott)
    3. 3. Strategy <ul><li>Maximize shareholder value by acquiring assets </li></ul><ul><ul><li>high quality </li></ul></ul><ul><ul><li>in prime locations </li></ul></ul><ul><ul><li>with significant barriers to entry </li></ul></ul><ul><li>Create value through aggressive asset management </li></ul><ul><li>Expand their leadership to take advantage: </li></ul><ul><ul><li>greater scale </li></ul></ul><ul><ul><li>geographic diversification in top markets (Europe, Asia) </li></ul></ul><ul><li>Be flexible: cash and not too leveraged </li></ul>3
    4. 4. Management <ul><li>Simple organizational structure => flexibility </li></ul><ul><li>Experienced and promoted from within </li></ul><ul><ul><li>expertise in the lodging real estate. </li></ul></ul><ul><ul><li>knowledge of real estate cycles and crisis </li></ul></ul>
    5. 5. Competitors <ul><li>Main direct competitor: Lasalle Hotel Properties. </li></ul><ul><li>Unquestionable Leader (market capitalization, revenues, assets…) </li></ul><ul><li>Higher capital efficiency and return on assets </li></ul><ul><li>Lower growth (rationalization) </li></ul><ul><li>Lower operating profit margin </li></ul>4
    6. 6. Profitability <ul><li>After tax operating profit margin= 16% </li></ul><ul><li>ROIC= 8% </li></ul>5 <ul><li>Good profitability </li></ul><ul><li>Real estate cycles </li></ul>
    7. 7. Financial condition <ul><li>LT Debt/ Equity = 1.07 </li></ul><ul><li>Debt maturing 78% in 2012 and after. </li></ul><ul><li>Current ratio= 4.9 </li></ul><ul><li>Important amount of cash (4.7% of assets) </li></ul><ul><li>Increasing operating cash flow= $1.050 billion </li></ul><ul><li>Increasing free cash flows= $741 million </li></ul><ul><li>Low financial risks, flexibility and options </li></ul>6
    8. 8. Risks <ul><li>Future decrease in hotels value </li></ul><ul><li>Lasalle Hotel Properties </li></ul><ul><li>Credit crunch </li></ul><ul><li>Volatility of profit and profitability </li></ul><ul><li>Stock price volatility => 8.55% of Default within 6 months (Merton model). </li></ul><ul><li>S&P BB rating. </li></ul><ul><li>Modest financial risk profile </li></ul><ul><li>Focus on prime location in constrained markets </li></ul><ul><li>Diversification </li></ul><ul><li>Good cash flow statement </li></ul>7
    9. 9. Historical Cash Flows
    10. 10. Quarterly Cash Flows
    11. 11. Historical TRS & Volatility
    12. 12. Cumulative log return
    13. 13. Volatility 8
    14. 14. Valuation (base case) V= 0.87
    15. 15. Valuation (stress case) <ul><li>Decrease of ROIC from 4% to 3% during phase 1 and from 12% to 11% in stage 2. </li></ul><ul><li>Decrease of sales growth from -10% to -12% in phase 1, from 8% to 7% in phase 2 and from 6% to 5% in phase 3 </li></ul><ul><li>Decrease of capital efficiency by 50 basis points in stage 1 and 3 as well as 20 basis points in stage 2. </li></ul><ul><li>Increase of cost of capital from 14% to 15% in stage 1 and from 10% to 11% in stage 3 </li></ul><ul><li>Price= $4.89 </li></ul><ul><li>Undervalued by 1%. </li></ul>9
    16. 16. Recommandation <ul><li>Buy shares to take advantage of the: </li></ul><ul><ul><li>undervalued stock, </li></ul></ul><ul><ul><li>future economic recovery </li></ul></ul><ul><ul><li>leading position in lodging real estate </li></ul></ul><ul><ul><li>good financial condition. </li></ul></ul>10