RLJ Lodging Trust: Recession Fears Bring Dividend Recovery Into Question (NYSE:RLJ)

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Steady Business But Slowdown On The Horizon

When I last covered RLJ Lodging Trust (NYSE:RLJ) in May, the hotel REIT had just started to see travel recover with occupancy rates at 90% of 2019 levels. This was after a slower than normal first quarter impacted by a covid wave in January. On that basis, I expected RLJ to raise the common dividend back to the $0.33 quarterly payout that it had before 2020. Since then, occupancy has stayed around 90% of 2019. Leisure travel and group business has been strong while business travel has not made a full recovery.

RLJ Occupancy

RLJ Lodging Trust

Average daily rates have recovered beyond 2019 levels, keeping up with inflation. As a result, revenue per available room (RevPAR) was back to 96% of 2019 levels in October. In their November presentation at the NAREIT Conference, the REIT noted that they trimmed about $20 million of operating costs since the pandemic and also completed upgrades to several hotels which will enhance revenue by $26 million annually. After a few years of selling properties after the FelCor merger, RLJ has been back in acquisition mode, buying 4 properties in the last couple years, adding another $14 million annual EBITDA. The REIT is basically back to pre-pandemic earning power.

RLJ Growth since 2019

RLJ Lodging Trust

Unfortunately, macro conditions for 2023 are expected to decline. The impact of a recession on the hotel business in the past has been as much as a 10% decline in occupancy in 2009 compared to normal as I showed in a chart in my article from one year ago. Industry analysts are not predicting anything so severe in 2023 as we see in this US industry-wide forecast from PwC:

Revised 2023 outlook

  • Demand recovery slows, as economic pressures affect most segments, resulting in occupancy of 63.6%
  • Growth in ADR moderates in line with demand pressure, and as the Fed begins to gain control over inflation, PwC expects it to be up 4.5% from 2022.
  • As a result, RevPAR experiences moderating, but still above inflationary growth, increasing 5.8%.

The 63.6% occupancy is actually an improvement from 62.8% in 2022. The current year was still weighed down by a weak 1Q due to a covid wave. The 2023 forecast does reflect a decline in occupancy of about 2 percentage points compared to the last 9 months of 2022.

RLJ occupancy has been around 7 percentage points higher than the industry average. This is driven by high concentration in urban areas and sunbelt cities with good weather year-round. The REIT also has over half its portfolio in the Urban Lifestyle and Resort categories, which attract travelers in the still-strong leisure segment.

RLJ Portfolio

RLJ Lodging Trust

RLJ has maintained a strong balance sheet with $488 million in cash and no debt due until 2024. This conservative financial management got the REIT through the pandemic. Unfortunately, it is possible that this conservatism could now lead RLJ to limit increases on its common dividend given the potentially slowing economy. They did just increase it to $0.05 following a pandemic-era quarterly dividend of $0.01, but far below the pre-pandemic $0.33 per quarter. My forecast for 2022 adjusted funds from operations (AFFO) has actually improved slightly since my last article and still looks to grow in 2023. The AFFO is high enough to cover a $0.33 dividend, but I now expect the payout to be less than that in the near term.

Financial Model

Starting from Q3 results, I show a seasonal decline in occupancy to 70% in Q4, even though October actuals came in strong at 75%. For 2023, occupancy averages 70.6%, 90 basis points above the full year 2022 average but 1.9 percentage points below the Q2-Q4 post-recovery average. Average daily rate in 4Q is estimated at $195, in line with October actuals. For 2023, I assume the 4.5% growth from the 2022 full year average, which gets the rate to $197.23, just slightly above 4Q 2022 rates. The resulting RevPAR for 2023 is $139.18, in line with the industry forecast of 5.8% growth from the 2022 average.

I estimate food and beverage revenue will be about 11.5% of room revenue, an improvement from the 10% in my last article. On the expense side, I show room expenses at 26% of revenues, 1 point higher than pre-2020, and food and beverage expense at 78% of revenues. Other revenues and expenses are assumed flat with 3Q 2022.

RLJ approved a buyback program of $250 million on 4/29/2022. Since then, they bought back 4.9 million shares for $57 million. I show $21 million per quarter spent on buybacks from 4Q 2022 through the end of 2023.

My resulting 4Q 2022 AFFO estimate is in line with 3Q actuals at $0.40 per share. This brings full year 2022 AFFO to $1.44 per share. For 2023, AFFO grows to $1.68.

RLJ Earnings Model

Author Spreadsheet

After the big improvement between 1Q and 2Q that I noted in my last article, AFFO has stayed at $0.40 and will only increase a couple pennies from there in 2023. This makes me less optimistic that RLJ can get back to its pre-2020 quarterly payout of $0.33 per share. While this would be covered by forecasted AFFO, I believe the REIT will want to remain conservative given the economic outlook in 2023 in case things turn even worse. The lower dividend would also help RLJ have more cash available in case properties come on the market at attractive prices from a distressed seller.

I now expect that for 4Q 2022, RLJ will pay out about $0.10 in dividends, which equals my GAAP income estimate of $0.17 minus the $0.07 they already paid this year. For 2023, I now expect $0.21 per quarter, which would be a payout ratio of 50% based on AFFO. The REIT kept payout ratio in this range prior to the FelCor merger. This takes my dividend forecast just under where it was two articles ago in December 2021. At the current share price of $12.19, the common would yield 6.9%.

Preferreds Have A Safe Higher Yield

The preferred (NYSE:RLJ.PA) was inherited from the FelCor merger and is convertible but far out of the money and is not callable. The quarterly dividend is $0.4875 for a 7.7% yield based on the recent price of $25.24. The preferreds are currently RLJ’s highest cost of capital, but they cannot retire them except by buying them back in the open market from those willing to sell.

As we see on the earnings model above, the preferred dividends are well covered 3 times by net income in 2023, an improvement from 2 times coverage in 2022. The preferred share price has been on the rise since long term interest rates began declining at the end of October. In the past, the preferreds have traded in the $28 area when the 10-year treasury was in the 2%-2.5% range.

Conclusion

RLJ Lodging Trust has recovered from the pandemic with occupancy steady around 90% of 2019 levels. The REIT is benefitting from higher room rates driven by inflation as well as remodeling and acquisitions of higher-rate hotels in the last couple years. RLJ has also gotten more efficient and trimmed its operating costs as a percentage of revenue.

A macroeconomic slowdown could be coming in 2023 which would reverse some of these gains. Still, the latest industry forecast suggests a year-on-year RevPAR gain in 2023, largely because of the comparison to a covid-impacted 1Q 2022. RLJ could also hold up better due to its concentration in urban areas in the southern US drawing more affluent leisure travelers.

Nevertheless, the cloudy economic outlook could cause RLJ’s conservative management to limit dividend increases in 2023. This could happen even though my AFFO estimate indicates they could afford to go back to pre-2020 levels.

Based on these conditions, I now rerate the common stock back down to Hold. The preferred shares are still a buy, since the yield is higher than what I am projecting for the common. Declining long term interest rates would also provide upside for the preferred share price.

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