Owning hotels is a tough business even in the good times, since the effective lease length of a room is a single day. However, Apple Hospitality (NYSE: APLE) believes it has a business model that sets it apart from the pack. Here's a quick look at that model, and what it has done for the real estate investment trust (REIT) and investors in the face of COVID-19.
Apple Hospitality owns 230 hotels containing nearly 30,000 guest rooms. The real estate investment trust's portfolio spans across 34 states and nearly 90 submarkets. The hotels it owns are operated under 12 different banners, including key Marriott and Hilton nameplates, and run by third parties not directly controlled by those brands. Its properties tend to be higher-end fare meant to provide a place to sleep, not a vacation experience like a resort. The average age of the company's portfolio is roughly four years, with 97% of its properties either built or renovated in the last eight years.
That's a lot of facts, but the important takeaway is that it adds up to a very specific approach. Just like diversification is good for your portfolio, Apple Hospitality believes that owning a lot of properties in a lot of different markets limits the hit from any one submarket. It aligns itself with top brands and top operators to ensure that it's teaming with the best in the business. A portfolio filled with fresh properties helps ensure that its facilities are attractive to its lessees, brands, and the end customer. And by focusing on hotels meant primarily for sleeping, Apple Hospitality avoids the extra costs and complexity of dealing with resort-type assets.
In many ways this is an attractive story for investors interested in the hotel space. However, none of it changes the highly cyclical nature of the hotel business. When economic times are good, people travel for business and leisure; when times are bad, they travel much less. The problem is that hotels have a lease length of one day, and all it takes to cancel a future hotel stay, with minimal to no financial impact to the customer, is a phone call. Thus, hotels very quickly feel the hit when demand drops off.
And then there was a global pandemic
This is an important factor to consider when looking at Apple Hospitality, or any other hotel REIT, since the United States fell into a recession in February. This downturn is different, because it has been driven by the global spread of COVID-19. In a normal recession, hotels would simply operate as usual as they tried to muddle through the downturn with temporarily depressed occupancy rates. When the economy picked up again, so would occupancy and financial results.
It is far from clear what the long-term impact of the coronavirus will be. The near-term impact, however, has been extremely painful. For example, Apple Hospitality's occupancy rate was 77% in 2019. As COVID-19 spread it quickly started to drop off, as you would expect based on the hotel model. In February occupancy was 76%, in March it fell to 41%, and in April it dropped to a disastrous 18%. Apple Hospitality quickly went into capital-preservation mode, working with tenants to reduce costs as it focused on fortifying its balance sheet. Key steps included reducing capital spending and suspending the dividend. These are the right moves to survive a crisis.
The problem today is that no one knows how long this demand weakness will last. Toward the end of June, the occupancy rate had recovered to nearly 45%, which is a good sign. However, that's not enough for the company to operate at anywhere near the financial levels it did before COVID-19. And since the illness is easily spread, there's a big question mark about how quickly people will return to travel even if the economy picks up again on a sustained basis. Note the disastrous impact that the coronavirus has had on the airline industry. If travel doesn't pick up, Apple Hospitality is unlikely to see its business return to normal anytime soon. Investors need to brace for a prolonged period of pain that could decouple its business from the ups and downs of the broader economy.
Notably, the company has been working with lenders to adjust its debt covenants. The main goal is to provide it with more breathing room on the liquidity front so it can manage through this severe and unusual downturn. Again, this is the right move, but it is a very troubling sign from an investment perspective.
Is it a buy?
Right now it is hard to suggest that investors should be jumping aboard Apple Hospitality stock. That's not because it is a bad company -- in fact, the core business model is fairly attractive as far as hotels go. But right now the REIT is facing an unprecedented headwind in COVID-19, and its business approach, like that of every other hotel owner, isn't holding up to the strain.
More aggressive types might reconsider the stock if there's substantial progress made containing the coronavirus, but most investors would be better off waiting for more material signs of a business turnaround at Apple Hospitality before investing here.
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