REIT Park Hotels & Resorts (NYSE:PK) is schizophrenic – some of their resorts are doing very well, but some of their urban hotels face a bleak future. These former “trophy” urban hotels in San Francisco and New York are worth a fraction of their value from a few years ago. The current dividend yield of 5.3% (not including the expected special dividend of $0.75) is not competitive to other alternative investments, such as U.S. treasury notes. Mostly because of the problems facing their urban hotels I rate PK a “sell”.
Stock Repurchases are Irrational
Starting with what I consider a major negative for this REIT – share repurchases. I know some investors just love stock repurchases, but I am absolutely against them especially for a highly leveraged company. Park has a junk bond rating of “B” from S&P and has $3.765 billion in debt (after factoring out the $725 million San Francisco mortgage), but they repurchased $227 million worth of stock in 2022 and $105 million for the first six months of 2023. In my opinion, this is completely irrational and irresponsible. That cash should have been used to reduce debt.
In March 2022, for example, they repurchased 3,409,949 shares with an average price of $17.99 and in May 2022 they repurchased 8,542,542 shares with an average price of $18.33. This compares to the latest price of just under $12. The repurchase of almost nine million shares so far in 2023 was somewhat higher than the latest PK market price. All the 2023 repurchases were done in Q1 and they did not repurchase any shares under the February 2023 $300 million repurchase program, which still has $225 million left for future repurchases, in Q2. The reality is not only are there effective “losses” on these repurchases, but the repurchases weakens their balance sheet because shareholder equity is reduced.
We just survived a major financial disaster caused by Covid-19 mandated closures. Companies need to take a much more conservative approach, in my opinion, in structuring their balance sheets because there is still the potential for another mutated virus in the future that could cause economic instability. In addition, interest rates soared during the time period that they were repurchasing stock, which could result in them having to refinance their debt at maturity at much higher interest rates.
Serious Problems in San Francisco
Many of their properties are in urban areas and are experiencing serious economic problems such as homelessness, store thefts, and migrant housing. San Francisco is indicative of their problems. In June Park elected to stop paying interest on a $725 CMBS loan secured by the Hilton San Francisco Union Square (1,921 rooms) and Parc 55 (1,024 rooms). They will be “handing over the keys” to the mortgage holders later this year, but the operating results for these two properties will still be reported on their various financial filings for 2023.
According to their latest 10-K the book value for their Union Square hotel was $340 million ($499 million minus $159 million accumulated depreciation) and $442 million for Parc 55 ($542 million minus $100 accumulated depreciation). The $782 million total is more than the $725 million CMBS loan, which implies the GAAP accounting values overstated the actual market value since they are willing to give the properties back to the mortgage holders. This is no surprise given what is happening in that area of the city and their 2Q 2023 occupancy rate for all four San Francisco properties was a bleak 57.7%.
The fact that many PK investors were happy they stopped paying interest and were letting the mortgage holders just take the property reflects the very troubling state of affairs for hotel owners in large urban areas. These were once trophy properties and now they are effectively liabilities because a number of their financial metrics, such as debt to EBITDA and interest coverage, will actually improve when these two properties are eventually removed from Park Hotels & Resorts’ books.
On the bright side, they are expecting to pay a $162.5 million special dividend from the after-tax gain on these properties according to a footnote in their May presentation. (page 8). This implies a special dividend of approximately $0.75 per PK share. I am assuming that because assets are depreciated at an accelerated rate for income tax purposes compared to GAAP rates, there are significant taxable income gains instead of a modest loss under GAAP. The tax on this gain will be partially offset by using part of their $400 million net operating losses – NOLs.
New York Hilton is a Huge White Elephant
I don’t think PK investors fully understand the potential future negative impact the New York Hilton could have on operating results. This former trophy property is now a huge white elephant. The net book value of this 1,878 room hotel is $1.481 billion ($1.786 billion minus $304 million accumulated depreciation) as of December 2022, which is 20.1% of their entire hotel portfolio net book value, after removing the two San Francisco hotels and the Hilton Miami Airport, which was sold earlier this year. This implies a book value of $789k per key.
The New York Hilton’s major competitor is right across 53rd Street – the 1,780 room Sheridan New York, which was sold by Host Hotel & Resorts (HST) for $356 million in 2022 or $200k per key. The Hilton is a better property, in my opinion, than the Sheridan, but that deal does represent the distressed valuations the New York hotel industry is facing.
In August the 610 room Park Lane Hotel on Central Park South sold for $622.9 million or about $1.02 million per key. This is a premier location overlooking Central Park and is a very high-quality hotel. The Helmsleys, who built the hotel decades ago, used to live on the 46th floor. The selling price was at a significant discount to the original $1.0 billion asking price. This is a top-of-the-line property and is in a different league than the New York Hilton. At the lower end, was the sale earlier this year of the 655 room Marriott Hotel on Lexington Avenue for $153.4 million or approximately $234k per key. Another Manhattan hotel, Margaritaville Resort Times Square, has already filed for Ch.11 after it was just completed in 2021.
The reality is that the New York hotel industry is currently being artificially inflated by the city housing immigrants in hotels. Last May, Mayor Eric Adams asserted nearly half of the city’s hotels were being used to house immigrants, but that assertion was questioned for accuracy. Since May the number homeless arriving in New York has soared and additional hotels are being used to house them. The city is not housing them in some “dive” hotels – many of the hotels are middle-market hotels that compete with the New York Hilton for customers.
I think that if it were not for these immigrants, the New York Hilton would have a much lower occupancy rate than the 86.8% rate in 2Q. Even at that occupancy rate the hotel had an EBITDA profit margin of only 17.6% compared to 27.7% for their entire portfolio of hotels in Q2 and EBITDA of $12 million. The reality is that the improved 2Q metrics from 1Q are mostly because of the huge increase in the number of immigrants coming into New York during that time period. If these hotels had to compete in a normal market without housing the immigrants, I think the New York Hilton would be operating at a significant loss. When this migrant crisis is resolved or at least reduced, most of the hotels in New York could be negatively impacted even those that are not currently housing immigrants.
On the positive side, New York has effectively banned (text of Local Law 18) using apartments for temporary rentals unless the tenant is present, which have been competing with local hotels. This restriction is being litigated by various parties, including Airbnb, but so far a judge dismissed their case (text of the decision). Approximately 15,000 apartments that were being rented out as an alternative to hotels were taken off the market in September after the law started being enforced.
Another positive is a new restrictive hotel permitting process that could reduce any new hotel construction in the city. The problem is there are already way too many hotels in the city and many of these were built during the “free money” QE1 and QE2 periods. A few years ago, you could not walk down many Manhattan side streets because there were so many middle-market hotels being built.
Using $400k per key, which is being rather bullish given comparable sales transactions in Manhattan, the current market value for the New York Hilton is approximately $751 million ($400k x 1878 rooms). This compares to a net book value as of December 31, 2022 of $1.481 billion. The difference is $730 million or $3.38 per PK share. That is a major hit to the value of PK.
Dividend Yield
Park Hotels & Resorts is back paying a quarterly dividend after discontinuing dividends during the pandemic. If you subtract the expected $0.75 per share special dividend from the current PK stock price of approximately $12, you get $11.25 and annualizing the current quarterly dividend of $0.15, the current yield on the adjusted stock price is 5.3%. This is not really competitive to yields available on alternative investment such as U.S. treasury 2-year notes that yield 5.07% or 10-year notes that yield 4.70% after factoring the higher risk associated with PK.
Quarterly Dividends
Since this REIT has sold 36 hotels with $2.135 billion gross proceeds since 2018 you would have thought there would be significant special dividends from these liquidations, but there was only one $0.30 per share dividend from liquidations in 2018. It has almost become a liquidating REIT.
The special dividend may cause some confusion for investors looking at the media reports of dividends and dividend yields. Adding the regular quarterly dividend of $0.15 and the expected special dividend of $0.75, would result in an annual total dividend of $1.35. Using the $12 PK price, the yield would be 11.25%. This seems to be a very attractive investment, but the reality is that going forward there most likely will not be annual special dividends of $0.75. The “real” yield would still be just 5.3%.
(Special note: I constantly read comparisons to 2019, which in itself is realistic, but too often the assertion is effectively incorrect. A financial item that was $1,000,000 in September 2023 is not really “flat” compared to $1,000,000 in September 2019. In nominal terms – yes. In real terms adjusted for inflation to be flat that metric would have to be $1,198,746.68 in September 2023 or almost 20% more. So, when some CEO states, for example, we are up 12% from 2019, they are actually down in real terms. When I read the conference call transcripts from Park and most other companies the positive statements are often not really as positive as they seem and may actually be negative in real terms. I am not sure why everyone seems to be forgetting about the rapid inflation we had over the last few years, but going forward SA readers need to be cognizant of this inflation factor.)
Conclusion
This article covers a number of issues that are often not covered in other REIT articles, which I consider important when valuing Park Hotels & Resorts and is not intended to be a complete coverage of all the factors.
While certain hotels and resorts in their portfolio are doing reasonably well and have a relatively bright future, there are hotels in large urban areas such as New York and San Francisco that are facing a very bleak future. Some of their former trophy properties are now white elephants. After the current immigrant housing issues are resolved, the New York Hilton, for example, could find itself facing extremely stiff competition that could result in much lower occupancy rates and lower pricing. Given all these problems and having a relatively low yield compared to U.S. treasuries, I rate PK a “sell” at $12 and a “hold” recommendation when it reaches $10.
Read the full article here
