3 Reasons Host Hotels Could Rise

By Markets Fool.com

Host Hotels & Resorts, a real estate investment trust (REIT) with 105 properties worldwide,and 2015 gross revenue of $5.8 billion,has slammed investors with a 23% stock-price decline over the past 52 weeks.Internationally, the company showed modest revenue improvement over the last year. However, currency impacts have mitigated that progress.

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The decline in the company's stock over the past year isn't terribly out of line with many of its competitors, and is not unreasonably priced in comparison to them, either. Indeed, it may arguably be a value play compared to entities like Pebblebrook Hotel Trustand here are three reasons why.

1. Macro trends appear intact
It's important to understand that Host operates in very specific categories of the hotel industry. The company's hotels are primarily in upper-upscale (about 72% of revenues) and luxury categories (about 26% of revenues), with no hotels in the economy, midscale, or upscale categories. For those dreaming of a night at one of Host's properties, you'd be staying at properties like The Luxury Collection or The W, managed by Starwood Hotels and Resorts, or the Autograph Collection and Le Mridien, managed by Marriott International.

Order a cocktail for me, by the pool, if you don't mind.

Since the financial crisis, demand for hotel rooms has outstripped supply. Thus, hotels have enjoyed pricing power, particularly in these two segments. For 2016, it is projected that demand will only exceed supply by about 0.5%.

However, industry data provided by STR Global demonstrates that 2015 key performance indicators were extremely robust, and that hotel rooms under construction is growing more than 17.1% year-over-year in the U.S. Sector analyst firm PKF Hospitality Research says there's enough room for this additional supply through 2016.

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Despite the fact that the economy is not growing as fast as one would hope, people continue to travel, and that means they need hotel rooms. Logically, as long as the economy doesn't crater, those with the highest levels of discretionary income are more likely to stay at hotels that Host specializes in.

2. Cash flow remains robust
Host is repositioning its portfolio by selling non-core assets where lower growth is anticipated, as well as selling properties where significant capital expenditures are required, and buying up these upper-upscale and luxury properties. It has also been able to utilize some of the cash flow from these transactions, as well as ongoing operational cash flow, to replace higher-cost debt (5%) with substantially cheaper debt (3.1%).

Clearly, Host's lenders are comfortable with this swap, and that suggests they like the current cash flow situation, as well as the expected boosts from acquisitions.

Remember, when it comes to a hotel REIT, net income can be a misleading metric on which to assess a company's health. That's why virtually every REIT reports metrics like FFO and Adjusted FFO.This informs investors if the company has generated enough cash to pay its debts and pay, or increase, its dividend.

For those who recall the financial crisis, many REITs had to cut or suspend their common dividend because cash flow was so badly affected. Host, in fact, cut their dividend to a mere $0.01 per share,but gradually and prudently raised it to its current level of $0.20. That, by the way, signifies astute capital deployment by management.

With cash flow likely to be stable, if not improve, management may increase the dividend beyond its already very attractive 5.20% yield. Combined with the stock's decline, this may entice dividend investors who also seek some capital gains, to step in.

2. Cash flow remains robust
Private equity funds raise capital to invest from high net worth individuals and things like pension funds. The theory is that the expertise of private equity managers allows them to deliver very high returns. In exchange for those high returns, investors pay very high fees, often 2% of total assets plus 20% of the fund's upside.Thus, the private equity managers have a lot of incentive to find investments they believe will significantly outperform the market. Their clients are paying a lot for them to deliver!

Consequently, sometimes when you see private equity ownership in a stock, it suggests that these funds believe the stock has significant upside. Otherwise, they'd deploy that capital somewhere else.

Three private equity funds own a total of about 10% of Host. That's quite a vote of confidence, considering private equity ownership of many other hotel REITs is not nearly as high..

Final Whistle: Is Host worthy of your capital?
When it comes to hotel REITs, there are just so many to choose from, and I believe valuation depends as much on management, skill with capital usage, and vision. It is one of the few areas where making direct comparisons strictly by crunching numbers is not always the wisest course of action. What I can tell you is that the P/AFFO ratio (which is the best way to value REITs as opposed to P/E ratios) for Host is 10.0,LaSalle Hotel Propertiesis at 8.72,and Pebblebrook's is at 11.3.Meanwhile, I think the market is drastically undervaluing small-cap plays like Ashford Hospitality Trust, which has a Price/FFO of only 4.0.

Your decision depends on your definition of safety and value.

The article 3 Reasons Host Hotels Could Rise originally appeared on Fool.com.

EllenYorkin has no position in any stocks mentioned. The Motley Fool recommends Marriott International and Pebblebrook Hotel Trust. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.