Renovations And Hotel Asset Sales Will Strengthen Future Position

Key Takeaways

• Selling hotels to reduce leverage aims to improve the balance sheet, while focusing on high-performing assets should enhance profitability.
  
• Strategic net lease acquisitions aim to stabilize rental income, driving growth in revenue and adjusted EBITDA.
  
• High debt burden, weak earnings, and increased expenses from renovations and taxes threaten financial flexibility and cash flows, risking net margins and revenue growth.

Catalysts

Service Properties Trust (Nasdaq: SVC) is a real estate investment trust with over $11 billion invested in two asset categories: hotels and service-focused retail net lease properties.

• The company is selling 114 Sonesta hotels, expecting to net at least $1 billion, which will be used to reduce leverage, potentially improving the company's balance sheet and interest expenses.
  
• Renovations at key hotels are underway, with expected completions in 2025, which should lead to increased occupancy and rates, thereby potentially boosting future revenue and hotel EBITDA.
  
• The focus on retaining higher-performing assets is expected to enhance the company's hotel segment profitability, potentially impacting net margins positively as weaker performing assets are divested.
  
• Growing the net lease portfolio through strategic acquisitions aims to enhance rental income stability and tenant diversification, which could result in improved revenue streams and earnings stability.
  
• Economic improvements from reinvestment in remaining hotels and continued strong performance from the net lease assets are expected to drive growth in adjusted EBITDA, supporting overall earnings growth.

Service Properties Trust Future Earnings and Revenue Growth

Assumptions

• Analysts are assuming Service Properties Trust's revenue will decrease by 9.7% annually over the next 3 years.
• Analysts are not forecasting that Service Properties Trust will become profitable in next 3 years. To represent the Analyst Price Target as a Future PE Valuation we will estimate Service Properties Trust's profit margin will increase from -14.5% to the average US Hotel and Resort REITs industry of 4.7% in 3 years.
• If Service Properties Trust's profit margin were to converge on the industry average, you could expect earnings to reach $65.7 million (and earnings per share of $0.39) by about May 2028, up from $-275.5 million today.
• In order for the above numbers to justify the analysts price target, the company would need to trade at a PE ratio of 9.8x on those 2028 earnings, up from -1.1x today. This future PE is lower than the current PE for the US Hotel and Resort REITs industry at 19.1x.
• Analysts expect the number of shares outstanding to grow by 0.53% per year for the next 3 years.
• To value all of this in today's terms, we will use a discount rate of 11.41%, as per the Simply Wall St company report.

Service Properties Trust Future Earnings Per Share Growth

Risks

• The company's hotel profitability has been impacted by renovations and increased expenses, including labor and real estate taxes, resulting in flat GOP and a decline in adjusted hotel EBITDA by 2.4%, which could affect net margins.
  
• The extended stay portfolio experienced RevPAR growth of only 1.2%, with renovations significantly impacting performance, posing a risk to revenue from this segment.
  
• SVC's normalized FFO and adjusted EBITDAre have decreased year-over-year, driven by higher interest expenses and lower interest income, negatively impacting overall earnings.
  
• The significant debt burden of $5.8 billion, with a weighted average interest rate of 6.4% and large debt maturities approaching in 2026, could constrain financial flexibility and influence earnings.
  
• Capital expenditures for property improvements remain high, with approximately $250 million planned for 2025, which could pressure cash flows and reduce funds available for other investments or debt reduction.

Valuation

• The analysts have a consensus price target of $2.767 for Service Properties Trust based on their expectations of its future earnings growth, profit margins and other risk factors. However, there is a degree of disagreement amongst analysts, with the most bullish reporting a price target of $3.3, and the most bearish reporting a price target of just $2.0.
• In order for you to agree with the analyst's consensus, you'd need to believe that by 2028, revenues will be $1.4 billion, earnings will come to $65.7 million, and it would be trading on a PE ratio of 9.8x, assuming you use a discount rate of 11.4%.
• Given the current share price of $1.86, the analyst price target of $2.77 is 32.8% higher.
• We always encourage you to reach your own conclusions though. So sense check these analyst numbers against your own assumptions and expectations based on your understanding of the business and what you believe is probable.