Hotel Property Investments is a AU$500m small-cap, real estate investment trust (REIT) based in Melbourne, Australia. REITs own and operate income-generating property and adhere to a different set of regulations. This impacts how HPI’s business operates and also how we should analyse its stock. In this commentary, I'll take you through some of the things I look at when assessing HPI.
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A common financial term REIT investors should know is Funds from Operations, or FFO for short, which is a REIT's main source of income from its portfolio of property, such as rent. FFO is a cleaner and more representative figure of how much HPI actually makes from its day-to-day operations, compared to net income, which can be affected by one-off activities or non-cash items such as depreciation. For HPI, its FFO of AU$41m makes up 94% of its gross profit, which means the majority of its earnings are high-quality and recurring.
Robust financial health can be measured using a common metric in the REIT investing world, FFO-to-debt. The calculation roughly estimates how long it will take for HPI to repay debt on its balance sheet, which gives us insight into how much risk is associated with having that level of debt on its books. With a ratio of 16%, the credit rating agency Standard & Poor would consider this as significantly high risk. This would take HPI 6.41 years to pay off using operating income alone. Given that long-term debt is a multi-year commitment this is not unusual, however, the longer it takes for a company to pay back debt, the higher the risk associated with that company.
I also look at HPI's interest coverage ratio, which demonstrates how many times its earnings can cover its yearly interest expense. This is similar to the concept above, but looks at the upcoming obligations. The ratio is typically calculated using EBIT, but for a REIT stock, it's better to use FFO divided by net interest. With an interest coverage ratio of 3.17x, it’s safe to say HPI is generating an appropriate amount of cash from its borrowings.
I also use FFO to look at HPI's valuation relative to other REITs in Australia by using the price-to-FFO metric. This is conceptually the same as the price-to-earnings (PE) ratio, but as previously mentioned, FFO is more suitable. In HPI’s case its P/FFO is 12.19x, compared to the long-term industry average of 16.5x, meaning that it is undervalued.
Next Steps:
As a REIT, Hotel Property Investments offers some unique characteristics which could help diversify your portfolio. However, before you decide on whether or not to invest in HPI, I highly recommend taking a look at other aspects of the stock to consider:
- Future Outlook: What are well-informed industry analysts predicting for HPI’s future growth? Take a look at our free research report of analyst consensus for HPI’s outlook.
- Valuation: What is HPI worth today? Is the stock undervalued, even when its growth outlook is factored into its intrinsic value? The intrinsic value infographic in our free research report helps visualize whether HPI is currently mispriced by the market.
- Other High-Performing Stocks: Are there other stocks that provide better prospects with proven track records? Explore our free list of these great stocks here.
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