Why You Shouldn’t Look At DiamondRock Hospitality Company’s (NYSE:DRH) Bottom Line

DiamondRock Hospitality Company is a US$2.2b mid-cap, real estate investment trust (REIT) based in Bethesda, United States. REITs are basically a portfolio of income-producing real estate investments, which are owned and operated by management of that trust company. They have to meet certain requirements in order to become a REIT, meaning they should be analyzed a different way. I’ll take you through some of the key metrics you should use in order to properly assess DRH.

View our latest analysis for DiamondRock Hospitality

Funds from Operations (FFO) is a higher quality measure of DRH’s earnings compared to net income. This term is very common in the REIT investing world as it provides a cleaner look at its cash flow from daily operations by excluding impact of one-off activities or non-cash items such as depreciation. For DRH, its FFO of US$219m makes up 86% of its gross profit, which means the majority of its earnings are high-quality and recurring.

NYSE:DRH Historical Debt, March 5th 2019
NYSE:DRH Historical Debt, March 5th 2019

In order to understand whether DRH has a healthy balance sheet, we have to look at a metric called FFO-to-total debt. This tells us how long it will take DRH to pay off its debt using its income from its main business activities, and gives us an insight into DRH’s ability to service its borrowings. With a ratio of 22%, the credit rating agency Standard & Poor would consider this as aggressive risk. This would take DRH 4.46 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.

Next, interest coverage ratio shows how many times DRH’s earnings can cover its annual interest payments. Usually the ratio is calculated using EBIT, but for REITs, it’s better to use FFO divided by net interest. This is similar to the above concept, but looks at the nearer-term obligations. With an interest coverage ratio of 5.35x, it’s safe to say DRH is generating an appropriate amount of cash from its borrowings.

I also use FFO to look at DRH’s valuation relative to other REITs in United States 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 DRH’s case its P/FFO is 9.9x, compared to the long-term industry average of 16.5x, meaning that it is undervalued.

Next Steps:

As a REIT, DiamondRock Hospitality offers some unique characteristics which could help diversify your portfolio. However, before you decide on whether or not to invest in DRH, I highly recommend taking a look at other aspects of the stock to consider:

  1. Future Outlook: What are well-informed industry analysts predicting for DRH’s future growth? Take a look at our free research report of analyst consensus for DRH’s outlook.
  2. Valuation: What is DRH 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 DRH is currently mispriced by the market.
  3. 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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