American Hotel Yields 9.3%: Should You Take the Risk?

There’s high uncertainty in American Hotel with normalized demand being unknown, its high debt levels, and portfolio repositioning.

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It has been ages since I covered American Hotel Income Properties REIT (TSX:HOT.UN). Sure enough, my record shows that I last sold out of the hotel and resort real estate investment trust (REIT) in 2018 and pretty much have not take a look at it since.

It would be interesting to see how the stock has progressed since its unfortunate epic decline from peak to trough of about 80% during the pandemic when traveling activities froze. From the basement price of about $1.50 per unit in March 2020, the stock recovered to as high as $4.60 per unit in June 2021 — three times investors’ money in the period! However, one has got to wonder how many investors timed their trades perfectly like that. Even someone who were able to double their money in the high-risk stock would have been considered absolutely amazing.

Today, the stock trades at about $2.64 per unit. Six analysts are calling the stock undervalued with a consensus 12-month price target of $3.74 for a discount of about 29%.

Recent results

So far, American Hotel Income Properties REIT has reported its 2022 results up till the third quarter (Q3). The year-to-date revenue increased by 19.5% to US$213.6 million versus the same period in 2021. However, net operating income (NOI) only climbed 1.5% to US$68.8 million, as the NOI margin shrank by 5.7% to 32.2%.

Similarly, its earnings before interest, taxes, depreciation, and amortization (EBITDA) increased by 2.4% to US$55.6 million, as its EBITDA margin compressed by 4.4% to 26.0%. The lower NOI margin suggests higher operating costs, which make sense given the higher inflation. The fact that the REIT sold two hotel properties since Q3 2021 also weighed on its NOI.

Its funds from operations (FFO), in the first three quarters of 2022, declined by 9.8% to US$32.4 million. On a per-unit basis, FFO declined 21.7% to US$0.36.

American Hotel’s FFO payout ratio is estimated to be 40% in 2023. This appears to be a conservative payout ratio for a REIT. However, it must be so because of its high debt levels.

High debt levels

REITs typically have high debt levels. However, American Hotel’s debt levels are higher than normal. For example, its long-term debt-to-capital ratio is about 169%. Notably, American Hotel’s Q3 interest expense was US$8.7 million, which is down 8.5% from Q4 2021. The lower interest expense is likely attributable to the sale of properties, which is helping reduce its debt levels.

Investor takeaway

The REIT will be releasing its Q4 results on Wednesday, which is something interested investors should look out for. In October 2022, the REIT sold about five hotel properties, which should help reduce its debt levels.

The hotel and resort REIT is still recovering from the pandemic. Its FFO per unit is still about 36% below the pre-pandemic levels. The market questions what the normalized demand for hotels will be. Additionally, its debt levels are high and the current higher inflationary environment will also weigh on the stock. Moreover, it’s repositioning its portfolio by selling non-core assets to pay down debt. This will also reduce its cash flow in the near term.

Its monthly cash distribution equates to an annualized payout of US$0.18 per unit. This results in a cash-distribution yield of almost 9.3% for Canadian investors based on the recent foreign exchange rate between U.S. dollars and Canadian dollars.

Essentially, American Hotel stock is a high-risk contrarian idea. Its high cash-distribution yield of over 9% is an indicator of its high risk. Analysts also believe that the stock has 12-month upside potential of about 42%. If you do take a position, size it properly to ensure you have a sufficiently diversified portfolio.

This article represents the opinion of the writer, who may disagree with the “official” recommendation position of a Motley Fool premium service or advisor. We’re Motley! Questioning an investing thesis — even one of our own — helps us all think critically about investing and make decisions that help us become smarter, happier, and richer, so we sometimes publish articles that may not be in line with recommendations, rankings or other content.

Fool contributor Kay Ng has no position in any of the stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.

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