By Lawrence Meyers

I’m a value investor.  I love it when the market unfairly marks a stock down to ridiculous prices.  Such a thing is happening right now to hotel REIT Ashford Hospitality Trust (NYSE: AHT).  The market has been selling anything that has to do with real estate, mortgages, financials, and travel.  Lucky for me, Ashford fits all four categories.  It’s been hit with a quadruple market whammy – almost all of it unjustified.

From my perspective, I see a stock trading at 38% of its intrinsic value, and offering a 24% yield that appears secure as of today’s analysis.

Today I’ll provide my analysis on the company and the stock.  In the week to come, I’ll present an interview with Ashford’s CEO Monty Bennett.  He’ll give us a primer on the hotel industry, and a more detailed look at why Ashford’s structure is unique.

We’ll start with the basics, and use Ashford’s July 10th Presentation at the Oppenheimer Growth Conference and their Q1 results as our guides.  

Current Company Health

Ashford owns 105 hotels.  The NAV of their properties –that’s net of debt – is $9 a share, according to the most recent estimate out of Robert W. Baird & Co.  Ashford’s total long-term debt is $2.6 Billion.  None of that debt is due this year, and only $200 Million is due in 2009 and 2010.  In Q1, Ashford’s cash flow covered all operating expenses, interest payments, preferred dividends, and common dividends.  In fact, that’s always been the case.  Ashford has never had cash flow issues.

Their balance sheet also shows $94 million in cash, $64 million in accounts receivable, $60 million due from third-party hotel managers, and $112 million in notes receivable.  That’s $330 million in additional cash equivalents (I call them that because its either cash they’ll collect in the short term or notes they could sell off).

Conclusion:  The balance sheet is healthy.  There is no cash crunch or liquidity crisis a Ashford. 

Debt

Of the assets carrying debt, 80% have assumable debt with average LTV of about 65%.  The Weighted Average Cost of their debt is a fantastic 4.99%, and the average maturity of that debt is 7 years.  Debt service is about $40 million quarterly, which is more than covered by operating income.  And again, they have only $200 million due in the next two years.

Conclusion:  The debt is cheap, easily serviced, and principal isn’t due for years.  It is not cumbersome to the balance sheet or cash flow.

Dividend

Ashford’s ratio of cash flow to the common dividend (CAD) paid to shareholder is 117%.  That means they had 17% more cash than necessary to pay the dividend.  

Conclusion: The dividend is covered by operational cash flow.

Management and Their Strategy

Monty Bennett and his team have done everything they said they would do since the day the company went public.  They outlined a specific strategy (which we’ll discuss with him) and have never wavered from it.   They’ve never misled investors, have never muddied their press or earnings releases with vague statements, and have consistently executed their strategic plan with aplomb.  I challenge any reader to find anything that contradicts what I’ve just stated.   Add to this Mr. Bennett’s 20 years of skillful hotel management experience and Ashford’s captain is confidently and firmly steering his ship.

Conclusion:  Management remains strong. 

Okay, that’s the past.  Now let’s look to the future in these same categories.

Future Company Health

Ashford, per its articulated strategy, is selling hotels during difficult economic times such as this one.   This permits them to do two things.  First, it allows them to recycle capital into paying off debt, making high-yielding mezzanine loans, buying back their super-cheap stock, and making required capital expenditures (for which they have contractually limited).  Second, by disposing of hotels, they hedge themselves against the risk of this economic period becoming worse.  For the NAV to be significantly impacted, the economy would have to be in far more serious trouble than it is now.  Remember, it’s the residential real estate market that’s in the toilet, not hotels.

It would take a lengthy Depression, not just a recession, to crater NAV by even 50% — which still leaves a 30% upside on the stock from here.

Conclusion: Barring a Depression, overall company health is in great shape going forward.

Debt

With so little debt coming due, the only thing Ashford needs to do is meet their quarterly payments.   Their EBITDA-to-Interest Expense ratio is a robust 2.4.  That means they are protected against a RevPAR decline of 15% — which would practically kill the hotel industry.

Conclusion:  Ashford will easily meet debt service and maturities going forward.

Dividend

A hotel REIT will typically set their dividend on an average estimate of yearly cash flow.  If one quarter’s cash flow is too low, another’s is likely to be more than enough to offset it.  Ashford has been tremendously reliable with its cash flow and its dividend, although this economy is the first real challenge they’ve seen.   Whenever anyone sees a dividend that is above 10%, they freak out.  Why?  It usually means it’s unsustainable.

Usually.

Ashford’s RevPAR will have to be significantly impacted over the next few quarters before they’ll cut that dividend.  In addition, they generate interest income via their mezzanine loans, so that will hedge against any RevPAR loss.  Thus, they’re a lot less exposed to revenue fluctuations than every other hotel REIT.  Plus, with their stock selling at $3.50, you can bet they’re going to buyback a lot of shares to reduce the amount they’ll need to pay out.

But let’s imagine a case where they did have to cut the dividend.  Well, so what? We’ve already established that the company’s overall health is excellent.  Any dividend cut would be temporary.  And by the way, it’s a generous dividend to begin with.

Conclusion:  The dividend seems safe for the foreseeable future,  barring a significant and lengthy recession.

What Does the Future Hold?

I’ll examine this in more detail after the interview.  But I want to address something right now: oil prices.  This is affecting airline capacity.  A July 9 study by hotel consulting group PKF reports that a 1% decline in airline seating capacity causes a 0.39% decline in hotel occupancy rates.  The L.A. Times reported this week that airlines may cut capacity by 8.8%. This would cause an industry-wide 3.9% decline in occupancy.  On the surface, this seems bad for Ashford.

However, PKF’s study showed that Denver, Orlando, Phoenix, and Miami are historically the most affected by declining airline capacity.  Ashford only has 6 hotels total in those cities.  And, of course, the routes airlines are deserting are to those cities with the least demand, which puts most of Ashford’s other hotels in a fairly safe zone.  In addition, Ashford is disposing of hotels, further hedging itself against an occupancy hit.

How long will these airline capacity cuts stay in effect?  They are directly related to oil prices and the airlines only just now instituted these cuts – with oil at $147.  As for oil prices, I see a blowoff top forming, which suggests there will be a significant decline.  Already in the past week we’ve seen the potential beginnings of that selloff.  Yes, there are market concerns due to Middle East politics.  But much of oil’s move has been due to speculation.   Once the price starts to fall, the speculators will switch to the short side of trades, and I expect oil to settle back down in the $70-80 range. The airlines will open up capacity again. 

Conclusion: Oil prices and airline cuts will be short-lived, with only marginal effect on Ashfor’d RevPAR.

So, to reiterate, Ashford Hospitality Trust:

1)    Is trading at a 62% discount to intrinsic value.

2)    Is paying a safe 24% dividend

3)    Has a healthy balance sheet, with cheap debt and EBITDA far in surplus of interest expense.

4)    Has outstanding management with a track record of weathering all economic cycles and sticking to their plan.

5)    Has great flexibility in how it deploys capital from asset sales.

6)    Would only be affected by a significant, and long-term, decline in RevPAR and/or airline capacity

I’m buying with both hands. 

Stay tuned as I interview CEO Monty Bennett in the next few days.

Lawrence Meyers is a former journalist for the Motley Fool, and is President of PDL Capital, a private equity firm (www.pdlcapital.com).  He currently owns shares of Ashford Hospitality Trust.  This article is only an expression of the author’s opinion, may contain inaccuracies, and is not a solicitation to buy or sell any security.  All readers are advised to consult with a financial advisor prior to making any investment.

The author may be contacted at pdlcapital@earthlink.net

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