Are times changin’?

When market value is unimpressed by higher earnings and improved operational efficiency

July 28, 2016

About the author

Noam Ganel, CFA is the founder of Pen&Paper, a value-oriented, contrary-minded journal of the financial markets. Between 2010 and 2020, Ganel worked for Silvergate as Vice President in Capital Markets. He provides advisory services to family offices,  private companies, and financial advisors.

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LaSalle Hotel Properties (NYSE:LHO) improved operations in the past five years. Earnings per share increased by over 300 percent, to $1.67 in 2015 from $0.39 in 2011. Funds From Operations increased by 146 percent, to $304 million from $123 million. And an efficiency ratio, such as operating expenses to revenue, declined to 84.65 percent in 2015 from 87.55 percent in 2011. And with over a billion dollars of revenue, the basis points are meaningful. The increased efficiency in operations contributed $35 million earnings to a $135 million bottom line. Put differently, LSO focus on operations efficiency resulted in an increase of 25 percent in earnings.   

Improving operational efficiency was not the only achievement. Revenue per available room (RevPAR), Average Daily Rate (ADR) and occupancy increased in past five years. In 2011, RevPAR was $148, ADR was $193 and occupancy was 76 percent. In 2015, RevPAR was $194, ADR was $239 and occupancy was 81%. Given the improvements in both the operational efficiency and revenue, the value of the Maryland-based Hotel REIT interest in 47 hotels should have increased.

But the 2015 value of the company is just about the same as was its value in 2011. Total Return is one metric to see that. Assuming $1,000 was invested in the LSO’s shares on December 31, 2010, with reinvestment of all dividends in common shares, five years later, on December 31, 2015, the value would be $1,134. That is a five-year yield of 2.5 percent. The value of a passive investment in the S&P 500 Index would be 60 percent higher, at $1,807.  And compared to the FTSE NAREIT Equity Index, the value would be 55 percent higher, at $1,755.

Industry-specific and company-specific factors may explain why the shares trade at a 20 percent discount to book value and at an even steeper discount to Net Asset Value. Industry specific factors include a 12-month decline in the valuation of most Hotel REITS. Facing behemoths rivals, such as Uber, is a concern for shareholders. And the competitive landscape is changing, notes Guy Langford, head of U.S. hospitality at Deloitte, a consulting firm.  

Company-specific factors include a subpar return on equity, a geographic concentration, and a dismal view by the market on LHO’s origination of a mezzanine loan. The five-year average return on equity of 5 percent is unattractive. It is also a sign of a highly competitive market place. Forty percent of the portfolio, 19 properties out of 47 hotel properties, is located in California. And on July 2015, the company provided a two-year, $80 million Junior Mezzanine, secured by pledges of equity interests in the entities that own the hotel properties. It is not a secure form of lending.  

The Industry-specific factors outweigh the company-specific factors. As a result, like a marathon runner who could not finish a race because of excruciating heat, and not the runner’s ability, LaSalle management must be frustrated. Only time will tell if the dormant market value is seasonal or permanent.