Because I’m not a big admirer of hotel REITs, I’ve been concentrating on the preferred shares issued by hotel REITs. Xenia Hotels and Resorts (NYSE:XHR) does not have any preferred shares available, but the common units appeared to be quite appealing at first glance, so I decided to delve a little deeper into the REIT’s Q1 results to check on the FFO, AFFO, and debt situation.

The FFO and AFFO Performance Is Quite Good

Xenia Hotels is a modest hotel REIT with only 32 properties. Approximately 80% of the properties are leased to Tier-1 franchisees including Marriott and Hyatt. The majority of the hotels are in the upper upscale market group.

While the net income result is largely unimportant for a REIT, it is worthwhile to examine the income statement because it is typically utilized as the starting point for the FFO computation. The hotel REIT earned approximately $269 million in revenue in the first quarter of this year, and after deducting the $179 million in operating expenses, the gross margin was rather good. Surprisingly, the $30 million increase in room revenue resulted in a $7 million increase in room running expenses.

Depreciation and amortization charges continue to weigh on the performance, with Q1 operating income coming in at $33.8M. That’s nearly double the $17.7M generated in the first quarter of last year. Although interest expenses grew, the pre-tax loss of $3.9M in Q1 2022 was turned into a pre-tax income of $11.8M and ultimately a $6.55M net income and $6.3M net income attributable to Xenia’s common shareholders.

A good outcome, but as previously stated, net income does not actually mean all that much. The emphasis is (or should be) on the FFO and AFFO results. FFO is calculated by adding back depreciation and amortization expenses to net income. The FFO recorded by Xenia in Q1 was roughly $40.2M (+60% YoY), while the AFFO was $45.2M, an increase of more than 50% over the first quarter of the previous year.

Given that Xenia Hotels and Resorts has roughly 109.5 million shares outstanding, the FFO and AFFO per share were $0.37 and $0.41, respectively. Surprisingly, the full-year AFFO guidance is now $1.39-1.60 per diluted share (see below). Not only is the advice based on the diluted share count, but it also has a somewhat large gap between the lower and upper end. If I used the current share count of 109.5 million shares, the AFFO range would be around $1.42-$1.64 per share. This suggests that the AFFO could be slightly lower than in the first quarter, which could be explained by the comparatively substantial share-based compensation adjustments in the first quarter of this year. The first and second quarters will account for roughly 60% of the full-year EBITDAre, while the second semester will only account for 40%.

The Balance Sheet Appears to Be in Good Shape as Well

Balance sheet strength is another critical factor. The FFO and AFFO may be excellent, but if the balance sheet appears to be in poor health, the REIT may be in trouble.

That appears not to be the case for Xenia. The REIT has $1.43B in total gross debt, but this is offset by $283M in cash and $58M in restricted cash. Even if I exclude the restricted cash position, the $283M in cash leads to a net debt level of around $1.15B. The LTV ratio is around 44.6% when compared to a book value of $2.58B for real estate assets. Given that the book value of the hotel properties already includes over $1B in accumulated depreciation, the LTV ratio is quite good.

The LTV is only 32% when compared to the acquisition cost of the assets (and this does not include the restricted cash, which would drop the LTV ratio below 30%). These are impressive metrics. Mortgage loans account for approximately $220 million of the debt; all other debt consists of business credit facilities and two $500 million bonds with expiry dates in 2025 and 2029.

Despite the positive results and a favorable LTV ratio, the bonds are trading below par. The 6.375% note maturing in August 2025 now has a price of over 98 cents on the dollar, implying a yield-to-maturity of well over 7%, while the 4.875% senior note due in June 2029 has a bid of 86 cents on the dollar, implying a YTM of close to 7.5%. Given Xenia’s good first-quarter performance and relatively respectable LTV ratio, I’d say the senior notes are quite appealing. If you buy the 2025 note, you can claim seniority by maturity, because the $500M 2025 note matures before any home loan or business credit facility.

Thesis on Investment

Xenia had a fantastic first quarter, but the full-year forecast implies that this would be tough to reproduce. That’s perfectly fine. Using the current share count rather than the fully diluted share count, the stock is currently selling at less than 9 times AFFO at the lower end of the range and less than 8 times AFFO at the top end. That makes Xenia a bargain from an AFFO multiple. Meanwhile, the balance sheet appears to be pretty healthy, so until the economy absolutely crashes, I don’t anticipate Xenia to have any balance sheet concerns.

I do not currently have a position in Xenia Hotels & Resorts, but I enjoy what I see. The common shares are inexpensive, but with a current yield of just over 3% (based on the current quarterly dividend of $0.10 per share, which was resumed in September last year), income-seeking investors may wish to consider Xenia’s senior notes.

Featured Image: Freepik @ standret

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