The BUSINESS of Hotel Real Estate
This week, we look to our northerly neighbors for our second look at Temple Hotels Inc. (TMPHF), a publicly listed real estate investment trust with hotel properties spanning across Canada. Since our last look in January 2014, Temple has continued to make strides in enriching its portfolio of properties to drive business results.
Net income between 2014 and 2015 grew by an impressive 82%.
In 2014, the company acquired seven additional properties, six of which are located outside of its previous, predominantly Alberta-centered properties.
Temple has reduced debt over the past year by 11.5%, with an associated 13% decrease in interest expense.
With the recent Alberta wildfires now in the rearview mirror, Temple stands to profit nicely from the increased demand for hotel rooms in Fort McMurray Alberta, where it is the community’s largest hotel operator. And as oil prices continue to climb and Canadian oil production increases, Temple’s properties located near these oil producing regions should begin to see increased demand as well. The company’s four convertible debenture issues, currently indicating a yield of about 9% for its shortest (maturing in about 6 months) or over 17% (for any of its other three), is an extremely attractive yield for investors seeking to increase overall portfolio return and add some Canadian currency diversification to their portfolios. Consequently, we are adding its June 2017 bond with its indicated yield of about 19.5% to our FX2 and FX3 high yielding global income portfolios.
Developments Since Our Last Review*
(*all currency amounts in this review are expressed in CAD)
We last reviewed Temple Hotels in January 2014. For full year 2014, the company posted net income of $22.6 M, omitting depreciation and amortization expense of $30.5 M. For 2015, again omitting depreciation and amortization and the one-time impairment charge, the company actually registered a gain in net income over 2014, registering $41.3 M in net income, an impressive 82% increase. Temple also began focusing on debt reduction in 2015, which is evident in its most recent financials. Between March 31, 2015 and March 31, 2016, Temple decreased its total debt by $70.3 million, from $607.4 M to $537.1 M. Along with this reduction also came a 13% decrease in interest expense ($9.1 M to $7.9 M). Temple also worked to reduce expenses, showing an 18.5% decrease in General and Administrative expenses between March 31, 2015 and March 31, 2016.
Since our last review, Temple Hotels has continued to build its portfolio of properties across Canada. In January 2014, the company acquired its second Yellowknife property, Nova Court, a 106-suite extended stay property. In February 2014, it acquired Hotel Saskatchewan (which it later sold in July 2015). By mid- 2014, the company had added five more properties, one in Ft. McMurray, Alberta and four in Ontario.
As of December 31, 2015, the portfolio of Temple Hotels Inc. consists of 29 hotel properties, representing almost 4,000 rooms and a participating 50% interest in two additional hotels, comprising 299 rooms. Temple Hotels Inc. is the largest hotel owner in Fort McMurray, Alberta, with a portfolio of over 800 rooms in nine properties.
In February and April of this year (2016), the company announced the continuation of its buyback programs for both its debentures and its common stock, and pursuant to its December 2015 announcements, the real estate mogul Morguard (a majority stockholder) presumed control of the company on April 1 of 2016 and has installed a new management team. Morguard’s owned and managed portfolio of assets is valued at more than $19.5 billion.
Fort McMurray – Rebuilding After the Wildfires
Fort McMurray Alberta, where Temple is the area’s largest hotel operator, recently experienced wildfires in May of this year, which originated just 9 miles southwest of the city in the oil sands region of Alberta. At its height, the fire engulfed nearly 590,000 hectares. The city was evacuated and in early June, officials began letting residents return. Nearly 2,400 structures were destroyed, with roughly 2,200 being residential homes. As residents return to the city to live and work, they will need temporary housing. Hotel space is already at a premium. With Temple being the largest hotel operator in the area, the company stands to benefit from the current housing shortage. Seven of Temple’s nine Fort McMurray hotels experienced only light to moderate impacts and continue operations while two of its hotels sustained greater damage in the fire, with estimates for repairs taking up to three months.
Increasing Oil Prices
Temple has a large footprint in the Fort McMurray area as well as in other Canadian locations whose economies are oil dependent. Amid the low price of oil, Canadian oil production is still expected to increase by 1.1 million barrels a day over the next 15 years. And the increase in oil prices over the last few months has also incentivized one of Canada’s largest energy players to increase the number of wells it plans to drill this year. The U.S. Energy Information Administration estimates energy prices will continue to increase as demand also increases from global emerging economies. This increased demand, along with increasing prices will likely spell good news for Canadian oil producers, and as an extension of this, Temple’s properties in oil producing regions.
About the Issuer
Temple Hotels Inc. was formed in accordance with a Plan of Arrangement which converted Temple Real Estate Investment Trust (TREIT) to a corporation, effective December 31, 2012. Temple Hotels Inc. continues the business of TREIT, which acquired its first property, Temple Gardens Mineral Spa, and became a publicly listed real estate investment trust on the TSX Venture Exchange on October 1, 2006. The primary investment objectives of the Company are to generate stable and growing dividends, enhance the value of the Company’s assets and maximize long-term share value through the active management of its assets, and expand the asset base and increase earnings through an accretive acquisition program with the objective of producing a geographically and sectorally diversified portfolio of hotel properties and assets.
The general strategy of the Company for external growth is to pursue the acquisition of hotel properties and assets in markets across Canada, and possibly in the United States, based on an investment criterion which focuses on return of equity, security of cash flow and potential for capital appreciation. The target capitalization rate for hotel acquisitions is generally between 9% and 12%. The overall investment strategy of the Company also encompasses the acquisition of hotels in regional clusters and of similar asset sizes in order to create economies of scale. In general, new property acquisitions are funded by arranging new mortgage financing or by assuming existing mortgage financing, with the remaining equity portion to be funded from
the reserves of investment capital. The equity portion of new property acquisitions may also be partially funded by the exchange of shares.
In 2014, one of Temple’s objectives with its acquisitions was diversification of the locations of its hotel properties across Canada. Temple went from a predominantly Alberta operation to a company with a presence in the Atlantic region of Canada, as well as Ontario and Western Canada. In 2014, the operating income from hotels outside of Fort McMurray Alberta accounted for 66% of the company’s operating income, compared to 45% in 2011. Today, out of its 3,870 room total, 891 (or 23%) rooms are located in the Fort McMurray area.
For 2015, Temple had operating income of $45.8 M and interest expense of $35.2 million for an interest coverage of 1.3x. While this coverage is less than many of the bond issues reviewed on this blog, the increased demand for hotel rooms in Fort McMurray, rising oil prices and increased Canadian oil production (as discussed previously) should positively affect this ratio moving forward.
The default risk is Temple’s ability to perform. Temple has made positive strides in diversifying the locations of its hotel portfolio, going from Alberta-centered, to spanning the Canadian provinces. Also, the company should start to see recovery in its Fort McMurray properties due to reasons stated earlier in this article (increased demand, oil recovering). With its recent debt and cost reductions, the company is ideally positioned to profit from its Fort McMurray locations as well as its hotel properties across Canada. In fact, in Q1 2016, apart from the Fort McMurray / Other Alberta areas, same property room revenues actually increased slightly, up 4% year-over-year.
Temple’s Fort McMurray properties have a high operating profit margin for the company, so changes in demand for these accommodations tend to have a larger impact on overall revenue and operating income as compared to hotel properties in other segments. Although the prediction is that demand will increase with the rebuilding of the Fort McMurray community, this demand could materialize slower than expected depending on the rate of rebuilding as well as other accommodation options that might be made available for returning residents.
With the denomination of these bonds in Canadian dollars, bondholders will be exposed to the Canadian economy and the exchange rate of the loonie to U.S. dollars.
This 12 month convertible Loonie bonds has similar yields and durations to other Canadian debt issues reviewed on Bond-Yields.com, such as the 12.15% IBI Group and the 16.75% Data Group convertible debentures.
Summary and Conclusion
Temple Hotels is in a prime position to profit from the recent wildfires in one of its prime holding locations in Fort McMurray Alberta. These high margin properties will provide a welcomed boost for this trans-Canadian hotel operator. With its properties outside of Alberta posting year-over-year increased revenues, the addition of increased revenues from the high margin Fort McMurray properties should bolster the company to a fantastic finish for 2016. With oil prices and Canadian production on the rise, this will add fuel to the fire as many of its Alberta properties are located near oil production areas. These convertible bonds provide excellent diversification into the hospitality / tourism industry. Therefore, we are adding these high yielding, 12 month Loonie debt instrument from Temple Hotels to our Fixed-Income2.com and Fixed-Income3.com global high yield fixed income portfolios.
Toronto: $1.19 6/29/2016
Debenture (Bond): TPH.DB.D
Conversion Price: $ 7.04
Yield to Maturity: ~19.58%
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Disclosure: Some Durig Capital clients may currently own Temple Hotel convertible bonds.
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