Apple Hospitality REIT

Moat: 2/5

Understandability: 1/5

Balance Sheet Health: 4/5

Apple Hospitality REIT is a real estate investment trust focused on owning a portfolio of select-service hotels in the United States, primarily operating under the Hilton and Marriott brands.

Investor Relations Previous Earnings Calls

The moat, understandability, and balance sheet health scores reflect a conservative evaluation to ensure a margin of safety in any assessment.

Business Overview

Apple Hospitality REIT (APLE) is structured as a Real Estate Investment Trust (REIT), meaning it’s designed to distribute a significant portion of its taxable income to shareholders in the form of dividends. The REIT model allows investors to participate in the income generated by the hotel properties without operating them directly. APLE focuses specifically on owning select-service hotels, which typically include well-known brands like Hilton Garden Inn, Hampton Inn, Courtyard, and Fairfield Inn & Suites. These hotels generally target business and leisure travelers who seek comfort, convenience, and a consistent experience without extensive amenities. The Company’s properties are primarily located across the U.S., in different markets and submarkets, and offer a wide geographic distribution.

  • Revenue Distribution: A majority of APLE’s revenue is directly tied to hotel operations, including room rentals, food and beverage sales, and other hotel revenue. A smaller amount of revenue comes from other sources like property management. While the distribution may seem straightforward, its stability is highly correlated with travel demand, occupancy, and the overall health of the hospitality sector. A critical part of APLE’s revenue also comes from acquisitions and property upgrades, both of which provide higher rents in the short term and also provide better returns over long term.

  • Industry Trends: The hotel industry, while seemingly stable, is actually in constant flux. It’s influenced by changes in travel demand, economic cycles, consumer preferences, and the supply of new rooms. In recent times, the industry has seen an increasing focus on unique or “boutique” brands, and a rise in the use of digital platforms for bookings. However, at this time, select service hotels are showing strong demand and high growth over other types of lodging.

Industry conditions have impacted the prices that hotels can charge.  As a result, hotels have been seeing a reduction in margin levels because their operating costs have increased significantly, while their pricing power has diminished. This has lead them to make big cost cutting measures and focus on efficiency to improve profit levels.
  • Margins and Competitive Landscape: The margins for select-service hotels generally tend to be relatively stable as they focus on a core set of services. However, these can be affected by shifts in demand, higher operating costs due to labor costs and energy prices, and other factors. Competition within the select-service sector is pretty high with several well-known hotel brands vying for market share. Most of the top brands are well-run and known to most of the public, such as Hilton, Marriot, IHG, Wyndham and Choice. It’s also important to note that the average age of a hospitality property is usually less than 15 years due to the changing requirements of travelers. APLE has invested a lot in acquisitions recently in order to be in a place to capture and retain customers at their hotel properties.
The company differentiates itself through strategic acquisitions of well-located properties, often focusing on properties that perform at the upper end of the limited-service category. They also work closely with well-known brands to provide good quality and reliable stays. Finally, they work with various operators to optimize hotel performance by targeting operations and cost efficiencies to increase margins, they are always searching for ways to improve the value of their assets. The REIT structure itself means that they are limited on what they can do to maximize their return, their primary objective is to provide a high dividend to shareholders.
  • Recent Concerns / Controversies and Problems:
 Some concerns were raised about the ability of the industry to make a full recovery to pre-pandemic levels and the effect that has on hospitality investments. In the Q1 2023 earnings calls, it was mentioned that they see that the "high-rate environment" has "not impacted demand" and that they have "not seen a demand cliff yet". Also that the operating costs pressures and inflation are starting to diminish but the pricing power has diminished because of the high inflation, leading to margin pressure. The company has been making a lot of new investments and property upgrades, which are expected to start generating income over the next year, which would hopefully push up prices and create a higher average rate per room. The biggest concern as per the call is that the industry hasn’t gotten to the point where hotels can push up room prices as high as the inflation costs, but the company believes this is a transition phase.
  
In the Q3 earnings call, the company stated that all metrics and financial performance are above the corresponding years. They have made improvements in occupancy, revenue per average room, and EBITDA performance. There is continuing high demand in the luxury and leisure sector. However, there are still lingering cost pressures for operating costs, and the company is working to increase margin from them. Management mentioned that the hotel industry as a whole has still not reached pre-pandemic levels in all metrics and they still haven’t seen a "return to the normal" after the large change due to COVID. They expect for the industry to continue to gain in the short term. 

The most recent quarter's (Q4 2023) earnings call revealed continued strong revenue and demand growth with a solid start to the year. The company was able to execute more on the high-end of their portfolio and continue to make investments in new properties. The operating margin for the company was 42.6% which was higher year over year. The CEO stated in the call that demand is “broad-based and resilient” across all of the company’s properties. The company's CFO did mention in the call, that they have taken steps to strengthen the company's capital position and the financial liquidity position in the company. In Q4 they had a 2.2 leverage ratio.

Financial Analysis

  • Revenue and Margins: The company has done well after the initial phases of COVID, and is starting to gain some traction and is consistently increasing revenues year over year. However, there are still high operating costs, which is affecting margins. This has been a constant concern that was addressed in recent calls.
  • Debt Levels: They have taken on a lot of debt with new acquisitions, their debt is relatively high but the risk is mitigated by the increase in revenue and increased assets. Recent reports and calls reveal their intent to manage the levels of debt as the revenues from the new properties starts to rise. The company has a 2.2 leverage ratio as of Q4 2023. The company aims to lower their leverage ratio for more financial flexibility.
  • Return on Invested Capital (ROIC) & WACC: The company’s ROIC and WACC figures will depend a lot on when the new acquisition and improvements start producing revenue and higher margins for the company. These metrics are still not readily available and hence cannot be accurately assessed at the moment.
  • Cash Flow: Cash flows are quite steady, as they make sure to keep occupancy and revenue coming from their properties. This helps them continue their operations and also helps with paying the dividend. They are also taking measures to manage their cash burn, and are reducing their expense costs and focus on efficient operations.
A major point that Graham emphasizes in his book, The Intelligent Investor is that an investor needs to always do "due diligence" and a "qualitative analysis" of the company. Based on recent reports and the latest earnings call, the management team seems to have a very strong and competent understanding of the business that they are in. They are being realistic about the current situation and the future, and do not make any grand promises. The are also focused on financial metrics to make sound investment decisions.

Moat Assessment (2 / 5)

APLE possesses a narrow moat at best, with limited sources of sustainable competitive advantage. Here’s a breakdown:

  1. Brand Recognition: While APLE is associated with well-known hotel brands like Hilton and Marriott, the brands themselves are not owned by APLE but rather franchisees, thus they have little to no control over them. The ability to set prices and other terms rests with the brand itself, but APLE, just like any other hotel franchise can offer these properties. However, they do work with these brands to make sure their properties are of a specific standard.

  2. Location: The location of hotels does create a limited local moat, if they are able to dominate that specific geography. However, it doesn’t completely protect APLE from outside companies if the location they are in are easily accessible and easily reproducible. Other hotel chains can also replicate locations by acquiring land in the same places, and even other franchises can enter the same market using the same brands. But, APLE does try to obtain locations that are very difficult and not that easy to reproduce. In general, land acquisition does offer some limited moat.

These moats are easily breached by a better run, better managed hotel or motel chain that is willing to provide a better experience at the same price, which would greatly increase their customer retention. Therefore, this is why it is rated as a "narrow" moat.

  1. Switching costs: The company does benefit to some extent from the switching costs from its frequent customers, as loyal customers are more likely to revisit the hotels that they are familiar with, and the data shows that most customers prefer sticking with one brand of hotel rather than switching often. This does create a very small but considerable long-term moat, as it makes APLE resilient. The ability of an individual hotel to have long-term customers will ultimately help it in generating better returns over time.

  2. Lack of Pricing power: The company has little ability to raise the price of their rentals significantly. This is because customers can simply switch to other well-known chains at relatively similar prices. This lack of strong pricing power does put a damper on the company’s ability to fully leverage its moats to increase return.

Legitimate Risks to the Moat and Business Resilience

  1. Economic Downturns: A recession can reduce travel and hotel occupancy, which would greatly hurt revenues for APLE. This is a major risk as it is a REIT, and hence is limited on the ability to diversify into new industries and revenue streams.
  2. Increased Competition: The hotel industry is relatively competitive with many competitors. New hotels and chains can lead to saturation in some markets, eroding APLE’s competitive position.
  3. Changing Preferences: Consumer preferences can change or shift to newer types of hotels or rentals. Since APLE focuses mainly on select-service brands, they can easily be susceptible to changes in consumer preferences.
  4. Interest Rate and Debt: APLE’s high debt load makes it vulnerable to rising interest rates which would increase cost of debt, thereby affecting financial performance.
  5. Acquisition risk: Acquisitions are not always guaranteed to produce more value and higher yields. APLE will also always have to keep track of competitors and any potential acquisitions they make that could affect profitability.
 Based on all these risks, it’s important to note that despite having a "narrow" moat, this does not make the company a "poor" investment, as the company has the potential to have high returns even though it does not have a "wide" moat.

Understandability: 1 / 5

The business of APLE is extremely simple to understand. A company purchases and manages hotels, and earns income through rent, and provides dividends to shareholders. There isn’t any underlying business that makes it difficult to understand. This simple business model makes it extremely easy to understand and model, especially compared to other complex businesses like technology, pharmaceuticals or insurance companies. This ease of understanding makes it highly attractive to average investors.

Balance Sheet Health: 4 / 5

While APLE carries a significant amount of debt, which does create some volatility, the company has a strong history of managing its financial performance by increasing profitability and improving cash flow. Their debt profile, while high, is backed by strong assets, with new acquisitions also helping increase the asset side. The company seems to be in a good position to take on extra debt and also manage and pay it back. They also generate quite consistent and high cash flows, which is an overall great sign for long-term financial health. While it is not the best balance sheet out there, it is pretty healthy and unlikely to cause any problems for investors.