Sunstone Hotel Investors, Inc.

Moat: 2/5

Understandability: 2/5

Balance Sheet Health: 3/5

Sunstone Hotel Investors, Inc. is a real estate investment trust (REIT) that focuses on acquiring, owning, and developing primarily upper-upscale hotels and resorts in the United States.

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.

Sunstone’s business revolves around real estate assets, primarily hotels and resorts. Its financial performance is strongly linked to the tourism and hospitality industry and can be influenced by macro economic factors.

Business Overview: Sunstone Hotel Investors, Inc. is a real estate investment trust (REIT) focused on acquiring and developing upscale hotels and resorts. The company operates in a very cyclical industry, where their results are tightly tied to the fluctuations of travel trends. Its income comes from two segments: rooms and other.

  • Revenues:
    • Room Revenues: The bulk of Sunstone’s revenue comes from the sale of rooms at their hotels and resorts, directly influenced by occupancy rates and average daily rates (ADR).
    • Other Revenues: This segment includes revenues from food and beverage sales, amenities, and other services offered at their properties, such as conference room rentals. These revenue streams supplement the main revenue source and usually vary with hotel occupancy.
  • Industry Trends: The industry is highly influenced by the state of the economy, especially changes in consumers’ spending patterns.
  • Increase in Travel Demand: After years of muted travel demand from COVID19, demand appears to be bouncing back which helps occupancy rates.
  • Business and Leisure Travel: Business travel has not yet recovered to pre-COVID levels, and some management teams, like Sunstone, expect that it will stay lower for the next few years. However, leisure travel is growing as people are more comfortable with it.
  • Inflationary Environment: With inflation pressures, hotels are expected to be able to raise their prices, which in theory, should push up their per-room revenues. However, the demand may be more variable depending on pricing.
  • Margins:
  • EBITDA Margins: The company’s EBITDA margins for the past three quarters are in the mid-20% range but have recently come down. Since they are a real estate company, they have very high depreciation, which brings down the net income quite a bit. High leverage also contributes to lower income per share.
  • Competitive Landscape: The hotel industry is competitive, consisting of a wide range of hotel brands with different offerings.
    • National Chains vs. Local Operators: There is a mix of large hotel brands that are competing with local, independent hotels.
  • Pricing Power: Hotels, especially in the budget and mid-tier range, tend to have low pricing power as customers will readily go to a competitor based on the price. In the high-end luxury market, companies with a strong brand, like Four Seasons or Ritz-Carlton have much more pricing power.
  • Supply and Demand: Demand for travel and hotel space is highly cyclical, which puts pressure on hotels, as it’s harder to keep consistent performance due to the fluctuating travel trends. Supply changes also can cause great fluctuations.

What Makes Sunstone Different While Sunstone has similar properties to other REIT’s, it attempts to set itself apart through a focus on its value creation ability. It claims that its operations-focused model, disciplined capital allocation, and strong operating partnerships with major brands differentiate it from its competitors.

Financial Overview:

  • Revenue Growth: Sunstone’s revenue has steadily increased after it was hit hard by COVID. This is being driven by increased occupancy and improved rate recovery.
  • Profitability: While operating performance is on the uptrend, profitability still has not returned to pre-pandemic levels due to increased expenses and debt burden.
  • Leverage: Sunstone is a highly leveraged company. High debt levels are a huge concern, especially as interest rates are on the rise.
  • Cash Flow: While Sunstone is not cash flow negative, cash flow remains limited.
  • Guidance: Management provided some guidance on revenues and hotel occupancy that is largely dependent on economic trends.

Moat Assessment:

  • Moat Rating: 2 / 5 Sunstone has a narrow economic moat stemming primarily from location and high-end branding.
    • Location: Some of Sunstone’s properties are located in desirable areas, where competition is lower and supply is restricted. However, given the mobility of the customers, this doesn’t offer a high enough barrier.
    • Branding: Some of Sunstone’s properties are in high-end chains, such as Marriott and Hyatt. While this ensures a degree of quality and brand recognition, it doesn’t provide enough exclusivity as the hotels are not owned by Sunstone.
  • Lack of Moat: Sunstone’s properties can be replicated if another company buys land in the same area and puts a hotel or resort there. The switching cost for customers is negligible.
  • Sustainability: Sunstone’s moat has a limited sustainability, because economic moats are very hard to create in this business. Hotels are easily replicable, and the company’s pricing power is low. The barriers to entry into this industry aren’t significant, meaning there is a constant threat of new entrants. The moat is not wide, meaning it can’t defend its profitability for a long time.

Risks to the Moat:

  • Recessions: Any recession or macroeconomic slowdown can affect the travel and hospitality sector, reducing occupancy and revenue for their properties.
  • Overbuilding: The overbuilding of hotels and resorts can lead to excess supply and reduce occupancies and rates.
  • Increase in Competition: New entrants can erode the company’s returns, while already existing players can compete away its pricing power.
  • Changes in consumer tastes: People’s traveling preferences can change, resulting in lower demand for hotels.
  • Rising Interest Rates: An increase in interest rates affects the cost of capital and debt refinancing, particularly concerning their debt obligations.
  • Technological Disruption: New technologies can disrupt the hospitality industry with new and better business models.

Business Resilience:

  • Variable Costs: Despite cyclical business, Sunstone has high operating leverage, which could be a risk. However, their management can adjust the cost base to match the demand.
  • Strong Brand Partnerships: The company has partnerships with world class hotel brands, which means that it will be easier for them to bounce back from an economic downturn.
  • Diversified Portfolio: Sunstone is geographically diversified, which offers some sort of safety through the varying economic landscapes across the country.

Understandability:

  • Rating: 2 / 5 The business itself is easy enough to understand. However, its financial statements are very difficult to fully understand because they are a REIT. Figuring out the effect of non-cash items like depreciation on the business is also tricky. The metrics used are also unique to the industry, so a deep understanding is required to analyze the company properly. Overall, the business requires a decent degree of analytical expertise.

Balance Sheet Health:

  • Rating: 3 / 5 Sunstone’s balance sheet is okay, but has a lot of debt and some concerning signs. While the company has a lot of assets, most of it is in illiquid properties. The company’s debt-to-equity ratio is 59.5 percent, above average for the industry, which makes them more susceptible to rising interest rates. The debt levels are particularly concerning given the limited profitability and free cash flows. Moreover, the interest coverage ratio is low, which further signals financial risk. The company also has a large amount of preferred stock that can dilute the equity. However, Sunstone has limited current liabilities and long debt maturity dates, which helps improve liquidity.

Recent Concerns/Controversies:

  • Interest Rates: During the recent earnings calls, management has clearly stated their concern about the increase in interest rates. They expect their debt payments to increase over the next couple of years.
  • Recession Fears: With recession looming, management has admitted that travel will decrease during a downturn. However, they also think they are positioned well to weather any downturn.
  • Inflation: High inflation is affecting the hotel industry, both positively and negatively. Management thinks they will be able to raise prices, but demand and margins may suffer as prices increase further.
  • Labor: Labor shortages and wage inflation have also been a recent problem and management is taking steps to tackle it. However, they are not too concerned about it.
  • Goodwill Write Offs: During Q2 earnings call the company had one-time impairment on goodwill which lowered its income for the quarter. Management said that they do not expect more of these impairments.