DiamondRock Hospitality: I’m Not Worried About The 8.4% Yielding Preferreds (NYSE:DRH)

Introduction

Typically a smaller challenge of most popular shares in a lesser-followed title may present a superb danger/reward ratio. I initiated an extended place in DiamondRock Hospitality’s (NYSE:DRH) most popular shares, that are buying and selling with (NYSE:DRH.PA) as ticker image. After I revealed the earlier article on DiamondRock, the popular shares have been buying and selling at a 1.5% premium to the principal worth of $25 per most popular shares however are at the moment out there at a reduction once more. I needed to comply with up on the REIT’s This autumn outcomes and outlook for 2023 to see if I ought to proceed so as to add to my place.

The fourth quarter was according to the expectations

I’ll primarily give attention to the REIT’s FFO and AFFO efficiency versus the overall money outflow associated to the popular dividend funds as the security of the popular shares is the main focus level of this text.

As you may see under, the REIT generated an AFFO of $0.23 per diluted share.

The total-year AFFO got here in at $216M which, divided over the present share depend of lower than 210M shares leads to an AFFO/share of $1.03. The $1.01 proven under relies on the weighted common share depend all year long whereas my $1.03 relies on the present share depend.

The This autumn and FY 2022 outcomes are crucial info. We all know the popular dividends are costing the REIT slightly below $10M per yr. And that is essential as a result of this implies the popular dividends are exceptionally well-covered by the AFFO profile of the REIT. Adjusted for the $9.8M in most popular dividend funds, the AFFO exceeds $225M on a pre-dividend foundation which suggests the REIT wants lower than 5% of its pre-dividend AFFO to successfully cowl the popular dividend funds. That could be very encouraging, and as DiamondRock pays a quarterly dividend of simply $0.03 per share on its frequent models, the vast majority of its AFFO is added to the stability sheet thereby making the stability sheet stronger by the quarter.

I added a little bit bit to my most popular share place

As defined in my earlier article, the sequence A most popular shares (NYSE: DRH.PA) are cumulative challenge, providing an annual most popular dividend of $2.0625 per preferred share paid in 4 quarterly installments. The securities might be known as from Aug. 31, 2025 on.

Earlier on this article I already established, the popular dividends are very well-covered, however I additionally wish to control the asset protection ratio. The stability sheet offers a superb look below the hood. We see the overall quantity of belongings as of the top of FY 2022 was roughly $3.2B, of which $2.75B have been actual property belongings.

As you may see under, the REIT had about $67.6M in money as of the top of final yr whereas the stability sheet additionally carried $1.19B in debt (aside from regular liabilities that come up in the middle of doing enterprise) leading to web monetary debt of simply over $1.1B. This represents roughly 40% of the guide worth of the belongings.

Whereas the guide worth of a REIT is at all times attention-grabbing, I additionally like to take a look on the acquisition price of the actual property belongings. And as you may see under, the $2.75B in guide worth consists of an amassed depreciation of roughly $1.2B, so the present market worth of the belongings is probably going considerably greater than the guide worth.

That is essential as a result of it permits buyers to attempt to get a greater understanding of how ‘secure’ the popular shares are from a stability sheet perspective.

There are at the moment 4.76M most popular shares excellent which suggests about $119M of the fairness on the stability sheet is attributable to the popular shareholders. This has two essential implications. To begin with, based mostly on the virtually $1.6B in fairness on the stability sheet, there’s nearly $1.5B in fairness ranked junior to the popular shares. That is a really stable ‘margin of error’ in case DiamondRock would run into stability sheet points.

Secondly, if we might assume the truthful worth of the belongings is someplace midway in between the guide worth of $2.75B and the acquisition price of $3.94B (so roughly $3.35B), this might point out there’s about $600M in ‘hidden worth’ on the stability sheet, which makes the stability sheet (and thus the popular shares) even safer.

So from an asset protection perspective, I am not fearful in any respect about the popular shares. And because the complete quantity of fairness ranked junior to the popular shares elevated with out seeing a extra substantial improve within the web indebtedness, I might argue the stability sheet has gotten safer.

In fact, the one aspect I should control is the evolution of the debt. A lot of the debt has a floating rate of interest, so there’ll for positive be stress on the FFO and AFFO generated by DiamondRock Hospitality. However as I already defined within the first a part of this text, the popular dividends are literally very nicely coated by the incoming earnings.

And with a median rate of interest of 4.83%, the worst of the rate of interest will increase must be behind us. If I might as an illustration apply a 6% rate of interest on the complete $1.19B in gross debt, the overall curiosity bills would improve to only $72M. And whereas that could be a substantial improve, it’s a very manageable $34M bump versus the FY 2022 web curiosity bills of $38M. The official steerage for 2023 requires an curiosity expense of $61M this yr.

Additionally essential: the vast majority of the debt is unsecured and DiamondRock may at all times take a look at issuing secured debt upon refinancing among the unsecured debt.

Funding thesis

DiamondRock ended 2022 on a powerful notice. The popular dividends are very nicely coated whereas the stability sheet appears to be like very sturdy as nicely. DiamondRock can name the popular shares from mid-2025 on, and I feel the chances of the REIT calling the preferreds are rising because the stability sheet is constantly enhancing due to DiamondRock’s give attention to retaining earnings. This could make it comparatively simple to only repay the $119M in most popular fairness which can subsequently carry the AFFO per frequent share by greater than 4 cents per share. The yield to name is roughly 8.95%. The present yield is 8.4% based mostly on the present share value of $24.60.

I’ll proceed so as to add to my place on weak spot (learn: under the $25 principal worth).