Fitch Upgrades Host Hotels' IDR to 'BBB'; Outlook Stable
KEY RATING DRIVERS
The IDR upgrade to 'BBB' reflects the issuer's demonstrated adherence to, and Fitch's expectation of, maintaining leverage within its more conservative 2.5x to 3.0x public financial policy target adopted following the last downturn. Sustaining leverage in this range during lodging industry expansions should allow Host to keep leverage during a downturn a turn or more below similarly rated REITs with less volatile cash flows. This assumes that the company's peak-to-trough EBITDA decline during a downturn is consistent with its negative 30% to negative 50% historical experience.
It is appropriate for Host to sustain trough leverage below similarly rated REITs with less volatile cash flows backed by longer duration contractual leases. This is due to the generally weaker institutional demand for secured property-level mortgages for hotels during periods of economic and capital markets stress relative to other CRE property type.
The ratings also consider Host's high-quality portfolio of geographically diversified upper-tier hotel properties, as well as its large and liquid unencumbered asset pool. Fitch views the latter as an important source of contingent liquidity that supports the rating. Host's portfolio is almost entirely unencumbered.
U. S. Lodging Cycle Peaking
Fitch projects that U. S. revenue per available room (RevPAR) will increase by 3%-4% during 2016 and by 1%-2% during 2017, with monthly comparisons possibly turning negative during the latter half of the year. We expect 2018 to mark the first full year of RevPAR declines, assuming the historical six - to 12-month lag between occupancy and RevPAR declines holds.
Fitch expects Host's RevPAR to grow moderately below the industry average during the year due to its exposure to upper-price-tier hotels and portfolio weightings in markets with weaker near-term outlooks, such as New York and Washington, D. C. Solid group demand and recently completed growth capex investments should support Host's RevPAR growth during 2016 and 2017 of 3% and 1%, respectively.
Sustained Lower Leverage
Host has reduced its leverage from its down-cycle peak of 5.8x to 2.6x for the trailing 12-month (TTM) period ending June 30, 2016. This leverage level is in line with Fitch's rating case projections through 2019. The reduction and Host's public commitment to sustain leverage in the 2.5x to 3.0x range are key considerations incorporated in Fitch's ratings.
Fitch's ratings for Host have only limited tolerance for leverage sustaining above 4.0x over the rating horizon (typically one-to-two years). However, the ratings contemplate a scenario where Host's leverage temporarily increases above 4.0x in recognition of hotel industry cyclicality and capital intensity, as well as the limited ability to retain cash and reduce debt due to its REIT status. Under such a scenario, the company's willingness and sense of urgency to bring leverage back to the 3.0x range would likely determine whether Fitch maintains its ratings and Stable Outlook, along with Fitch's outlook on for leverage to return to the company's 2.5x-3.0x policy range.
Fitch's stress case forecast assumes that peak cyclical leverage is comfortably below 4.0x. Fitch defines Host's leverage as debt, net of readily available cash divided by recurring operating EBITDA.
Large and Liquid Unencumbered Portfolio
Host's large unencumbered asset pool provides an excellent source of contingent liquidity. Fitch calculates the company's unencumbered assets-to-net unsecured debt (UA/UD) ratio at 2.5x as of June 30, 2016. Fitch reflects the cyclicality of Host's cash flows in its UA/UD analysis by haircutting its TTM unencumbered EBITDA by 20% and applying a stressed 8x multiple to calculate unencumbered asset value.
Host's unencumbered asset profile has several attractive features that should enhance its appeal as collateral. The company's hotels are principally located in key 'gateway' markets that balance sheet lenders tend to favor. Moreover, its hotels are generally aligned with the strongest brands in the industry. Finally, Host owns some of the largest and most valuable hotels in the U. S., which should allow it to raise a large amount of secured debt capital quickly, if needed.
Strong Fixed-Charge Coverage
Fitch's rating case projections anticipate that Host's fixed-charge coverage (FCC) ratio will improve to the 7.0x to 8.0x range over the rating horizon. Strong property-level EBITDA growth, lower leverage and the refinancing of higher-cost debt support these expectations. Fitch defines FCC as recurring operating EBITDA less renewal and replacement capital expenditures, divided by cash interest expense and capitalized interest.
Host maintains a high-quality, geographically diversified portfolio of 98 consolidated luxury and upper upscale hotel properties across the U. S. including nine international hotels located in, Australia, Brazil, Canada, Mexico, and New Zealand. The company's portfolio provides significant financial flexibility and geographically diverse cash flows, which Fitch views positively.
Heightened Event Risk Potential
Fitch's ratings for Host do not contemplate a deviation from the company's current financial policies. However, Fitch recognizes the heightened possibility for 'event risk' in the form of a change in financial policy given the weak absolute and relative performance of the company's shares and concerns expressed by some market participants that the company's low leverage strategy is suboptimal.
Fitch's ratings for Host have some tolerance for share repurchases, provided the company executes its program within its stated financial policies, primarily sustaining leverage below 3.0x. Nevertheless, Fitch views share repurchases as a credit negative, all else equal, that favor equity holders over bondholders.
The company's board authorized a $500 million share repurchase program in October 2015 to respond to the share underperformance. Host has repurchased approximately 21 million shares for $338 million under its current authorization, leaving $162 million of capacity remaining at June 30, 2016.
Cyclicality Drives Earnings Volatility
The cyclical nature of the hotel industry is Fitch's primary credit concern. Hotels re-price their inventory daily and, therefore, have the shortest lease terms and least stable cash flows of any commercial property type. Economic cycles, as well as exogenous events (i. e. acts of terrorism), have historically caused material declines in revenues and profitability for hotels.
Host has a strong liquidity position that is underpinned by its committed revolving credit facility and retained cash flows from operations. The company has a coverage ratio of 1.8x, including estimated retained cash flows from operations and no refinancing of maturing debt and 2.0x, assuming 80% of secured debt is refinanced at maturity.
Fitch expects the company to exercise its option to extend maturity of its $500 million term loan due 2017 to 2019, which would result in a coverage ratio of 3.7x, including estimated retained cash flows from operations and no refinancing of maturing debt and 4.2x, assuming 80% of secured debt is refinanced at maturity.
The Stable Outlook centers on Fitch's expectation that Host's credit profile will remain appropriate for the 'BBB' rating through economic cycles, barring any significant changes in the company's capital structure plans. The Stable Outlook also reflects the quality of Host's portfolio and unencumbered asset coverage that provides good downside protection to bondholders.
Fitch's key assumptions within our rating case for the issuer include:
--U. S. lodging industry RevPAR grows 3%-4% during 2016 and 1%-2% in 2017 before turning negative in 2018; upper-price-tier hotels deliver moderately below-average RevPAR growth;
--Fitch expects Host's RevPAR growth trails the industry for the full year 2016 at 3% due to its portfolio exposures to weaker markets, such as New York City and Washington, D. C. Fitch's 2016 and 1% 2017 RevPAR growth expectations assume continued healthy group demand trends and a moderate benefit from its recently renovated hotels. Host's 2016 RevPAR guidance of 2%-3% growth excludes recently renovated hotels. Fitch has assumed a 2.5% RevPAR decline for Host during 2018;
--Host's EBITDA margins are flat through 2017 and contract slightly in 2018, excluding non-routine items;
--Fitch expects annual maintenance capital expenditures of $300 million through the forecast horizon.
--Host completes the sale of two New Zealand hotels currently under contract in 2016. No further acquisitions or dispositions during the forecast period;
--The company completes its $500 million share repurchase authorization during 2016. Fitch has also assumed no share repurchases in 2017-2019 as the disposition slow and the company has publicly stated that it will not leverage up beyond its policy targets to repurchase stock.
--Host adopting a publicly stated leverage target below its current 2.5x to 3.0x policy could lead to positive momentum. Fitch believes this is unlikely given the company's growth strategy and historical financial policies.
--Host revising its policy leverage target above 3.0x could have negative rating implications. The ratings have limited tolerance for Host's leverage temporarily increasing to the mid-3.0x range for a strategic acquisition and, to a lesser extent share repurchases. This assumes we see a path for Host's leverage to return to its 2.5x-3.0x policy range within approximately one year (strategic acquisition) to six months (share repurchases) and that Fitch has a stable or positive lodging industry outlook.
--Fitch's expectation for leverage to sustain above 4.0x over the rating horizon, due to a cyclical lodging industry downturn could also lead to a downgrade in the ratings and/or Outlook. Fitch has little or no tolerance for Host's leverage exceeding 6.0x during a cyclical downturn at the 'BBB' rating level.
--A U. S. lodging industry downturn more severe than Fitch's stress case scenario could also cause a negative rating action. Fitch's stress case contemplates industrywide RevPAR declines of 13%-15%, which is conservative, but less severe than the 20% declines in 2008-2009.
FULL LIST OF RATING ACTIONS
Fitch has upgraded the ratings as follows:
Host Hotels & Resorts, Inc.
--Long-Term IDR to 'BBB' from 'BBB-'.
Host Hotels & Resorts, L. P.
--Long-Term IDR to 'BBB' from 'BBB-';
--Senior unsecured credit facility to 'BBB' from 'BBB-'
--Senior unsecured notes to 'BBB' from 'BBB-'.
The Rating Outlook is Stable.