Fitch Affirms Host Hotel & Resorts' IDR at 'BBB-'; Outlook Stable
KEY RATING DRIVERS
The ratings reflect Fitch's expectation that Host will sustain leverage at or below its stated 2.5x to 3.0x leverage target and that the company's credit metrics will remain appropriate for the 'BBB-' IDR through the lodging cycle. 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.
U.S. Lodging Still in a Good Place
Accelerating U.S. GDP growth and low levels of new supply set the table for strong U.S. lodging industry fundamentals during 2015. Robust demand has boosted occupancy rates, providing hotels with material pricing power. Fitch expects U.S. RevPAR to increase by 7% this year, based on a 2% occupancy gain and 5% average daily room rate (ADR) growth.
Fitch expects Host's RevPAR to grow moderately below the industry average during this 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., as well as renovation disruption at several large properties. Accelerating group fundamentals and strong growth from recently renovated properties should support solid RevPAR growth during 2016 and 2017. Fitch has assumed 5% and 4%, respectively.
Sustained Lower Leverage
Host has reduced its leverage from its down-cycle peak of 5.8x to 2.8x for the trailing 12-month (TTM) period ending June 30, 2015 - a level that is in-line with Fitch's rating case projections. 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. Host's TTM leverage was 2.6x on a pro forma basis that assumes its \\$400 million 2.5% exchangeable notes are converted to equity during October 2015.
Fitch's ratings for Host have only limited tolerance for leverage sustaining above 4.0x over the rating horizon (typically one-two years). However, the ratings contemplate a scenario where Host's leverage temporarily increases above 4.0x - a 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 below 4.0x would likely determine whether Fitch maintains its investment-grade ratings.
Fitch's stress case forecast assumes that peak cyclical leverage is comfortably below 5.0x and that it would decline to below 4.0x within the ratings horizon. 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 that the company's unencumbered assets-to-net unsecured debt (UA/UD) ratio at 2.6x as of June 30, 2015. The company's UA/UD ratio improves to 2.8x on a pro forma basis that assumes its \\$400 million 2.5% exchangeable notes are converted to equity during October 2015.
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 their 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 secured debt capital quickly and in size, if needed.
Strong Fixed-Charge Coverage
Fitch's rating case projections anticipate that Host's fixed-charge coverage 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 Fitch's expectations. Fitch defines Host's fixed-charge coverage as recurring operating EBITDA less renewal and replacement capital expenditures, divided by cash interest expense and capitalized interest.
Diversified Portfolio
Host maintains a high-quality, geographically diversified portfolio of 110 consolidated luxury and upscale hotel properties across the U.S. including 16 international hotels located in, Australia, Brazil, Canada, Chile, 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 its current financial policies. However, Fitch recognize the heightened possibility for 'event risk' in the form of a change in financial policy given the weak absolute and relative performance of its shares and concerns expressed by some market participants that the company's low leverage strategy is suboptimal.
Share Repurchases
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 view share repurchases as a credit negative, all else equal, that favors equity holders over bondholders.
The company's board authorized a \\$500 million share repurchase program earlier this year to respond to the share underperformance. Host has repurchased 17.4 million shares for \\$330 million under its current authorization, leaving \\$170 million of capacity remaining at Sept. 25, 2015. The \\$19.00 per share average repurchase price is roughly 18% above Host shares' \\$16.05 closing price on Sept. 25, 2015.
Cyclicality Drives Earnings Volatility
The cyclical nature of the hotel industry is Fitch's primary credit concern related to Host. 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.
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.
KEY ASSUMPTIONS
--U.S. lodging industry RevPAR grows 7% during 2015; Upper-price-tier hotels deliver moderately below-average RevPAR growth;
--Group demand (room nights booked in blocks of 10, or more) momentum continues to improve;
--Host's RevPAR growth trails the industry for the full year 2015 at 4.25% due to its portfolio exposures to weaker markets, such as New York City, Houston and Calgary, as well as renovation disruption at several large hotels. Fitch's 5% RevPAR expectation for 2016 assumes continued healthy group demand trends and a moderate benefit from its recently renovated hotels. Fitch has assumed 4% RevPAR growth for Host during 2017.
--Host's EBITDA margin improves by roughly 50 bps per year through 2017, excluding non-routine items.
--No acquisitions or dispositions during the forecast period;
--The company satisfies its exchangeable notes put obligation through the issuance of new shares, rather than cash;
--Host draws the remaining \\$200 million under its \\$500 million delayed draw term loan during 4Q15;
--The company completes its \\$500 million share repurchase authorization during 2015. Fitch has also assumed the company repurchases an additional \\$250 million of shares during 2016 and 2017 that are currently not authorized.
RATING SENSITIVITIES
--A reduction in Host's public stated leverage target of 2.5x to 3.0x and commensurate deleveraging of its balance sheet could lead to positive momentum. At this point, Fitch believes this is unlikely given the company's growth strategy and historical financial policies.
--Fitch expects management to support its balance sheet at a level commensurate with a 'BBB-' rating. There could be negative rating implications if Host revises its financial policy leverage target above 3.0x.
--Fitch's expectation for leverage to sustain above 4.0x over the rating horizon, due to a cyclical lodging industry down turn could also lead to a downgrade in the ratings and/or Outlook.
--A negative rating action could also occur if a downturn is more severe than Fitch's stress case scenarios, which contemplates industrywide RevPAR declines of 13%-15%. Due at least in part to the more attractive supply growth environment relative to the last recessions, Fitch believes RevPAR declines would be somewhat less severe than the 20% declines experienced in 2008-2009.
--A material reduction in Host's UA/UD ratio could have negative rating implications.
FULL LIST OF RATING ACTIONS
Fitch has affirmed the following ratings:
Host Hotels & Resorts, Inc.
--Long-term IDR at 'BBB-'.
Host Hotels & Resorts, L.P.
--IDR at 'BBB-';
--Senior unsecured credit facility at 'BBB-'
--Senior unsecured notes at 'BBB-';
--Senior unsecured exchangeable notes at 'BBB-'.
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