The BUSINESS of Hotel Real Estate
Each week we screen thousands of corporate bond listings from around the globe to find what we believe to currently be the best opportunity for fixed income investors needing or seeking higher yields and good cash flow with as minimal risk as possible relative to its projected return. We take on this task because we are convinced that holding a small, but well chosen, basket of individual bonds with maturity certain dates may offer significant advantages to bond mutual funds that; (1) may carry the risk of being subjected to forced redemptions and devaluation should the sentiment of other investors turn in mass against them; (2) typically do not have fixed rate payouts; and (3) typically do not have maturity certain dates at which investors can anticipate achieving both a return of principal and its stated yield.
While the high 6½ to 9% yields currently indicated in several Canadian dollar convertible debentures from Temple Hotels, Inc. (TPH.TO) are certainly attractive enough, the bondholder’s option to convert these instruments to stock anytime up until maturity offers the potential to deliver even higher returns through long term capital gains should the stock price of Temple Hotels appreciate significantly in value. Our research leads us to believe that these bonds, although unrated by a major credit rating agency, will continue to uphold our unblemished record of acquiring higher yielding bonds that steer clear of default while providing excellent cash flow. We also believe these issues offer sound diversification away from the financial services sector of the global economy and from over-weighted US dollar based assets. Therefore, we are opportunistically targeting the better of them for inclusion into ourFixed-Income2.com and Fixed-Income3.com portfolios.
Temple Hotels Inc. was formed in accordance with a Plan of Arrangement which converted Temple Real Estate Investment Trust (TREIT) to a corporation, effective December 31, 2012. Temple Hotels Inc. continues the business of TREIT, which acquired its first property, Temple Gardens Mineral Spa, and became a publicly listed real estate investment trust on the TSX Venture Exchange on October 1, 2006. The primary investment objectives of the Company are to generate stable and growing dividends, enhance the value of the Company’s assets and maximize long-term share value through the active management of its assets, and expand the asset base and increase earnings through an accretive acquisition program with the objective of producing a geographically and sectorally diversified portfolio of hotel properties and assets.
The general strategy of the Company for external growth is to pursue the acquisition of hotel properties and assets in markets across Canada, and possibly in the United States, based on an investment criteria which focuses on return of equity, security of cash flow and potential for capital appreciation. The target capitalization rate for hotel acquisitions is generally between 9% and 12%. The overall investment strategy of the Company also encompasses the acquisition of hotels in regional clusters and of similar asset sizes in order to create economies of scale. In general, new property acquisitions are funded by arranging new mortgage financing or by assuming existing mortgage financing, with the remaining equity portion to be funded from
the reserves of investment capital. The equity portion of new property acquisitions may also be partially funded by the exchange of shares. During 2012, Temple acquired five hotels and a 50% Limited Partnership interest in two hotels, resulting in a property portfolio, which encompassed an investment in eighteen hotels as of December 31, 2012. After pro-rating for the 50% Limited Partnership interest, the acquisitions added 913 hotel rooms resulting in 2,295 revenue generating rooms in the Temple property portfolio as of December 31, 2012.
During 2012, Temple raised a total of $101 million from a public offering of trust units/convertible debentures in March 2012 and a public offering of convertible debentures in August 2012. The convertible debenture offerings consist of the 7.75% Series D debentures (conversion price if $7.04 per share) and the 7.25% Series E debentures (conversion price of $8.00 per share). Temple also retired/redeemed two series of convertible debentures in 2012, comprised of approximately $1.8 million of the remaining 7.5% Series A debentures and $82,000 of the remaining 8.75% Series S debentures. Temple acquired two additional hotels in Fort McMurray, Alberta – the Radisson Hotel & Suites and the Clearwater Residence Hotel, Timberlea. Temple is the largest hotel owner in one of the highest occupancy hotel markets in Canada. Also during 2012, Temple also entered into an agreement to acquire the Acclaim Hotel Calgary Airport, with the closing to occur subsequent to the completion of a 102 guestroom expansion project. Following the acquisition of the Acclaim Hotel, Temple will have a presence in all major centers across western Canada. On December 31, 2012, Temple completed its first hotel acquisition in Central Canada, acquiring a 50% Limited Partnership interest in the Marriott Courtyard in Ottawa, Ontario. The acquisition is an expansion of Temple’s hotel portfolio into major centers in Central Canada.
In January 2013, Temple acquired a 50% Limited Partnership interest in the Residence Inn in London, Ontario, and on March 1, 2013, Temple completed its first hotel acquisition in Atlantic Canada, acquiring a portfolio of three hotel properties (549 rooms) in Nova Scotia. Temple issued 2 million common shares at $6.25 per share relating to the acquisition of these Nova Scotia Hotels. One of the primary objectives of Temple for 2013 was to continue to expand its portfolio of hotel properties, and in March of 2013 it raised $38 million with a 7% Series F convertible debenture offering. As of September 30, 2013, the hotel portfolio of the Company consists of twenty-one hotel properties with a cost of approximately $551 Million and an appraised value of approximately $641 million, including eight hotel properties located in Fort McMurray, Alberta. Temple also has 50% equity investments in two hotel properties with a cost of approximately $18 million. The weighted average interest for Temple Hotels total debt of $456.6 million at September 30, 2013 was about 5.65%.
Occupancy averages for the three months ending Sept. 30 were 79%, compared to 73% for the first nine month of 2013, while operating profit margins for the quarter were 38% compared to 36% over all three quarters. Temple completed the nine months ended September 30, 2013 with net income of $4.3 million, compared to $2.1 million during the nine months ended September 30, 2012, representing an increase in income of $2.2 million. Cash from operating activities for the nine months ended September 30, 2013, excluding working capital adjustments, amounted to $20.0 million, representing an increase of $7.9 million compared to the first nine months of 2012. It bears noting here that consistent with a primary investment objective of the Company to generate stable and growing dividends, Temple Hotels began quarterly cash distributions (of $.10) the first quarter of 2010, changed to a monthly distribution of $0.03334 after the first quarter of 2011, increased it to $0.04 in October of 2011, and then increased it again in September of 2012 to $0.045. Under the terms of the trust indentures relating to Temple’s outstanding debentures, Temple is prohibited from paying any distributions on the Common Shares if it is in default of its obligation to pay the principal or interest on the applicable series of debentures.
On October 1, 2013, Temple acquired the Holiday Inn Express Hotel and Suites Ottawa West Nepean for $19.5 million and on November 1, 2013, Temple acquired the Acclaim Hotel in Calgary at a cost of $42 million. On October 28, 2013, Temple entered into an agreement to acquire the 106 suite Nova Court extended-stay project for $21.68 million, and the acquisition is expected to close by December 31, 2013. Last week, the Company reached an agreement with a syndicate of underwriters to issue, on a bought-deal basis, 8.621 million common shares at a price of $5.80 per common share, representing gross proceeds of approximately $50 million. Furthermore, we also want to bring attention to the fact that Arni Thorsteinson, a Chartered Financial Analyst and the CEO and Chairman of the Board of Directors for Temple Hotels, has repeatedly increased his holdings (direct and indirect) in Temple Hotels through dividend reinvestment and purchases in the open market, adding over 417,601 shares since the beginning of the year at prices ranging from $5.13 to $6.21/share. This most recent endorsement from the equity market and the many votes of confidence from the Company’s Chief Executive Officer lead us to believe that additional equity capital will likely continue to be available and supportive of this well managed company’s aggressive expansion and growth strategy.
The strategy of the Company is to efficiently utilize and manage leverage, targeting mortgage debt in the range of 50% to 60% of appraised value in order to maximize return on equity while maintaining cash flow stability. We think this is fundamentally sound, and it appears to be working very well. Furthermore, in addition to the cash flow and value of the business model itself, there remains a firm foundation of value residing in the real estate portfolio of the Company (last appraised at over $640 million) to assure bondholders a return of principle. In addition to the 7.0 to 8.0% coupons (paid semi-annually) and the various maturity dates (from Dec 31, 2016 to March 31, 2018) its series of four different debentures offer, bondholder retain the option to convert it at anytime prior to maturity to common stock at the conversion price ranging from $5.82 to $8.00, depending on terms of the particular note.
It should be noted that while we prefer the lower conversion price ($5.82) of the shorter maturity convertible (Dec 31, 2016) and its potential to further increase the over 6% yields that are currently indicated, we also find the higher yields (possibly as much as 9%) indicated in the 6 and 9 month longer bonds (but higher respective conversion prices of $7.04 and $8.00) to be extremely attractive. The best choice may ultimately reside in whichever of these lesser known and thinly traded debentures can be “opportunistically” acquired at the most reasonable prices.
The default risk is Temple Hotels ability to perform. Considering its historical and recent performance, its evidently easy access to additional to capital from the equity market, and the excellent cash flow that is projected to service their interest bearing debt, it is our opinion that the default risk for these relatively short convertible debentures is minimal relative to its highly favorable return potential or the currency risk of the Canadian dollar.
The hospitality industry and tourism in general can be more prone to profit volatility. However, considering that Hilton Worldwide Inc, the world’s largest hotel operator, raised roughly $2.34 billion in its initial public offering this week after its backer private equity and real estate firm Blackstone Group LP priced Hilton shares at $20, we think the shorter term maturity of these notes and the nearly monopolistic nature of Temple Hotel’s highly profitable Fort McMurray properties significantly reduce this risk.
The company also has execution and market risks as a relatively young and rapidly expanding company making numerous new acquisitions, as companies often encounter unforeseen issues. This is a common risk associated with younger, fast growing companies.
Being denominated in Canadian Dollars, this note also exposes bondholders to the Canadian economy and the exchange rate of the Loonie.
We believe that these Temple hotel convertible debentures have similarities to other Canadian convertible notes we have previously reviewed, including those from Tricon Capital, Neo Materials/Molycorp (MCP), TransGlobe Energy (TGA), and Brigus Gold (BRD), several of which have already achieved significant capital gains since our initial recommendation.
Temple Hotels has clearly made great strides in its core business over the last several years, and good execution is achieving rapid success with its business model. The ability of its management team to efficiently raise capital and effectively turn it into excellent cash flow while increasing the value of underlying assets is very impressive. All things considered, it is our opinion that this company has established itself as a successful niche player at a critical time in the hospitality industry, and is well poised for continued future growth. We see these Temple Hotel convertible debentures as offering an incredibly high yield in Canadian currency relative to the risks that we can identify, and a possibility for significant capital gains due to its convertibility feature. Furthermore, they offer sound diversification away from overweighted U.S dollar assets and the financial services sector. Therefore, we are selectively and “opportunistically” adding one or more of these higher yielding, short maturity, Temple Hotel Canadian dollar convertible debentures to our ourFixed-Income2.com and Fixed-Income3.com portfolios.
Temple Hotels Bonds
Toronto: $5.73 1/16/2014
Debenture (Bond): TPH.DB.C
Conversion Price: $ 5.82
Yield to Maturity: ~6.5%
Debenture (Bond): TPH.DB.D
Conversion Price: $ 7.04
Yield to Maturity: ~7.75%
Debenture (Bond): TPH.DB.E
Conversion Price: $ 8.00
Yield to Maturity: ~9%
Debenture (Bond): TPH.DB.F
Conversion Price: $ 7.80
Yield to Maturity: ~9%
Disclosure: Some Durig Capital clients may currently own Temple Hotel convertible bonds.
Please note that all yield and price indications are shown from the time of our research. Our reports are never an offer to buy or sell any security. We are not a broker/dealer, and reports are intended for distribution to our clients. As a result of our institutional association, we frequently obtain better yield/price executions for our clients than is initially indicated in our reports. We welcome inquiries from other advisors that may also be interested in our work and the possibilities of achieving higher yields for retail clients.
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