Pebblebrook Hotel Trust (NYSE: PEB) will likely continue to report negative funds from operations through the end of the first nine months of 2021, before leisure and business travel return to normal. However, the cash burn will likely continue to decline until September 2021, after which I expect PEB’s hotel properties to generate net positive cash flow. Increasing occupancy of currently open hotels and the re-opening of closed hotels will likely reduce the cash burn over the coming months. Overall, I believe PEB can ride out the pandemic due to its present liquidity position. I’m expecting PEB to return to the pre-pandemic dividend level by the mid of 2022. Based on my outlook of negligible dividends and dividend yield until 2022 and the subsequent normalization, I’m adopting a neutral rating on PEB.
Current Liquidity Position Gives Hope
PEB reported funds from operations (“FFO”) of negative $82 million in the third quarter, which is a small improvement from the second quarter of 2020. Around nineteen out of a total fifty-three of PEB’s hotels resumed operations during the third quarter to take the total number of open hotels to thirty-nine, according to details given in the November NAREIT Summary. The re-opening of hotels and some recovery in leisure and business travel led to a slight improvement in FFO. The following table shows PEB’s FFO and revenues over the last few quarters.
The management believes that it can break even if its occupancy level reaches the “early 50s” (meaning 50% to 53%), as mentioned in the third quarter’s conference call. This break-even occupancy level is almost double of October’s occupancy of 27%, as mentioned in the NAREIT Summary. In my opinion, PEB’s hotels will be unable to reach 50% occupancy until the last quarter of next year. I’m expecting positive cash flow in the fourth quarter of 2021 because several experts agree that life will be normal by then. The management of a COVID-19 vaccine frontrunner recently mentioned that life could return to normal by next winter, while the United States’ vaccine program advisor recently predicted that life could return to normal by May 2021.
The question is: can PEB ride out the pandemic till it reaches the break-even point?
PEB currently has a monthly cash burn rate of $16 million to $21 million, while it has cash on hand of $217 million and total liquidity of $570.2 million, as mentioned in the third quarter’s investor presentation. The cash burn will reduce over the coming months as occupancy improves in PEB’s 39 hotels that are currently open. Further, the re-opening of the remaining 14 hotels in the coming months will reduce the cash burn. However, I’m assuming that in the worst-case scenario, PEB will not be able to improve its cash burn at all through the next twelve months. Further, I’m not expecting debt repayments to boost the cash burn because PEB just has $57 million of debt maturing in November 2021, and the REIT does not have any major debt repayments until November 2022, as mentioned in the conference call. As a result, PEB will burn $246 million up to the end of the third quarter in the worst-case scenario, as shown in the table below.
The cumulative cash burn for the worst-case scenario is slightly more than PEB’s current cash on hand of $217 million. However, the projected worst-case cash burn is well within the total liquidity of $570 million. Therefore, PEB appears to have enough liquidity even for this worst-case scenario.
Leisure and Business Travel Recovery to Slow the Cash Burn
The scenario discussed above is worst-case, which suggests no improvement in the cash burn rate through the next twelve months. In a more realistic base-case scenario, the cash burn will likely steadily decline to zero through the first nine months of 2021, following which the hotel portfolio will finally start generating net positive cash flow.
The slow and gradual economic recovery throughout 2021 will be pivotal for positive cash flow. Business travel will most probably rebound as economic activity picks up pace in 2021. Additionally, I’m expecting pandemic fatigue to boost leisure travel in the second half of 2021 when the public immunization against COVID-19 is well underway.
Moreover, fourteen of PEB’s hotels that are currently closed will likely resume operations next year, which will reduce the cash burn. The management mentioned in the conference call that it was considering opening two of the closed hotels this winter, while the rest will get delayed until after the winter season.
Due to the factors mentioned above, I’m expecting the net cash burn till September 2021 to be only $100 million to $150 million. This estimate is considerably lower than the worst-case scenario estimated cash burn of $246 million.
The Best Guess for Dividend Normalization is Mid-2022
PEB slashed its dividend payout to just $0.01 per share in the first quarter of 2020, from $0.38 per share in the last quarter of 2021. PEB is unlikely to return to the pre-pandemic dividend payout immediately after its cash flow turns positive. Instead, the REIT will most probably build up cash for the sake of being prudent. PEB will also need to build up cash and capital to honor the covenants on its loans, which have been waived through the end of the second quarter of 2021, as mentioned in the conference call.
The following chart shows PEB’s FFO since March 2018.
Considering that PEB made an average FFO of around $50 million per quarter in the last eight quarters before the pandemic, I’m expecting the REIT to wait for two to three quarters before returning to the pre-pandemic level of dividend. Earning FFO of $50 million per quarter for two to three quarters will likely help recover most of the $100 million to $150 million cash burn that I’m expecting until September 2021. Consequently, I’m expecting PEB to continue to pay $0.01 per share through the mid of 2022 before returning to a dividend payout of $0.38 per share. The closing price for November 27, 2020, suggests a dividend yield of 7.8% for the twelve months ended June 2023. For 2021, I’m expecting a dividend yield of 0.2%.
I believe that investors who aren’t already invested in PEB should look elsewhere for an earlier return on investment. I would prefer to invest in a multifamily or industrial REIT with a lower dividend yield than PEB at this point. Based on my dividend outlook, I’m adopting a neutral rating on PEB.
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
Additional disclosure: Disclaimer: This article is not financial advice. Investors are expected to consider their investment objectives and constraints before investing in the stock(s) mentioned in the article.