Apple Hospitality Stock: Growing Cash Flows and 7% Dividend Make This a Buy (NYSE:APLE)

Apple Hospitality REIT, Inc. (NYSE:APPLE) is the only hotel/restaurant REIT I have covered recently, and it is also the only REIT from this sector currently in my portfolio.

The underlying thesis is based on a combination of high dividend yield, favorable multiple (compared to peers and own history), improving financials and, very importantly, a strong balance sheet. Of all the drivers of the thesis, the most important, if I had to pick one, is definitely the capital structure aspect, where it is crucial to have very low leverage to minimize the risk of a sudden dividend cut. For hotel REITs, this is especially important given the inherently unpredictable nature of revenues, which unlike many other REIT sectors (e.g. office, industrial, retail, data centers) do not have long-term leases that provide the necessary cash flow visibility.

However, if we look at the total return since the publication of my original thesis, we will see that APLE has significantly underperformed the broader REIT market. In the first few quarters after the article was published, APLE showed great momentum and traded in the alpha range. However, from April 2024, as the market began to price in increased recession risks, all gains were gradually neutralized, although the rest of the REIT market recovered quite quickly and shot up (due to the more positive interest rate outlook).

In my opinion, this could be explained by the following two factors:

1. Due to the nature of the hotel business, APLE is vulnerable to economic risks.
2. Relatively limited duration factor as the sales are not based on fixed long-term agreements, which in turn means that interest rate cuts have less impact on the underlying multiple.

However, the fact that APLE has underperformed the index means that there is still opportunity to capture value (through share price appreciation) in addition to the juicy dividends, which currently yield around 7.3%.

Looking at the financial figures for the second quarter of 2024, the case becomes even more interesting.

Let me now turn to the latest quarterly report in more detail and explain why I remain optimistic.

Assessment of the thesis

The most important message we took from the Q2 2024 report is that APLE is a growing company with core metrics continuing to improve across the board.

For example, comparable hotel revenues were $387 million in Q2 2024 and $718 million for the year, up 3% and 2%, respectively, from the same period in 2023. The main source of revenue growth was an increase in comparable hotel RevPAR – up 2.5%. The rest came from slightly higher occupancy, which grew ~2%, providing a nice tailwind to overall revenue. The combination of higher RevPAR and higher occupancy sends a clear message that APLE is able to raise rates without impacting demand.

As for the cost base, comparable hotel costs increased by ~3.5% in Q2 2024, slightly exceeding the increase in revenue mentioned above. The driving force for the cost increase here was the wages and salaries component. This is clearly not a sustainable development for APLE, as costs are increasing faster than revenue (even if this still leads to a positive cash flow effect in absolute terms). However, there are two important aspects we should consider:

1. The momentum of cost increases has eased, with APLE reporting a 100 basis point improvement in the second quarter of 2024 compared to the rate of change in the first quarter of 2024.
2. Management has taken some steps to reduce reliance on temporary staff, which, combined with generally improving working conditions (from the employer’s perspective), should ease pressure in the future.

The commentary by Liz Perkins, CFO, gives a good insight into this particular aspect:

We expect near-term growth in labor costs per occupied room to be more in line with the modest increases we saw in the second quarter as the labor market stabilizes and overall inflation numbers decline. Contract labor remained relatively stable at 8.6% of total wages during the quarter, down 230 basis points, or 17%, from the same period in 2023. With lower turnover and less reliance on contract labor, we are better positioned to increase productivity at the property level. We will continue to work with our management companies to increase the efficiency of our operations over time.

Now, turning to the key metrics that measure underlying cash generation – Adjusted EBITDAre and MFFO – we see a much better picture than what was reproduced above. Namely, Adjusted EBITDAre and MFFO growth was 9% compared to Q1 2023. The reason for the discrepancy between the organic growth numbers and the overall cash generation growth results is entirely related to APLE’s M&A activities, where around $1 billion has been invested in acquiring new hotel properties since the pandemic. Granted, APLE has also divested a significant amount of properties ($294 million), but on a net basis, the portfolio has grown.

Based on management’s guidance and the fact that there was continued M&A activity by APLE in the second quarter of 2024, we can assume that the process will remain unchanged going forward (i.e. that APLE is a net acquirer).

It is important to emphasize here that APLE has the right balance sheet to enable growth. In Q2 2024, net debt to TTM EBITDA was 3.4x, which is below the industry average and indicates a conservative leverage profile. In addition, the MFFO payout ratio of 48% (based on annualized MFFO and dividend levels for Q2 2024) leaves a notable amount of internal cash generation on the books, automatically enabling M&A activity without aggressively relying on debt financing.

The conclusion

The second quarter 2024 results prove that Apple Hospitality REIT is a stable, well-capitalized and growing company. While the share price continues to be suppressed by the market, the underlying fundamentals show improving momentum.

Given the FWD P/FFO multiple of 8.6x, a dividend yield of ~7.3% and continued growing cash flows backed by a solid balance sheet, APLE is a clear buy.

Granted, the risk could come from the weakening economy, which could theoretically pose serious headwinds for APLE given its exposure to the volatile hotel segment. However, in my opinion, the following factors are enough to offset this, making the stock still a buy:

• Conservative MFFO payout ratio of ~48%, which provides sufficient safety margin to avoid a dividend cut.
• One of the strongest balance sheets in the hotel REIT sector.
• Positive organic growth statistics with favorable cost base outlook.
• A business strategy that focuses on the upscale customer base, which is naturally less sensitive to economic headwinds.
• Low FWD P/FFO multiple of 8.6x, reducing the risk of multiple contraction due to overvaluation.

For this reason, I remain optimistic about Apple Hospitality REIT.