I recently published an article entitled “The Best Monthly Dividend Stocks” where I evaluated 17 C-corporation stocks that pay dividends monthly. In that previous article I covered the benefits of monthly dividends and provided the reader with a red/yellow/green recommendation on investment potential and a brief rationale for the recommendation on each of the 17 stocks.
To provide more granularity on those stocks ranked green in the previous article, I’m covering in more detail the four stocks I consider “The Best of the Best Monthly Dividend Stocks”. I previously covered STAG Industrial in the first of this series. This article covers the second stock in the series, Chatham Lodging Trust (CLDT).
Introduction to Chatham Lodging Trust
In the spirit of providing currently actionable investment recommendations, I chose to cover the four “Best of the Best” monthly paying stocks in order of most undervalued to least undervalued. I believe CLDT is currently undervalued when compared to its peers in the industry.
Many investors view the REIT sector as a fairly uniform group of companies (trusts) that own property or make loans on property with the investor focusing on the highest yield in the sector. This approach to primarily looking at REIT’s yield is a mistake. All REITs are not created equally and equity REITs and mortgage REITs are as different as apples and oranges.
When selecting a REIT for investment, it is important to interpret dividend yield through a qualitative (versus strictly quantitative) lens looking at the underlying risk adjusted performance to ensure the overall metrics such as the balance sheet, diversification, earnings growth, and payout ratios support continued growth of the REIT and its dividend. Consistent with this approach, the investment thesis for CLDT is laid out in the following paragraphs and charts.
CLDT is a lodging REIT that invests in Premium-Branded, Upscale Extended Stay, and Select Service hotels. This category of hotels typically have higher profit margins than full service hotels with a higher growth profile due to higher consumer demand. CLDT has a coastal preference with 50% of the portfolio located on the West Coast and 24% in the Northeast. CLDT has the 2nd highest exposure to West Coast markets of all U.S. lodging REITs.
In 2015, the company acquired four high-quality hotels in San Diego, Boston, Ft. Lauderdale, and Los Angeles. All strong market growth, multiple demand generators, with high barriers to new supply in each of these markets. At the end of 2015, the company owned 38 hotels with an aggregate of 5,675 rooms and a 10% interest in two joint ventures owning 95 hotels.
How Has Chatham Lodging Trust Performed?
One of the key performance metrics for lodging REITs is the occupancy rate. Obviously, higher is better and CLDT’s occupancy rate is one of the best.
CLDT’s occupancy rate for the nine month period ending December 31, 2015 was 83.2%, bettering most of its peers. Historically, CLDT’s occupancy rate has been higher than the US average for all hotels and higher than the average for the upscale hotels. High occupancy is a good start for making money but we have to look at whether CLDT has been able to turn occupancy into earnings.
Boy howdy, can CLDT turn high occupancy into earnings! CLDT has the highest EBITDA margin compared to all of its peers and by a significant delta. So, CLDT can generate earnings, but how fast have they been growing those earnings?
Indeed, CLDT can also grow their earnings and cash flow better than most of their peers. The chart above shows the compound annual growth rate (CAGR) of funds from operations (FFO) for CLDT and its peers. CLDT’s FFO is not the highest but it is a very healthy 27%. The chart below provides a little more granularity on CLDT’s FFO growth including the fourth quarter of 2015 and CLDT’s estimated 2016 FFO.
CLDT continues to grow its FFO. By the end of 2016, CLDT’s FFO CAGR will have be a very healthy 23%. A growing FFO is key to being able to grow dividend distributions and CLDT has not disappointed investors with its dividend payments.
CLDT’s dividend growth has been excellent at an annual rate of 13.5%. CLDT has a maintained a relatively low and conservative FFO payout ratio of about 50%. As of May 19, 2016, CLDT’s dividend is $1.32 per year providing a yield of 6.4%. Not bad in today’s low interest rate environment.
Why Do I Consider Chatham Lodging Trust Undervalued?
I’ve laid out above CLDT’s past performance but we also need to investigate CLDT’s current valuation to see if we would be getting a fair or maybe even a good deal. CLDT is currently priced at about $20.60 per share and it has a 52 week high of $28.85 and a low of $16.15 so it is closer to its low for the year.
The recent release of the April Federal Open Market Committee meeting minutes has pushed the price of CLDT and its peers down. This definitely helps the REIT sector’s overall valuation, but what about CLDT’s valuation relative to its peers?
Today, CLDT’s dividend yield is higher than it peer average at 5.8%. While CLDT’s Price/FFO at 11 is a little higher than its peer average at 10, with CLDT you are buying a strong past performance, solid and conservative management history, and a consensus forecast of future growth. Of the six analysts that follow CLDT, 4 rate it as a BUY and 2 rate it as a HOLD with a consensus fair value of $24.75 per share.
What Are The Risks Of An Investment in Chatham Lodging Trust?
The first risk is the potential for interest rates to rise significantly. CLDT is primarily an income investment with slow to medium growth with a significant dividend yield. It therefore falls into the category of bond surrogate and will likely see its share price fall if interest rates begin to rise.
Because CLDT is able and expected to grow along with the economy, a fall in CLDT’s valuation due to rising interest rates would likely be temporary. The second impact of a rising rate environment would be an increase in CLDT’s borrowing costs to continue to grow its real estate footprint. CLDT’s cost of growth capital would go up in a rising rate environment.
All that said, I don’t expect the US Federal Reserve will make any significant move to raise interest rates. It is an election year, the US economy is soft, the employment metrics have turned down over the last couple of months, and the rest of the world is still trying to juice their economies via loose monetary policy. If there is to be an increase in the Federal Funds Rate in June, I expect it will be a small one.
The second risk would be a general economic slump or recession in the US. An economic downturn would negatively impact business and leisure travel and CLDT’s revenue and earnings would likely be adversely impacted. I’m not expecting to see a recession or significant economic downturn in the US. My expectation is for more of the same low interest rate and slow grow environment that we have had over the last few years. Gasoline consumption is on a tear in the US and I expect that to continue through the summer vacation season suggesting that CLDT’s hotels will continue to their streak of high occupancy and high earnings.