I recently published an article titled “The Best Monthly Dividend Stocks” where I evaluated 17 C-corporation stocks that pay dividends monthly. In that 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, Financial).
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. Chatham 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 REITs' 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 Chatham is laid out in the following paragraphs and charts.
Chatham is a lodging REIT that invests in premium-branded, upscale extended stay and select service hotels. This category of hotels typically has higher profit margins than full-service hotels with a higher growth profile due to higher consumer demand. Chatham has a coastal preference with 50% of the portfolio located on the West Coast and 24% in the Northeast. Chatham has the second-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, Florida, and Los Angeles –Â 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 Chatham’s occupancy rate is one of the best.
Source: Chatham Lodging Trust Investor Relations
Chatham’s occupancy rate for the nine-month period ending Dec. 31, 2015 was 83.2%, bettering most of its peers. Historically, Chatham’s occupancy rate has been higher than the U.S. 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 Chatham has been able to turn occupancy into earnings.
Source: Chatham Lodging Trust Investor Relations
Boy, howdy, can Chatham turn high occupancy into earnings! Chatham has the highest EBITDA margin compared to all of its peers and by a significant delta. So Chatham can generate earnings, but how fast has it been growing those earnings?
Source: Chatham Lodging Trust Investor Relations
Indeed, Chatham can also grow its earnings and cash flow better than most of its peers. The chart above shows the compound annual growth rate (CAGR) of funds from operations (FFO) for Chatham and its peers. Chatham’s FFO is not the highest, but it is a very healthy 27%. The chart below provides a little more granularity on Chatham’s FFO growth including the fourth quarter of 2015 and Chatham’s estimated 2016 FFO.
Chatham continues to grow its FFO. By the end of 2016, Chatham’s FFO CAGR will be a very healthy 23%. A growing FFO is key to being able to grow dividend distributions and Chatham has not disappointed investors with its dividend payments.
Source: Author
Chatham’s dividend growth has been excellent at an annual rate of 13.5%. Chatham has maintained a relatively low and conservative FFO payout ratio of about 50%. As of May 19, Chatham’s dividend was $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 Chatham’s past performance, but we also need to investigate Chatham’s current valuation to see if we would be getting a fair or maybe even a good deal. Chatham is 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 Chatham and its peers down. This definitely helps the REIT sector’s overall valuation, but what about Chatham’s valuation relative to its peers?
Today, Chatham’s dividend yield is higher than its peer average at 5.8%. While Chatham’s Price/FFO at 11 is a little higher than its peer average at 10, with Chatham you are buying a strong past performance, solid and conservative management history and a consensus forecast of future growth. Of the six analysts who follow Chatham, four rate it as a BUY and two 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. Chatham 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 Chatham is able and expected to grow along with the economy, a fall in Chatham’s valuation due to rising interest rates would likely be temporary. The second impact of a rising rate environment would be an increase in Chatham’s borrowing costs to continue to grow its real estate footprint. Chatham’s cost of growth capital would go up in a rising rate environment.
All that said, I don’t expect the U.S. Federal Reserve will make any significant move to raise interest rates. It is an election year, the U.S. 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 its 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 U.S. An economic downturn would negatively impact business and leisure travel and Chatham’s revenue and earnings would likely be adversely impacted. I’m not expecting to see a recession or significant economic downturn in the U.S. 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 U.S., and I expect that to continue through the summer vacation season suggesting that Chatham’s hotels will continue to their streak of high occupancy and high earnings.
(By Dirk S. Leach)
Start a free seven-day trial of Premium Membership to GuruFocus.
