Buy Host Marriott paper on weakness, credit analyst suggest

By Ronda Fears

Nashville, May 19 - Host Marriott Corp. paper might get cheaper, but Gimme Credit analyst Kimberly Noland suggested in a report Monday to buy on the recent weakness.

"Bonds in the high yield lodging sector have enjoyed significant post-Iraq-war spread tightening despite weakening fundamentals," Noland noted in the report.

But lower occupancy and room rates at Host Marriott's (Ba3/B+) upscale hotels sent revenue per available room down almost 6% in first quarter, and the company's bonds cheapened, she added.

"Although there is anecdotal evidence of a rebound in travel, we think top line erosion for the remainder of 2003 will hurt [Host Marriott's] operating performance, resulting in weaker credit ratios," Noland said.

"Bonds could get cheaper again, despite the company's ample liquidity and real estate asset value that underpin credit quality," she said, adding: "We think Host Marriott bonds will get cheaper and would look to buy on weakness."

Host Marriott said second quarter results will be worse with RevPAR declines of 6-8%. Costs are creeping up too. Comparable hotel level operating margin declined almost 15%, or 390 basis points, year-over-year because of higher insurance, energy and wage expenses.

The combination of revenue decline and increased costs sent EBITDA down almost 15% from last year's first quarter to $175 million.

Host Marriott reduced full year guidance and Gimme Credit estimates 2003 EBITDA at the low end, or $750 million. Without significant debt reduction, the analyst also noted that leverage likely will increase a full turn this year to almost 7.5x and interest coverage could fall to 1.6x.

Host Marriott wants to sell up to $250 million of assets this year and use the proceeds to reduce debt or acquire new properties.

"Even if management were committed to applying the proceeds solely to debt reduction, the weak asset sale environment and the company's reluctance to sell at low prices may result in few executions," Noland said, noting Host Marriott didn't complete any material asset sales last year.

Free cash flow won't be a big contributor to debt reduction, either, as the analyst expects free cash flow to be just over breakeven, despite a lower capital spending budget.

"Operating results may not be robust, but the company has plenty of liquidity," Noland pointed out.

In addition to over $300 million of cash on the balance sheet, Host Marriott has an undrawn revolver of another $250 million under its recently amended bank credit facility. Importantly, the amendment modified financial covenants, which should reduce the risk of near-term covenant noncompliance.

The company likely will not be able to pay its preferred stock dividend for the fourth quarter, she said, but no liquidity issue looms as debt maturities are modest until August 2005, when $500 million of senior notes matures.

"We expect an economic recovery to stimulate lodging demand by then, mitigating refinancing risk," Noland said.

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