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How Should You Analyze REIT Stock DiamondRock Hospitality Company (NYSE:DRH)?

Simply Wall St

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DiamondRock Hospitality Company is a US$2.1b mid-cap, real estate investment trust (REIT) based in Bethesda, United States. REITs own and operate income-generating property and adhere to a different set of regulations. This impacts how DRH’s business operates and also how we should analyse its stock. I’ll take you through some of the key metrics you should use in order to properly assess DRH.

Check out our latest analysis for DiamondRock Hospitality

REIT investors should be familiar with the term Fund from Operations (FFO) – a REIT’s main source of cash flow from its day-to-day business activities. FFO is a higher quality measure of earnings because it takes out the impact of non-recurring sales and non-cash items such as depreciation. These items can distort the bottom line and not necessarily reflective of DRH’s daily operations. For DRH, its FFO of US$219m makes up 86% of its gross profit, which means the majority of its earnings are high-quality and recurring.

NYSE:DRH Historical Debt, July 9th 2019
NYSE:DRH Historical Debt, July 9th 2019

Robust financial health can be measured using a common metric in the REIT investing world, FFO-to-debt. The calculation roughly estimates how long it will take for DRH to repay debt on its balance sheet, which gives us insight into how much risk is associated with having that level of debt on its books. With a ratio of 22%, the credit rating agency Standard & Poor would consider this as aggressive risk. This would take DRH 4.46 years to pay off using operating income alone. Given that long-term debt is a multi-year commitment this is not unusual, however, the longer it takes for a company to pay back debt, the higher the risk associated with that company.

I also look at DRH's interest coverage ratio, which demonstrates how many times its earnings can cover its yearly interest expense. This is similar to the concept above, but looks at the upcoming obligations. The ratio is typically calculated using EBIT, but for a REIT stock, it's better to use FFO divided by net interest. With an interest coverage ratio of 5.35x, it’s safe to say DRH is generating an appropriate amount of cash from its borrowings.

I also use FFO to look at DRH's valuation relative to other REITs in United States by using the price-to-FFO metric. This is conceptually the same as the price-to-earnings (PE) ratio, but as previously mentioned, FFO is more suitable. DRH's price-to-FFO is 9.53x, compared to the long-term industry average of 16.5x, meaning that it is undervalued.

Next Steps:

DiamondRock Hospitality can bring diversification into your portfolio due to its unique REIT characteristics. Before you make a decision on the stock today, keep in mind I've only covered one metric in this article, the FFO, which is by no means comprehensive. I'd strongly recommend continuing your research on the following areas I believe are key fundamentals for DRH:

  1. Future Outlook: What are well-informed industry analysts predicting for DRH’s future growth? Take a look at our free research report of analyst consensus for DRH’s outlook.

  2. Valuation: What is DRH worth today? Is the stock undervalued, even when its growth outlook is factored into its intrinsic value? The intrinsic value infographic in our free research report helps visualize whether DRH is currently mispriced by the market.

  3. Other High-Performing Stocks: Are there other stocks that provide better prospects with proven track records? Explore our free list of these great stocks here.

We aim to bring you long-term focused research analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material.

If you spot an error that warrants correction, please contact the editor at editorial-team@simplywallst.com. This article by Simply Wall St is general in nature. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. Simply Wall St has no position in the stocks mentioned. Thank you for reading.