Pebblebrook Hotel Trust is a US$4.1b mid-cap, real estate investment trust (REIT) based in Bethesda, United States. REIT shares give you ownership of the company than owns and manages various income-producing property, whether it be commercial, industrial or residential. The structure of PEB is unique and it has to adhere to different requirements compared to other non-REIT stocks. In this commentary, I'll take you through some of the things I look at when assessing PEB.
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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 PEB’s daily operations. For PEB, its FFO of US$136m makes up 52% of its gross profit, which means over a third of its earnings are high-quality and recurring.
In order to understand whether PEB has a healthy balance sheet, we have to look at a metric called FFO-to-total debt. This tells us how long it will take PEB to pay off its debt using its income from its main business activities, and gives us an insight into PEB’s ability to service its borrowings. With a ratio of 4.9%, the credit rating agency Standard & Poor would consider this as aggressive risk. This would take PEB 20.24 years to pay off using just operating income, which is a long time, and risk increases with time. But realistically, companies have many levers to pull in order to pay back their debt, beyond operating income alone.
I also look at PEB'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 2.52x, PEB is not generating an appropriate amount of cash from its borrowings. Typically, a ratio of greater than 3x is seen as safe.
I also use FFO to look at PEB'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. In PEB’s case its P/FFO is 30.29x, compared to the long-term industry average of 16.5x, meaning that it is overvalued.
Pebblebrook Hotel Trust 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 PEB:
- Future Outlook: What are well-informed industry analysts predicting for PEB’s future growth? Take a look at our free research report of analyst consensus for PEB’s outlook.
- Valuation: What is PEB 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 PEB is currently mispriced by the market.
- 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.
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