RLJ Lodging Trust is a US$3.0b 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 RLJ’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 RLJ.
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 RLJ’s daily operations. For RLJ, its FFO of US$395m makes up 71% of its gross profit, which means the majority of its earnings are high-quality and recurring.
In order to understand whether RLJ 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 RLJ to pay off its debt using its income from its main business activities, and gives us an insight into RLJ’s ability to service its borrowings. With a ratio of 18%, the credit rating agency Standard & Poor would consider this as significantly high risk. This would take RLJ 5.58 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 RLJ'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 3.88x, it’s safe to say RLJ is generating an appropriate amount of cash from its borrowings.
In terms of valuing RLJ, FFO can also be used as a form of relative valuation. Instead of the P/E ratio, P/FFO is used instead, which is very common for REIT stocks. In RLJ’s case its P/FFO is 7.49x, compared to the long-term industry average of 16.5x, meaning that it is undervalued.
RLJ Lodging 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 RLJ:
- Future Outlook: What are well-informed industry analysts predicting for RLJ’s future growth? Take a look at our free research report of analyst consensus for RLJ’s outlook.
- Valuation: What is RLJ 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 RLJ 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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