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Morningstar | Updated Outlook From Pebblebrook After LaSalle Merger Disappoints; Reducing FVE to $36

Pebblebrook Hotel Trust completed its merger with LaSalle Hotel Properties midway through the fourth quarter, making direct comparisons to our estimates difficult. However, management's 2019 guidance suggests that many of the cost-saving measures and EBITDA gains they had initially laid out will take longer to realize, leading us to reduce our fair value estimate to $36 from $39. Pebblebrook's same-store results, which includes the acquired LaSalle hotels for December, saw occupancy decline 1.8% to 74.3% and average daily rate increase 2.6% to produce revenue per available room growth of 0.7% for the fourth quarter. Adjusted funds from operations came in at $0.33 for the quarter, missing our estimate of $0.38 and management's prior guidance of $0.36 to $0.43.

While we expected some noise in the fourth quarter from costs related to closing the merger, we view 2019 guidance as a slight disappointment. We thought that there was more low-hanging fruit for management to pluck from the LaSalle portfolio to drive higher revPAR and margin growth in 2019, but the guidance ranges of 1.0% to 3.0% revPAR growth and negative 0.5% to negative 0.4% EBITDA margin declines are in line with peers for the year. The lower numbers partially stem from the company's plan to renovate 13 of the company's properties this year, which should lead to large EBITDA gains in future years. Still, the amount of capital spending is higher than we anticipated, and we are cautious that there is significant operational risk behind these gains. Additionally, general and administrative spending for 2019 appears higher than we expected, as the company didn't fully capture management's planned cost synergies. As a result, Pebblebrook's AFFO guidance for 2019 of $2.59 to $2.67 falls short of our $2.77 estimate. While we think the company will still unlock much of the value of the merger eventually, our slightly reduced outlook combined with the time value of money reduces our estimate for the company.

Pebblebrook has accomplished several parts of its post-merger plans with solid execution. The company announced that it has completed the sale of the Liaison Capitol Hill and Hotel Palomar Washington, D.C., for total proceeds of $251.5 million. The economic NOI cap rate on these dispositions averaged 5.5%, well below our 6.6% assumption. Pebblebrook additionally plans to dispose of another $250 million in LaSalle assets in the second quarter and another $100 million in the third quarter at similar cap rates, showing that it is achieving better pricing then we expected on noncore assets.

Management also was able to replace $1.1 billion of expiring LaSalle debt and all of the outstanding balance on their credit facility with a new $1.75 billion term loan. While the company's net debt/EBITDA ratio of 4.9 times was above Pebblebrook's 4.2 before the merger and above the company's long-term goal, the recently completed sales will drop management down to a 4.7 times coverage ratio and debt reductions from the remaining asset sales should put the company close to its desired level. Pebblebrook is also left with no debt maturities in 2019 after the recent moves, leaving the company with the financial flexibility to address the capital needs of the portfolio in the short term.