NEW YORK--(BUSINESS WIRE)--Fitch Ratings has affirmed Starwood Hotels & Resorts Worldwide Inc.'s (Starwood) Issuer Default Rating (IDR) at 'BBB'. The Rating Outlook remains Stable. A full list of ratings actions follows at the end of this release.
The affirmation primarily reflects positive industry fundamentals, the company's strong market position and brand awareness, its public commitment to manage leverage between 2.0 times (x) and 2.5x over the long term, and its ongoing transition to an asset-light business model that will reduce cash flow volatility. Concerns reflected in the current rating include the inherent cyclicality in the lodging industry, the company's limited track record of maintaining investment grade metrics through a lodging cycle, and the potential for a large acquisition, increased investment spending, or an increase in shareholder friendly actions. However, there is room within the current rating for these actions given the current core lease-adjusted leverage at March 31, 2014 of 1.6x.
KEY RATING DRIVERS
Leverage Below Target
Given no change in its financial policy, Fitch expects an increase in Starwood's leverage towards its targeted range over time through share repurchases and common dividends, and possibly brand acquisitions if opportunities are present. Starwood's leverage is currently strong for the 'BBB' rating and provides ample flexibility to absorb a significant weakening in the overall economy (leading to high single/low double digit revenue per available room [RevPAR] declines) without a negative rating action.
Lower borrowings, in combination with EBITDA growth, has reduced Starwood's core-lease adjusted leverage to 1.6x for the trailing 12 months (TTM) ending March 31, 2014 from 3.8x at year-end 2010. The company has reduced its recourse debt levels from $2.8 billion at year-end 2010 to $1.2 billion as of March 31, 2014.
Although the company's current leverage is well below Fitch's 2.75x target for Starwood at the 'BBB' rating, management has publicly reiterated its 2.0x-2.5x target leverage commitment - a level the company believes will allow it to retain its investment grade rating through a full lodging cycle.
Committed to Capital Light
Fitch believes that Starwood remains committed to transitioning to a capital light strategy and expects fee income to grow to approximately 80% of the company's segment level operating profit (i.e. before G&A) by 2016. Starwood has grown its recurring fee income as a percentage of segment level operating profit to 63% of total operating profit during 2013 from 17% in 2000. Although Starwood has sold roughly $8.7 billion of owned hotels since 2000, the global financial crisis (GFC) hampered the company's recent progress towards asset light by limiting its ability to dispose of properties at attractive prices.
However, Fitch expects asset sales to increase during the forecast period due to strong investor demand for hotel properties. Starwood cited favorable trends in pricing and liquidity within the hotel investment sales market during its fourth-quarter 2013 earnings conference call, striking a noticeably more bullish tone that suggests the company may accelerate its asset disposition plans. Fitch estimates that several billion dollars of real estate on Starwood's balance sheet could be monetized and returned to shareholders through additional special dividends and/or share repurchases.
Starwood has sold $232 million of owned hotels so far during 2014, including the $213 million sale of The St. Regis Bal Harbour Resort in Miami Beach, FL and the Aloft Tucson University, AZ for $19 million. Both sales were conditioned on Starwood receiving a long-term management contract. This follows the sale of six owned hotels for $248 million of net proceeds and eight hotels for $520 million during 2013 and 2012, respectively.
Bending on Return of Capital Strategy
All things equal, Fitch views the improved visibility provided by Starwood's announcement that it will repurchase $614 million of stock in 2014 as a credit positive - a rare instance where bondholder and shareholder interests are aligned. Outside of debt repayments, Fitch views acquisitions as the most creditor friendly avenue of free cash flow deployment for lodging C-corps, followed by share repurchases and special and regular common dividends.
Starwood management has consistently stated that share repurchases are an important component of its broader capital allocation strategy that is designed to provide maximum flexibility with respect to returning capital to shareholders. Regular common and 'recurring' special dividends are the two principal alternative avenues that the company uses.
In February, Starwood announced a $500 million of special dividend to be paid in four 'recurring' quarter distributions during the year from the net cash generated from its recently completed St. Regis Bal Harbour residential project and related hotel sale. The company paid the first $0.65 per share special quarterly distribution in March and declared the next dividend on May 1 to be paid on June 27 to shareholders on record as of June 6.
Leveraged to More Volatile Segments
Fitch generally views Starwood's emphasis on upper price tier hotels and its relatively high exposure to advanced emerging economies as a credit positive through the cycle. These segments are well positioned to benefit from key demographic trends within the global hospitality industry, a rapidly growing middle class in selected countries (e.g. China) that are leading to increased inbound and outbound travel demand. However, Fitch acknowledges that these segments of the industry have historically been more volatile than the averages in terms of RevPAR growth, which along with the company's sizable owned hotel portfolio could lead to greater cash flow volatility for Starwood. Fitch has reflected this risk in its stress scenario analysis for Starwood by assuming a greater than industry average drop in RevPAR, as well as a larger reduction in its EBITDA margin.
Positive Industry Fundamentals
The affirmation reflects Fitch's positive outlook for the lodging industry in 2014 with a conservative base care scenario for U.S. RevPAR growth of 5.5%. This level of growth is roughly in-line with the 5.4% growth in 2013 and a modest deceleration from the 6.8% growth in 2012, according to STR Global industry data. Fitch expects average daily rate (ADR) increases will drive a majority of the RevPAR improvement given that occupancies are at or above peak levels in many markets. Fitch expects Starwood's systemwide RevPAR to grow at the U.S. industry average due to its exposure to select geographies, such as China and Western Europe, that Fitch expected to grow slower than the industry average.
Fitch expects supply to grow by 1.1% in 2014 - a modest acceleration from the 0.7% growth in 2013, but still well below the 1.9% long-term average since 1987. Low new supply growth continues to support greater pricing flexibility for the industry generally and Starwood specifically. Supply growth reached its cycle low at 0.5% in 2012.
The ratings incorporate Fitch's current macroeconomic outlook, including annual U.S. GDP growth of 2.8% and 3.1% in 2014 and 2015 and world economic growth of 3.6% and 3.4% during the same respective periods. Fitch recognizes the cyclical nature of the lodging industry and the potential for heightened global macroeconomic. However, Starwood is well positioned to withstand softer economic conditions than those contemplated in Fitch's base case expectations, as discussed below.
--Starwood's current leverage is more consistent with a higher rating. A positive rating action could occur if the company publicly commits to a more conservative financial policy, and Fitch believes that the company has the intent and ability to carry out such policy. Fitch does not expect the company to revise its publicly stated financial policies.
--The company has ample flexibility at the current rating to pursue special dividends, debt funded acquisitions or share repurchases as long as it maintains core lease adjusted leverage below 2.75x.
--A negative rating action could occur if management changes its financial policy and increases leverage substantially to return capital to shareholders. Starwood's public commitment to manage leverage in the 2.0x-2.5x longer term is comfortably within Fitch's target of 2.75x for a 'BBB' rating.
--There is tolerance in the rating to temporarily increase leverage above the target level for a 'BBB' rating so long as Fitch anticipates a reduction in leverage to 2.75x or below within 12-18 months.
Fitch has affirmed Starwood's ratings as follows:
--IDR at 'BBB';
--$1.75 billion senior unsecured credit facility at 'BBB';
--$1.2 billion of senior unsecured notes at 'BBB'.
Additional information is available at 'www.fitchratings.com'.
Applicable Criteria and Related Research:
--'Inn the Footnotes: Comparison of Adjusted Credit Metrics and Contingency Risk for U.S. Lodging C-Corps' (Jan. 7, 2011);
--'2014 Outlook: Cross-Sector Lodging & Timeshare - The Penthouse View' (Dec. 13, 2013);
--'Corporate Rating Methodology' (Aug. 5, 2013).
Applicable Criteria and Related Research:
2014 Outlook: Cross-Sector Lodging & Timeshare (The Penthouse View)
Corporate Rating Methodology: Including Short-Term Ratings and Parent and Subsidiary Linkage
Inn the Footnotes: Comparison of Adjusted Credit Metrics and Contingency Risk for U.S. Lodging C-Corps