One Metric To Rule Them All: Sotherly Hotels Inc. (NASDAQ:SOHO)
Sotherly Hotels Inc. is a US$109m small-cap, real estate investment trust (REIT) based in Williamsburg, United States. REITs own and operate income-generating property and adhere to a different set of regulations. This impacts how SOHO’s business operates and also how we should analyse its stock. Below, I'll look at a few important metrics to keep in mind as part of your research on SOHO.
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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 SOHO’s daily operations. For SOHO, its FFO of US$26m makes up 56% of its gross profit, which means the majority of its earnings are high-quality and recurring.
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 SOHO 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 6.7%, the credit rating agency Standard & Poor would consider this as aggressive risk. This would take SOHO 14.86 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.
Next, interest coverage ratio shows how many times SOHO’s earnings can cover its annual interest payments. Usually the ratio is calculated using EBIT, but for REITs, it’s better to use FFO divided by net interest. This is similar to the above concept, but looks at the nearer-term obligations. With an interest coverage ratio of 1.31x, SOHO is not generating an appropriate amount of cash from its borrowings. Typically, a ratio of greater than 3x is seen as safe.
In terms of valuing SOHO, 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 SOHO’s case its P/FFO is 4.16x, compared to the long-term industry average of 16.5x, meaning that it is highly undervalued
Next Steps:
In this article, I've taken a look at Funds from Operations using various metrics, but it is certainly not sufficient to derive an investment decision based on this value alone. Sotherly Hotels can bring about diversification for your portfolio, but before you decide to invest, take a look at the other aspects you must consider before investing:
Valuation: What is SOHO 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 SOHO is currently mispriced by the market.
Management: Who are the people running the company? Experienced management and board are important for setting the right strategy during a volatile market. Take a look at information on SOHO's executive and directors here.
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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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.
