MHI Hospitality: Nice Assets Encumbered With Costly Leverage

MHI Hospitality Corporation (MDH) began its journey in 1957 (under a different name) with a single motel and slowly grew until its IPO in 2004. Crushed by the crash, survival of the company was uncertain as the share price fell to under a dollar in 2009 from its initial offering price of $10. In recovery mode, MDH was forced to take on debt under unfavorable terms. Today, MDH stands with 10 properties and a Lilliputian market cap. of $36.0mm. Working diligently to repair the financial damage, MDH has made some progress. We will begin by examining the specific steps taken and follow with an overview of the company's present condition.

Partial redemption

On 6/20/12 MHI Hospitality announced execution of a $14mm secured, amortizing loan at a fixed rate of 5.6%. Much of this money was used to redeem about half the shares of its Series A preferred which exemplifies the unfavorable debt that MDH was forced to take on. With the 12% coupon on the preferred being replaced by 5.6% capital an annual savings of approximately $800,000 is realized. For such a small company, this is a massive amount of savings, and it facilitates the extension of a mortgage on the Crowne Plaza.

Crown Plaza Hampton Marina mortgage

MDH was able to extend the $8.1mm mortgage attached to this property until 6/13 on condition that quarterly principal payments of $200,000 are made. While a one year extension of a loan is perhaps only a small difference, the terms show the goals of management to reduce overall debt.

With these recent improvements, where is MDH now?

In terms of assets, MDH looks strong. All of its properties have been recently renovated and are mostly upper-upscale. These properties feature brand names and are well located in major cities throughout the south-eastern US. With the forecast increases to national RevPAR, strong performance seems likely. However, the high cost of debt absorbs much of the revenue these assets produce and precludes MDH from experiencing the prosperity which some other hotel companies may obtain. While MHI Hospitality has certainly reduced its cost of debt, more improvement is needed and the small size of the company makes procuring favorable rates difficult.

Company (ticker)	Recent Market Price	Annual Dividend $	Yield as % of Recent Price	EBITDA/interest expense
MHI Hospitality (MHI)	$3.59	$0.08	2.22%	1.3
Sector Avg.	n/a	n/a	2.85%	2.5

As a stock, MDH has potential for growth, but in the near-term it appears to be fully valued based on the following measures.

Price/FFO: Extrapolating its first quarter AFFO, it has a price/AFFO ratio of around 10 which places it near the average in the sector.

EBITDA/interest expense: At 1.3 this ratio is the statistical manifestation of MDH's debt troubles.

Yield: While it has slightly below average yield, MDH has announced intent to raise the dividend by the end of the year.

MHI Hospitality is taking the right steps, but it remains encumbered. The stock has performed well in the last year, but within the hotels sector other options seem stronger.

Disclosure: 2nd Market Capital and its affiliated accounts are long MDH.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.