On our last coverage of Hudson Pacific Properties, Inc. (NYSE:HPP) we had a cautionary tone for those who thought the newly cut dividend was safe. Our rationale was that the debt wall was just too strong and the adjusted funds from operations (AFFO) would barely make a dent in it after the (reduced) dividend payment. Even a full stoppage would not be enough to help the company.
As noted above, the debt to adjusted EBITDA is already at 8.5X. For argument’s sake let’s assume that the company does not pay any dividends from now on and uses its AFFO just to pay its debt maturities. The current run-rate of $140 million annually in AFFO won’t make a dent in the upcoming wall.
Well, they did stop the dividend completely and it only took them one more quarter. Let’s look at the rationale, the progress on deleveraging and give you our updated thesis.
The pressures that led to the full dividend suspension were already in play in the last quarterly results. Just looking at the year over year changes in the percentage of space leased gave you an idea of how little buffer the company had. Office occupancy declined to 85.2% versus 90.8% in June 2022.
More importantly for people keeping their finger on the pulse, office occupancy declined from 86.9% in Q1-2023 to 85.2% this quarter. The AFFO has dropped by 46% year over year. The only reason the payout ratio looked reasonable was that the company had already done a 50% dividend reduction in the prior quarter. The quarter over quarter changes have continued in one direction. While the broader stock market continues to project euphoria, the real metrics for the office REIT sector continue to be challenging. The drop in occupancy occurred even as HPP did execute a number of leases.
Executed 61 new and renewal leases totaling 403,231 square feet, including a 56,000-square-foot renewal and extension with Rivian Automotive at Clocktower Square through 2028
GAAP and cash rents decreased 3.8% and 8.1%, respectively, from prior levels
Source: Q2-2023 Supplemental
In additional source of strain was that GAAP and cash rents declined collectively on these lease renewals. There is no shortage of space in San Francisco and it shows.
The Studio Strike
As a company that does cater to Hollywood Studios, the ongoing strike must be unnerving. There is definitely a solid chunk of revenues coming from this segment and it was a relative bright spot in the first half of this year, at least relative to the office segment. HPP was weighing the impact of the strike alongside what is happening to its interest expenses.
That 62% jump in interest expenses is the key metric that is forcing the company’s hand. Yes the studio strike is likely to impact but by itself, the fallout would be mild to modest. The bigger situation is the rising interest expense coupled with a debt maturity wall that is looking intimidating.
The Debt Wall
The surface, the immediate threats look small for the company’s liabilities. $50 million of Series E notes due in a week are a non-issue. The next set of consolidated debt comes due in December 2024.
The bigger issue is that total unsecured and secured debt is miles and miles ahead of the AFFO. Total debt including proportionate share of unconsolidated debt, is about $4.0 billion. Well, the AFFO run rate is close to $120 million.
Further, the weighted average maturity is just 3.8 years and this is extremely low for the environment. Even the secured debt side, which investors may try and ignore, has a very problematic future. There, the weighted average is just 2.4 years and that number was as of June 30, 2023. There is a lot more color on the debt in the last financial statement. For example, this line shows that banks are happy to take losses as HPP pays down some debt.
Repaid the Quixote loan for $150.0 million, a $10.0 million discount on the principal balance, with funds from the unsecured revolving credit facility
While some may see that as a good sign, it is indicative of banks exercising the “he who panics first, panics best.” That loan is now someone else’s problem.
Here is some more information on these secured loans.
Regarding our upcoming maturities, we only have one small maturity remaining in 2023. Our $15 million private placement note due next month, which we will pay with our line of credit. We have two maturities in 2024. Blackstone is leading discussions around the extension of our Bentall Centre loan, which matures in July 2024, of which our 20% ratable share is $100.5 million.
Blackstone “leading discussions” is exactly as it sounds as the banks are not throwing money at this problem. The discussions likely center around how much of a paydown they want and what kind of covenants they want in place to prevent a default down the line. We think the outcome is unlikely to be great for HPP’s liquidity.
So far, we have not tripped any covenants. The two we would watch most carefully are the ones highlighted below.
Investors may think we are being overly cautious but here our argument. Take a look at the same metrics from Q1-2022 and tell us that you are not worried about the deterioration.
If you examined the stock without looking at the mountain of debt behind the equity, you are likely to get a rude surprise during a down cycle.
Moody’s recently downgraded the credit rating of Hudson Pacific Properties, adding more pressure to the firm’s studio operations just days before the union representing over 160,000 film and television actors voted to strike. The downgrade included a reduction in Hudson Pacific’s preferred stock rating from Ba1 to Ba3 and a decrease in its senior unsecured debt rating from Baa3 to Ba1, as reported this week.
Moody’s decision to downgrade the ratings was influenced by the ongoing screenwriters’ strike, which both Moody’s and Hudson Pacific have acknowledged as impacting studio revenues, along with lackluster leasing performance in their office portfolio. SAG-AFTRA, the actors’ union, joined the writers’ strike actions this week.
According to Moody’s report, the agency does not anticipate Hudson Pacific’s cash flow to be sufficient to cover operating expenses, leasing capital spending, and upcoming debt maturities.
Source: The Registry
The downgrades as always come too late to help out but here we were amused by Fitch’s detachment from reality.
Fitch Ratings, in their own assessment of Hudson Pacific, expressed “near-term concerns” about the studio business due to the strike and the company’s significant exposure to technology and media companies. However, Fitch Ratings did not make any changes to the company’s credit ratings.
Source: The Registry
The bond market continues to speak and the 10.38% yield on their 6 year debt is likely to go further into double digits.
The dividend elimination helps just a bit and might be the crucial difference if the market starts turning around. HPP needs to sell at least a $1 billion of assets over the next 18 months to get leverage back in line. That is going to be tough in this market with deals occurring at 30% to 40% of pre-pandemic prices. Office loan delinquencies are spiking at a rapid clip in Fog City.
It is possible that the thirsty yield seekers will now turn their attention to the last Venus flytrap left here, Hudson Pacific Properties, Inc. 4.750% CUM PFD C (NYSE:HPP.PR.C). All arguments about how safe this has become thanks to the common dividend cut, are missing the big picture. The debt dwarfs the common and preferred equity market capitalizations. The 10% yield not remotely compensate you for the risks. Stay out.
Please note that this is not financial advice. It may seem like it, sound like it, but surprisingly, it is not. Investors are expected to do their own due diligence and consult with a professional who knows their objectives and constraints.