Real estate investment trust (REIT) DiamondRock Hospitality (NYSE: DRH) operates in one of the sectors hardest hit by the coronavirus pandemic. Now that vaccines are being distributed, however, investors might be tempted to see it as a recovery play. While that's not a bad take on the situation, don't go in without understanding how big a hit the hotelier is dealing with and a realistic view of what it will take to get the REIT's business back to normal.
It was (and still is) really bad
There's no question that 2020 will go down in history as the year of the global coronavirus pandemic. But that top-level view hides a great deal of variation underneath when you're talking about individual companies. For example, some sectors actually saw a coronavirus boost, such as packaged food makers and internet retailers, while others saw bankruptcies skyrocket, like clothing retailers with a heavy brick and mortar focus. Hotels, meanwhile, were among the hardest-hit names.
The reason is pretty simple: Governments around the world shut nonessential business, limited travel, and asked people to socially distance. All of that, it was hoped, would slow the spread of the novel illness, but it definitely made it hard for some companies to do business. DiamondRock, which owns 31 premium hotels and resorts, was pretty much at the center of the storm.
To put some numbers on that: Revenues declined 16% year over year in the first quarter of 2020 as the pandemic was starting to spread. They fell 92% year over year in the second quarter, during the worst stretch. And they were off by 79% in the third quarter, when economic restrictions were starting to be loosened. When a nearly 80% top-line hit is actually an improvement, you know things are bad.
Not shockingly, DiamondRock suspended its dividend early on in 2020. It stated that it would pay just enough to maintain its status as a REIT in January of 2021 if it needed to do so. (REITs have to pay out 90% of the taxable income each year to maintain REIT status.) Given the performance through the first nine months of 2020, it's not likely that DiamondRock will need to pay a dividend.
Getting back to normal
In some ways, there's a lot of recovery potential here for DiamondRock's hotel business. And coming from such a low base in the second quarter, even modest improvement will look pretty huge. Only there's a long way to go before business is back to normal, and there's no clear sign at this point that it will be a quick rebound. At the end of 2020, occupancy levels in DiamondRock's portfolio were still just a fraction of what they were before the pandemic hit.
To be fair, the vaccines now being distributed are a very big positive here. But the rollout will take time, so 2021 is likely to be a year of recovery for DiamondRock, but not the year when it reaches pre-pandemic operating levels. That pushes the story out to 2022, only there are new variants of the novel illness now moving through the world that have further complicated the medical issue. The vaccines now being distributed may not be enough to get things back to normal. So 2022 is in flux, as well, with slow improvement more likely than a sudden upswing. Indeed, it will take time for customers, in large numbers, to get comfortable with travel and vacationing again. Which gets the story to 2023, roughly three years out, before it becomes easier to see DiamondRock's business getting back to pre-coronavirus levels.
Business travel could require even more time before it recovers. If there's one thing the pandemic has proven, it's that companies can use the internet to successfully conduct their operations. Sending a human being out to meet clients or attend meetings isn't a necessity. That's doubly true when doing so could mean putting employees at risk. And let's not forget that conducting business via the internet is cheaper than paying for airfare and a hotel room, which is a savings that many companies will be loath to give up. This presents another potential headwind to a full recovery for DiamondRock that will stretch the rebound out.
Pricing in good news
All in, expecting a quick recovery seems overly optimistic for DiamondRock Hospitality's business. But the stock is down just 10% from where it started in 2020, so investors appear to have already priced in a sizable business rebound. That seems premature, and long-term investors should probably tread with caution here at least until the REIT reinstates a regular dividend.