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Mathew Ingram

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Room to grow

Mathew Ingram


TORONTO (GlobeinvestorGOLD) — Legacy Hotels Real Estate Investment Trust, along with the rest of the Canadian travel and tourism industry, experienced everything short of a Biblical plague of locusts in 2003: a war between the U.S. and Iraq, the outbreak of not one but two infectious diseases (one involving cows), a massive power blackout, and a rapid rise in the value of the Canadian dollar.

After that kind of year, just about anything is bound to look good, and most industry analysts expect Legacy and the rest of the sector to have a much better year in 2004. How much better, however, is open to some debate. Since Legacy's unit price has climbed by more than 40 per cent from its low in June to a recent close of $7.40, some skeptics feel it has already factored in most of the upside from an industry recovery.

Legacy's performance climbed from about $5.50 to $7.40 from June 2003 to Feb. 2004.

Legacy's units were worth close to $9 in early 2002, when the chain was still doing well, despite the lingering economic downturn in the U.S and elsewhere. It began to slip in late 2002, however, as the threat of war escalated, and then it plunged through 2003 as the SARS outbreak combined with mad-cow hysteria and the rising Canadian dollar to put pressure on occupancy rates.

Harry Rannala, the veteran real estate analyst at Raymond James, said in a recent report that the lodging industry had a year of unprecedented declines in revenue per available room (RevPAR). Unlike 2001, he said 2003 also included "meaningful declines" in the average daily rate (ADR) paid by customers. In the first nine months, the industry saw demand fall by 13 per cent, and the four hotel REITs saw their income drop by double-digit percentages.

Mr. Rannala points out that in addition to the war, SARS, mad cow, a strong Canadian dollar and a weak airline industry, the Canadian lodging business also saw forest fires in B.C., a blackout in Ontario, and damage from Hurricane Juan in the Maritimes. Hotel REITs such as Legacy make more than 70 per cent of their revenue in the second and third quarter, the two periods that were hardest hit.

Legacy felt the impact more than some of its competitors, and saw its distributable income fall 85 per cent versus, 29 per cent for Canadian Hotel Income Properties Real Estate Investment Trust and 56 per cent for Royal Host Real Estate Investment Trust. That's because Legacy's assets are concentrated in core centres, with 58 per cent of its rooms in major cities — 19 per cent in Toronto alone. The company's three Toronto hotels saw a 40-per-cent drop in revenue in the second quarter and 25 per cent in the third quarter.

Mr. Rannala says that he expects a recovery in both revenue and income in 2004, but "we remain cautious about the magnitude of this recovery." He is still concerned about the growth of the Canadian economy and the impact of the rising Canadian dollar, which could drive customers south. The analyst said he expects Legacy will reinstate its distribution, which it cut in the second quarter of 2003, but that it will probably be below the 74 cents the company was paying per year in 2003, and will likely be about 40 cents.

Others are more optimistic about Legacy's prospects. Scotia Capital's Himalaya Jain was still bullish on the company after it released fourth-quarter results in late January, despite the climb in the unit price since June. When Mr. Jain wrote his report, the units were at $7.30 and the analyst said they were still below the REIT's net asset value, which he said was the proper benchmark to use for hotel trusts during a "short-term period of unusually low free cash flows." According to Scotia, the units should be at $8.60 in 12 to 24 months.

The brokerage firm said that most of the other REITs it covers trade at a 20- to 30-per-cent premium to their net asset value, while Legacy is at a 6 per cent discount to its NAV, the only REIT in that category. Scotia said that it may take 12 to 18 months for the industry to fully recover from the events of 2003, but that once it does, Legacy should be well positioned, and that its distributions could be as high as 60 or 70 cents by 2005.

After Legacy reported its fourth-quarter results in January, Morgan Stanley said they were ahead of estimates and that RevPAR was beginning to recover. The firm said the loss of 3 cents (excluding one-time costs) was better than the 10-cent loss it had been expecting and that revenue of $179-million was also better than expected. RevPAR was only down 2.5 per cent compared with Morgan's estimate of 7 per cent, and the brokerage firm said it expects "significant RevPAR improvements in 2004." It said dividend reinstatement could come as early as the first quarter of 2004 and that it has an $8 price target for the company's units.

The fact that Legacy still hasn't resumed distributions means that things still aren't quite back to normal for the hotel operator, and it could take a little while before they are — but at the same time, that also means Legacy likely has the most upside of any of the hotel REITs. That could provide a fair amount of juice for the unit price in the future, provided the economy co-operates.

Mathew Ingram joined The Globe and Mail's online news team in June of 2000, after spending four years as the Western business columnist, based in Calgary.

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