The First Stock That Could Go Bankrupt in 2024

Franchising has been one of the most popular business models of the past 20 years.

Under the franchising model, branded businesses can grow a lot faster. They don't need to tie up as much money building new restaurants, stores, or hotels.

And franchisees don't need to build a brand-new brand and convince customers to spend money at their businesses. They can draft off of an existing brand... meaning they can make money faster.

To build up a franchise, a franchisee often needs to take on a lot of debt. Or it can outsource all that debt to someone else.

Enter Service Properties Trust (SVC).

The company is a real estate investment trust ("REIT"). It's also a classic example of a business that gets in trouble during a Federal Reserve tightening cycle.

Service Properties focuses on hotel, restaurant, gas-station, entertainment, and retail locations across the U.S. Since the pandemic, its retail locations have taken a steady hit thanks to the e-commerce explosion. The death of retail over the past decade-plus hasn't helped.

To make matters worse, Service Properties' gas-station and fast-food clients are facing similar existential crises from electric vehicles and healthier eating trends, respectively.

Its hotel portfolio hasn't fared much better. While the hospitality industry benefited from the surge of "revenge travel" through 2022, consumers are now cutting back as budgets get tighter. This business is also staring down the barrel of tougher results.

And as Service Properties faces these challenging business headwinds, its debt maturities are looming...

The company has $1.17 billion of debt coming due by 2024. Its debt-to-EBITDA ratio is an elevated 9.3 times, indicating that it already has a ton of leverage. ("EBITDA" stands for earnings before interest, taxes, depreciation, and amortization.)

Some of its lenders may not want to refinance its debt at all, which could force it to sell assets at a tough time. And even if it does refinance, doing so will crush the company's profitability.

Service Properties' funds from operations ("FFO") – the cash flows it generates to invest in new properties and pay dividends – is forecast to be $290 million in 2023.

It currently pays an average 4.4% interest rate on debt coming due through 2024.

The company has two bonds that mature in 2028 and 2029... the likely maturity period in which it will need to refinance its debt. They're currently yielding 10.4%, even though both bonds have much lower coupons.

Yields that high tell us the credit market doesn't think this company is safe. That means refinancing its debt could be tough. And even if it does refinance, interest expenses will jump by $70 million.

That will cause FFO to drop by 24% in 2024. Investors will panic.

All these warning signs show up in our systems as well. It's why the company is flashing red across the board, from performance to valuations to credit rating.

Service Properties Trust is a ticking time bomb.

Regards,

Joel Litman and Rob Spivey
December 1, 2023