Hudson Pacific Properties: Dividend Elimination Not Enough For 11% Yielding Bonds (HPP)

Hudson Pacific Properties (NYSE:HPP) is a West Coast based real estate investment trust that specializes in the ownership of office buildings and sound stages. With the strikes in Hollywood hurting the business, Hudson Pacific cut its dividend earlier this year only to eradicate it in the following quarter. While the strike is over, after reviewing the company’s financials, I’m not taking a position in the shares or the debt, despite the bonds trading with yields over 11%.

The strike in Hollywood may have been the scapegoat for eliminating the dividend, but investors should be mindful that nearly 90% of Hudson Pacific’s revenue is comprised of its office segment. The office segment’s revenue is also declining at a more rapid pace than the studio revenue with year-to-date revenues down $24 million compared to less than $4 million for studio revenues.

The operating expenses for the studio segment are up massively, making operating income of only $44 million in the first nine months of 2023 compared to $120 million in the same period last year. Furthermore, the company’s operating income is not even close to covering $162 million in interest expenses, up more than $60 million from a year ago.

Hudson Pacific’s underwhelming financial performance is not helped by its declining occupancy. Occupancy is down to under 81% from over 87% a year ago. This is a leading indicator that revenue is going to continue to be weak, especially since the average rent rate per square foot is only up 2%. In addition to occupancy challenges, more than 25% of the company’s leases expire between the fourth quarter of 2023 and the end of 2025, leaving opportunity for encourage occupancy loss and revenue declines.

Hudson Pacific’s balance sheet has a few notable changes this year. On the asset side, the $300 million refuse is due to the sale of assets, depreciation exceeding investment in fixed assets, and a drawdown in cash from $255 million to $75 million. Some of the cash drawdown went to good use as the company reduced its long-term debt by nearly $170 million during the year. Shareholder equity has declined from $3.3 billion to under $3.2 billion.

Hudson Pacific’s income statement and occupancy data are deterrents to an equity investment and the cash flow statement is a deterrent to an investment in the company’s debt. Operating cash flow dropped by a third in the first three quarters of 2023, and the company produced zero free cash flow as capital expenditures consumed all operating cash flows. The company was able to pay down debt through the sale of assets, but ultimately there was insufficient cash to fund any dividends.

Hudson Pacific’s decision to pay down debt was influenced by the fact that the company had $320 million in debt coming due in 2023. While $180 million was paid with cash on hand, the remaining amount was financed by drawing on the company’s unsecured revolving credit facility. Hudson Pacific has another $325 million in debt coming due next year, followed by sizable maturities in 2025 and 2026.

Hudson Pacific does have sufficient liquidity in its unsecured revolving credit facility to cover its 2024 maturities. Additionally, the company can upsize its credit facility by an additional $1 billion, which would be enough to cover its 2025 maturities as well. Unfortunately, Hudson Pacific’s debt covenants may block its ability to utilize the revolver in full. While the company’s secured debt ratios are under control, the ratios governing unsecured debt appear to be near their maximums, meaning that should Hudson Pacific use its unsecured revolver to fund its $324 secured debt maturity next year, it would likely end up with a covenant violation.

With the office segment of commercial real estate still in refuse and no sight of the bottom, I’m hesitant to invest in Hudson Pacific Properties stock or bonds. The drop in operating performance combined with the sudden evaporation of cash flow to cover the dividend is deeply worrying. Add in the large block of upcoming lease expirations and the risks are too many to ignore for investors.