Last week fellow Seeking Alpha writer Dane Bowler wrote an article that examined four so-called blue-chip REITs and his words he believed the companies to be a "value relative to the market as a whole." As he went on to explain:
Blue-chip companies are generally considered the cream of the crop for their strong financials, high credit ratings, operational fortitude and market presence. As such, they command the respect of investors and tend to trade at premium multiples. Presently, with the U.S. equity REITs trading at an average FFO multiple of 16.4, most blue-chips exchange hands in the 20-25 range. However, a select few have slipped through the cracks giving investors the rare opportunity to invest in premium companies at a reasonable price.
As Bowler pointed out, the Blue-Chip REITs are especially expensive today as many of the stalwart performers have produced strong current dividend yields (relative to other income assets) and also because investors expect operating earnings to grow strongly as the economy improves.
Take for example Blue-Chip Federal Realty (FRT). This Rockville-based shopping center REIT - with a market cap of over $7 billion and shares trading at $107.85 - has an incredible track record of dividend consistency. With a P/FFO of 23.9 (source: FAST Graphs) and dividend yield of 2.71%, Federal has an extraordinary history of paying and increasing dividends for 45 years in a row. But even with such "blue-chip" credentials, it is unlikely that investors can turn the blue (chip) into green.
Nonetheless, that's an amazing record as Federal Realty is in the same category as other "dividend champions" (as defined by DRiP Investing) such as Chubb Corp. (CB), Coca-Cola (KO), Colgate-Palmolive (CL), Consolidated Edison (ED), Lowe's (LOW), Procter & Gamble (PG), Sherwin Williams (SHW), and Wal-Mart (WMT).
As the FAST Graph illustrates below, Federal Realty has become a Blue-Chip with little to no "margin of safety." The dividend consistency is unmatched; however, the price has become out of reach for most dividend investors. Note: The black line represents the price and the shaded light blue area represents dividends paid. The orange line marked with an F represents FFO growth.
So what about the second place award for dividend consistency - the "runner-up" - of REIT-dom: HCP, Inc. (HCP)? After all, HCP has the next best divided paying record (compared to Federal Realty) and with a P/FFO of 17.4, there appears to be a more favorable difference between price and value.
As the legendary investor Ben Graham believed, investors could be exposed to "considerable peril if a strong company (like Federal Realty) were purchased at too high a price;" conversely, an "intelligent investor" should examine whether there is "some kind of buffer - or margin of safety - to protect against market fluctuations.
Here is a snapshot of the "dividend champions" and "dividend contenders" of REIT-dom:
HCP: A Blue-Chip Health Care REIT
In Ralph Block's book, Investing in REITs, he explained the definition of a Blue-Chip REIT:
The blue chip REITs take you safely through the ups and downs in the sector's cycles and deliver consistent, rising, long-term growth in FFO (funds from operations) and dividends. Because they are financially strong and widely respected, they will always have access to the additional equity and debt capital that fuels the engine. They will not always provide the highest dividend yields or even, in many years, the best total returns, nor can you buy them at bargain prices - but they should provide years of double-digit returns with a high degree of safety. These are the REITs least likely to shock investors with major earnings disappointments, and will provide very satisfying returns.
Block is correct in his explanation that most blue-chip REITs can't be bought at "bargain prices;" however, compared with the other health care sector REITs, HCP's P/FFO of 17.14 is cheap - below the peer average of 18.29 - and even a bargain compared with other non-REIT alternatives.
Going back as far as 1985, HCP has been an extraordinary example of dividend repeatability. REITs are most appropriately valued based on the cash distributions they are capable of distributing to their stakeholders. In order to deliver an attractive level of cash distributions, a REIT must be capable of producing solid funds from operations (FFO).
Noticeably, prior to the Great Recession, HCP was able to generate a very predictable and consistent level of FFO growth, as clearly depicted in the FAST Graphs™ below (the orange line marked with an F). Conversely, even in difficult times (during and after the Great Recession), HCP still managed to maintain a consistent level of growing dividends - an important aspect of the Blue-Chip value proposition (the blue shaded area represents HCP's dividends distributed to shareholders).
HCP is not what I would consider a "steal," but the 4.23% current, and above-average growing yield, in today's low interest rate environment, should not be ignored - especially when you consider the 28-year track record (below) of dividends paid:
Just a few weeks ago, HCP announced that it had increased its dividend from $0.50 per share to $0.525 per share. The annualized rate of distribution went from $2.00 for 2012 to $2.10 for 2013. The company's quarterly cash dividend was paid on February 19, 2013.
What's the Power Behind the Repeatable REIT Platform?
Very clearly, the well-balanced diversification has allowed HCP, Inc. to capitalize on opportunities in different markets based on individual market dynamics, providing a hard-to-replicate competitive advantage over its peers. Since 2008 (over the last 5 years) HCP has grown its assets from $11.85 billion to just under $20 billion. That represents 41% growth or around 8% compounded annually.
During the same time frame (2008-2013) HCP has grown its properties from 694 to 1,182. That represents an average of 97 properties added during each of the five previous years.
In 2012, HCP closed on $2.6 billion of accretive investments led by the $1.7 billion senior housing portfolio acquisition of the "Blackstone JV." These 133 senior housing assets (10,350 units) are master-leased (average age of 14 years) to Emeritus (ESC). These news properties are geographically diversified in 29 states with key concentrations in Oregon, Georgia, Washington, Texas, South Carolina, and California.
Here is a snapshot of HCP's Top Tenants:
HCP has a diverse portfolio that the company refers to as the "5 X 5 Business Model." This translates to five sub-sectors: senior housing, post-acute skilled nursing, life science, medical office buildings (also MOB), and hospitals. In addition, HCP invests across five asset categories including real estate, joint ventures, development, debt, and RIDEA-TRS.
HCP's revenues are diversified with a large majority of the income derived from contractually long-term triple-net leases. Here is a snapshot of HCP's revenue by segment:
HCP's leases are differentiated by stable and predictable income. As Dane Bowler explained:
HCP epitomizes the term "blue-chip" as it is strong and stable in every aspect of its operations. It has over $1.4B of annual triple net leased rent, $1.133B of which is locked in until after 2016. The leases have attached rent escalators providing organic growth. As these leases are with individually strong and well diversified tenants, delinquency risk is minimal. With healthcare REITs, the other source of risk to income is that from policy changes to Medicare and Medicaid. In this regard, HCP is comparatively healthy as only 13% of the revenue associated with its properties is from Medicaid and 21% from Medicare.
Here is snapshot of HCP's limited near-term lease expirations:
Since 2005, HCP has grown its Funds from Operations from $549 million to over $1.18 billion in 2012. That translates into over 23% annualized growth in FFO.
In the most recent earnings transcript:
HCP reported full year 2012 FFO of $2.72 per share (which reflected the combined impact of $0.06 per share from noncash charges related to its preferred stock redemption and land sale impairment and transaction expenses for our Blackstone JV acquisition).
Excluding these items, FFO as adjusted for 2012 was $2.78 per share (and FAD was $2.22 per share), increases of 3.3% and 3.7% over 2011, respectively. The results were driven by same-store performance and accretive acquisitions closed during the second half of 2012.
Since the beginning of calendar year 2005, HCP, Inc. has generated $535.53 worth of dividends on an initial $1000 investment, as compared to only $145.63 from dividends through an equivalent $1000 investment in the S&P 500. But perhaps more importantly, HCP's average growth of dividend has exceeded 7% per annum. Investors deserve a raise in pay each year, and for the past eight years HCP has "delivered in spades." Finally, HCP has generated a 10.6% compounded annual total return since the beginning of 2005 that is 2½ times higher than an equal investment in the S&P 500.
HCP: A Blue-Chip Balance Sheet
Also from the latest earnings transcript:
During 2012, "HCP raised $3.5 billion of debt and equity in the capital markets to fund accretive acquisitions and refinance higher interest rate debt and preferred securities. During the fourth quarter HCP raised $1.8 billion, consisting of $979 million in common stock and $800 million of 2 5/8% senior unsecured notes due 2020. HCP used these proceeds to finance the "Blackstone JV" acquisition - consistent with the company's long-term capital structure of 40% debt and 60% equity."
Here is a snapshot of HCP's total debt to asset history:
HCP ended the year (2012) with $248 million of unrestricted cash, including proceeds from fourth quarter asset sales and excess proceeds from the November bond issuance after funding the "Blackstone JV" acquisition. HCP's remaining 2013 debt maturities total $695 million, with an average interest rate of 6%, representing attractive refinancing opportunities in the second half of this year.
HCP has no outstanding balance on its $1.5 billion revolver at year-end, and less than 1% of its debt obligations are subject to floating interest rates.
The company has just over 19% in secured debt:
At year end, HCP's financial leverage (debt to market cap) was under 30%:
As per the latest earnings transcript:
HCP's secured debt ratio improved to 8.3x. Fixed charge coverage for 2012 increased to 3.6x, and for the fourth quarter, improved to 3.8x. Net debt to EBITDA for the year was 5.3x and improving to 5.0x for the quarter. Recognizing the significant positive momentum in HCP's credit profile, during the fourth quarter, both Moody's and S&P upgraded the company's credit ratings to Baa1 and BBB+.
That makes HCP one out of eleven equity REITs with an investment-grade rated balance sheet:
In fact, of that same group of "investment grade-rated" REITs, HCP has the highest dividend yield (4.32%). That is well above the peer "investment grade" group average of 3.11%.
During the company's most recent earnings call (Q4-12), HCP's Chairman and CEO, James F. Flaherty, explained:
In the past 2-plus years, HCP has received 6 positive rating actions from the 3 agencies that cover the company. This unprecedented credit profile improvement has materially reduced HCP's cost of capital. With our current Baa1 (Moody's), BBB+ (S&P), BBB+ (Fitch) ratings, there are now only 3 REITs with ratings superior to HCP. One of the REITs, Public Storage, has a unique capital structure, that while we admire, HCP cannot realistically hope to emulate. The 2 remaining REITs, rated above HCP, with single A ratings, have leverage, fixed charge coverage and secured debt metrics that are inferior to those of HCP's.
HCP's 2013 FFO is projected to range from $2.92 to $2.98 per share, which at the midpoint represents 6.1% growth compared to the company's 2012 FFO as adjusted. The growth is driven by the accretive benefit from 2012 acquisitions and forecasted same-store growth on a GAAP basis. In regards to the recent earnings results, HCP's CEO, James F. Flaherty, explained the latest dividend increase as follows:
Turning to 2013, the double-barreled engine of strong profit performance and last year's accretive acquisitions position the company's Board of Directors to raise HCP's dividend by 5% 3 weeks ago, the largest increase in over 10 years. As important, at the midpoint of our 2013 FAD guidance, we forecast a FAD payout ratio of 87%, the lowest in HCP's history. And it is with enormous pride that we move ahead into another year as the only REIT included in the prestigious S&P 500 Dividend Aristocrat index.
HCP: A Blue-Chip REIT That's Hard to Beat
Over the last three years, HCP has outperformed the larger (diversified) peers as well as the broader indices. With a 3-year total return of 90.95%, HCP almost doubled the performance of the S&P 500:
Over the last year, HCP has also outperformed the larger (diversified) peers as well as the broader indices. With a 1-year total return of 30.49%, HCP more than doubled the performance of both the S&P 500 and the Russell 2000:
Compared with other Health Care REITs, HCP is still one of the lower dividend paying REITs. With a current yield of 4.32%, HCP is ranked below the peer average dividend yield of 5.00%.
However, compared with the "dividend champion/contender" peer group, HCP's dividend (4.32%) is just above the average yield of 4.22%
To boil it all down, I like HCP. I believe that the current $48.61 price tag is moderately valued - meaning it's not a steal, but given its Blue-Chip credentials, the shares are not expensive. As one of just eleven investment-grade rated REITs, HCP has the highest dividend yield (4.32%) of the group.
I plan to make a decision in the next two weeks as to whether I plan to include Ventas (VTR) or HCP in my SWAN (sleep well at night) portfolio (Forbes Newsletter). However, I plan to stick with the smaller "pure play" health care REITs in my SALSA portfolio. Here's why (from an article I wrote back in December 2012):
Although Ventas is not trading at a monster premium (P/FFO of 16.59), investors can still find attractive pricing with the smaller non-mega REITs. By combining multiple "pure play" REITs, an investor can gain diversified exposure to healthcare while also maintaining a risk-adjusted "circle of competence" portfolio. By doing so, investors find that dividend yields are much more attractive and simply a better value proposition for "sleeping well at night.
Here's a quick recap/comparison of my SALSA Health Care REIT picks (average dividend yield is 5.69%):
In addition, the SALSA Health Care portfolio has returned (on average) 39.93% year-over-year. Keep in mind that Healthcare Trust of America (HTA) went public on June 6, 2012 so this does not represent an actual year. In fact HTA recently hit an all-time high recently (11-15-13) of $11.68 and the 30-day total return is 10.36%.
So clearly there is risk-adjusted premium to investing in a smaller diversified group of "pure play" REITs compared with the larger "blue chips." Here is a snapshot comparing the group:
So at the end of the day, every investor should determine his or her circle of competence. As Warren Buffett said,
Risk comes from not knowing what you're doing.
HCP Inc. has an attractive price - especially since it is an exceptional blue-chip REIT. The diversified health care REIT is 'less risky' to own at $48.61 than the group of riskier "pure play" SALSA REITs (HTA, OHI, and MPW). However, the investment grade REIT (BBB+) does not enjoy the same "circle of competence" as the smaller (SALSA) REITs and that is why the higher yielding ones have a better (higher) risk-adjusted dividend yield.
Perhaps HCP can be summed up by the defensive attributes that Benjamin Graham described when he explained the "margin-of-safety" concept - one that was "used to advantage and distinguish the difference in an investment operation and a speculative one." As Graham wrote:
One of the most persuasive tests of high-quality is an uninterrupted record of dividend payments going back over many years. We think that a record of continuous dividend payments for the last 20 years or more is an important plus factor in the company's quality rating.
As Graham explained:
It is the consistency in the products that creates consistency in a company's profits. Consistency and durability are attributes for competitive advantage.
Finally, Graham went on to write:
Successful investing is about managing risk, not avoiding it.
Source: SNL Financial, FAST Graphs