HCP, Inc. (HCP) has been put through the wringer a bit over the last couple weeks since the management shakeup and recent downgrade by RBC, but it seems much of the Seeking Alpha community is still in support of the company as a long-term hold. I remain long HCP despite the recent setbacks, and I too feel strongly that it's a long term hold. It can be easy to get discouraged when sudden negative news comes out about one of your holdings, but it can also give you an opportunity to buy cheaper shares of a good company. This is the case with HCP.
The CEO termination certainly made for a stellar news day, since HCP doesn't have much in the way of news on a regular basis. Perhaps traders, shocked by this massive revelation, got a bit overzealous with their selling? The charts would seem to point to that idea, but that's only a small fraction of the overall downward trend this stock has seen over the last six months. HCP, like the rest of the market, had a nice run in the first half of 2013, but it started selling off in May and has underperformed the S&P 500 by about 20% on the entire year.
That might not bother some dividend investors, especially people who are using reinvestment plans, but it bothers me a little bit. I bought into this company for the dividend growth and capital stability. Yes, I am looking for capital appreciation, but in this case I was very happy with the yield and steady (albeit slow) growth in the share price. Now I'm in the red, but I'm not completely discouraged because I know the selling phase is coming to a close. I've also collected a decent amount of dividends throughout my holding period.
The Case for Dividend Income
HCP currently pays a $2.10 annual dividend, $0.525 quarterly, a 5.05% yield at the Friday, October 11 closing price of $41.54. Not a shabby yield, and if you're willing to withstand the short term volatility you can beat out a savings account over the long run. The biggest risk to this yield, and their profitability in general, is what happens to interest rates in the next year or so. Since the debate around Fed rates has been covered to death in a sea of publications I'll spare you the guts of the argument and just say that I don't expect rates to increase anytime soon. Even if they do, I believe HCP already has an investment portfolio established on the low rates of the last five years, which will help offset any diminishing returns from higher rates in the future.
Looking at their dividend history for the last few years we see its growth accelerating quite a bit from 2010 through 2013. This was fuelled by relatively stable earnings, but not really stimulated by earnings growth. This is where I would advise caution on this company for anyone looking to "set it and forget it." The pay-out ratio has been regularly above 100% for the last few quarters (see table below), but because it's a REIT it's required to pay out at least 90% of taxable income. The fact that they pay more than 90% and maintain dividend stability shows that they care about shareholders and income investors. Unless we see a catastrophic earnings report, I don't expect the dividend to get culled back; the worst we'll see is a decrease in the growth rate.
|Year||Declaration Date||Dividend Amount||Relevant|
(Data obtained from 10-K and 10-Q filings on the HCP investor relations website)
The data in the table below shows an increasing dividend growth rate and a decreasing dividend yield. This is mostly due to the rush for yield over the last few years, but also the rising market in general. That's why right now is a great opportunity to buy because the yield is back above 5% and the share price is recovering. HCP still owns quality income-producing assets and shareholders will reap the benefits in the long run. New investors can get in on the dip now and ride the share price recovery and dividend for the foreseeable future.
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Fundamental Review and Business Outlook
A few highlights from their most recent filing for Q2 ending June 30th:
- Revenue $516.3M, up 12% Y/Y
- Net Income $450.5M, up 12% Y/Y
- Operating Cash Flow $571.6M, up 18% Y/Y
A few things to look out for:
- Expenses up 17% Y/Y
- Gross margin down from about 40.8% to about 38.4%
What's bothersome about that picture is that expenses have increased faster than revenues, but it could be explained by a number of different things. Their SG&A, operating, D&A and interest expenses are all higher in this period. This is nothing to get alarmed about though, HCP was actively investing in new properties. Page 9 of the Q2 filing goes into detail about the "Blackstone JV," in which HCP acquired 133 senior housing communities for $1.73B in a JV with Emeritus Corporation and Blackstone Real Estate Partners.
Why should you get excited about this? If you have aging parents and grandparents then you know that these facilities are increasingly in demand. My 100-year-old granny lives in one of these places and it's an expensive ordeal. To illustrate the growth in this real estate segment, we can look at statistics for the growth of the aging population in the US. The United States Department of Health & Human Services Administration on Aging made the following statement:
The older population--persons 65 years or older--numbered 39.6 million in 2009 (the latest year for which data is available). They represented 12.9% of the U.S. population, about one in every eight Americans. By 2030, there will be about 72.1 million older persons, more than twice their number in 2000. People 65+ represented 12.4% of the population in the year 2000 but are expected to grow to be 19% of the population by 2030.
Although 2030 is still 16 years out, we still see that the projected population of persons 65 and older is set to almost double by that time. It's pretty encouraging data.
In terms of valuation, I find HCP to be fairly valued relative to its peers, excluding any outliers (noted below).
|Ticker||EPS||P/E||P/S||Mkt Cap||ROA||ROE||ROI||Revenue ($M)||Net Income ($M)|
(Source: Google Finance)
I would exclude Health Care REIT, Inc. because the numbers are askew too much, as well as Alexandria Real Estate Equities, Inc. because it's not a health care REIT in the same sense of the other ones. While I don't typically like to use P/E as a valuation metric, a quick scan shows that the P/E for HCP is fairly in line with its competition, perhaps slightly undervalued. If you care about the P/E then the numbers would suggest there is room for HCP to move up. HCP is also relatively undervalued in terms of price-to-sales, but some might argue this isn't an appropriate valuation metric for a REIT. More applicable though, HCP has the highest net income of these selected peers, as well as strong ROA, ROE and ROI metrics. HCP is a stable business competing well in a growing industry.
A Quick Look at Analyst Ratings
Analyst ratings can oftentimes be controversial, one way or the other, but they still hold some merit in making stock picks or valuation calls. MarketWatch is currently tracking 18 analyst ratings with an average price target of $44.45, a 7% premium to the current price. The most recent downgrade by RBC put a $38 price target on it, or an 8% discount to the current price, but even that goes to show that this stock has price support near $40. The consensus earnings estimate for Q3 is $0.51/share, which is a 13% increase on Q3 2012 earnings of $0.45/share and an 8.5% increase over the last quarter ($0.47). I should emphasize that 18 analysts is a lot of coverage to include in an average, so the overall consensus is optimistic. Looking at the charts, I have a hard time believing that this optimism is already priced into the stock. Even an extremely rudimentary approach to valuation using the trailing P/E would put the share price around $43.57 after earnings: ($0.51x4) * 21.36.
But that's not all...
Technical Analysis - Support at $41
Given the intensity of the share price decline over the last six to seven months, we've seen a shift in direction for the moving averages. I like to use a 50-day moving average to judge intermediate trends for periods where I can collect at least two or three dividend payments. The 50-day moving average is settling toward $41, with the 15-day moving average decreasing in volatility and share price retracing back above $41. It will take a few more bars to confirm that $41 is the new level of support, but if the share price can stay above the 50-day moving average I will take that as a sign of support. This will be the second opportunity for the price to test that average since it bearishly crossed over on May 24, before that it had enjoyed a nice steady bull run above the moving average from January 1.
Furthermore, the MACD is starting to stabilize around zero after indicating a few periods of unusually oversold conditions. The RSI has been maintaining a steady balance between 60 and 30. Those factors, together with the test of the 50-day moving average, are signaling that the price is finding support and setting up for a trend reversal. It won't be drastic or immediate, but I see the price recovering back to $45 by the end of the year, and recapturing $50 by mid-2014.
The Case for Options
With a $45 price target in mind and a time horizon of a few months, I've been looking at HCP options as a way to make some extra cash. I wouldn't normally trade in options with such low liquidity and wide spreads, but there is a decent amount of open interest at relatively attractive strike prices. The recent increase in volatility has produced better premiums, but they are more pronounced in the back month options, so we'll have to take on a bit more risk to capture that precious time value.
Important note: this is intended to be a long-term hold, so I do not advise selling calls against this since the possibility exists that the shares may get called away from the option seller. This would defeat the purpose of buying for long-term growth and income. Therefore, I've only suggested selling puts as a means to acquire the stock at a cheaper price. All prices are as of closing Monday October 14.
Here's how the put scenario works out, with two expiration cycles:
|Contract||Premium||Dividend Collected||Total Income Per 100 Shares||Cash put up||Basic Return||Holding period days|
|Nov 15 Put @ 40||$0.90||$0.00||$90.00||$4,000.00||2.25%||31|
|Jan 17 Put @ 40||$1.65||$0.00||$165.00||$4,000.00||4.13%||94|
In this case, the premiums are pretty good since the underlying price is close to $40 already. Enter this position if you like the stock and want it at a lower price, but instead of waiting for it to drop (and not collecting dividends) you pocket some cash in the form of premium and wait to see what happens.
Options involve different risks that are not suitable for every investor. Only enter this position if you are comfortable owning the shares at $40 and have the cash to cover the transaction.
Despite the recent news and increasing downside volatility I am still bullish on HCP for the long term. I see price support at the $40-41 range with a short-term potential to retrace back to $45 per share. I feel strongly in the ability of HCP to continue executing on their strategy despite the management shake up, and see the firm creating shareholder value through increasing dividends and earnings. What we're seeing right now is the end of a correction that lasted too long and was fuelled too much by errant news. Over the next three to six months we will see a return to normal growth patterns.