A few weeks ago I wrote an article explaining my decision to unload shares in HCP, Inc. (HCP). As I wrote, "the decision was not stock or business performance-based, but rather a view that the board lost faith in Mr. (Jim) Flaherty's management style". It was well know that HCP's former CEO is a "tough businessman" and "that translates into a reputation and track record for winning". It was also well known (among analysts) that "his reputation for reporting earnings have been a standard for REIT-dom and his "take it or live it" approach is likely the reason he is no longer in charge".
So as a follow-up article I explained my reasons for investing in Ventas, Inc. (VTR). I could definitely do without the "boardroom drama" at HCP but more importantly, Ventas is an exceptional REIT that continues to lead the diversified health care REIT sector with the highest dividend growth. Here is a snapshot that illustrates the "bottom line" strategy and the reason I moved on to Ventas:
However, as part of my due diligence practice, I believe it's important to consider ALL of the peers and that includes the third large-cap diversified REIT known as Health Care REIT (HCN), an S&P 500 company with headquarters in Toledo, Ohio. Based on assets, HCN is the largest health care REIT in the US.
Based on Market Capitalization, HCN is the third largest health care REIT, behind Ventas and HCP, Inc.
As of June 30, 2013, the HCN's broadly diversified portfolio consisted of 1,183 properties in 46 states, the United Kingdom, and Canada. HCP has been at the forefront of senior living and health care real estate since the company was founded in 1970 and then became public in May 1985.
The company's portfolio concentration in affluent, high barrier to entry markets and affiliation with industry leading operators and health systems fuels superior same store NOI growth and appreciation is asset value. The company derives 82% if its revenue from private pay sources. Here is an overview of HCN's portfolio composition:
HCN's diverse operating model consists of Senior Housing (Triple Net), Senior Housing (Operating), Skilled Nursing, Hospital, Medical Office, and Life Science. Here is a snapshot of the company's portfolio based on Net Operating Income (or NOI):
(click to enlarge)One key differentiator for HCN is the company's higher concentration (82%) of private pay sources. In a recent Seeking Alpha article, Factoids wrote:
The private pay differences between the two (HCP and HCN) are huge. HCN operators get 82.4% from private pay. HCP operators get 32.4%. HCN wins on this attribute. If you are buying other Healthcare REITs for growth or yield where the private pay percentage is small, hedge your bets by choosing HCN in this decision.
Here is a snapshot illustrating the portfolio performance of HCN:
HCN's Affluent Market Locations
HCN has grown by 29% annually since 2008 and 80% of the portfolio is located on the East and West coasts or in the top 31 MSA's. These strategic locations create the highest quality portfolio and generate secure cash flows. Here is a snapshot of the company's geographic concentration:
In January 2013 HCN completed the $4.3 billion acquisition of Sunrise Senior Living, which included 125 private pay properties located in high-end, high barrier to entry markets such as New York, Los Angeles, Washington, DC, Boston, Chicago, San Francisco, and London. In addition, HCN has strategically partnered with leading providers of independent living, assisted living and memory care services across the country. Here is a summary of HCN's Top Ten Operating Partners:
Sunrise Senior Living, located in McLean, Virginia is a privately held company that operates 296 premium private pay seniors housing communities with over 27,300 units in the United States, Canada, and the United Kingdom. The portfolio is concentrated in infill locations in major metro markets. As of 6/30/2013, the HCN portfolio consisted of 125 private pay seniors housing facilities with an investment balance of $3.3 billion.
Genesis HealthCare, located in Kennett Square, PA, is a privately held company that is the nation's largest skilled nursing care provider with more than 400 skilled nursing centers and assisted living residences in 28 states nationwide. Genesis also provides rehabilitation therapy to over 1,500 healthcare providers in 45 states. As of 6/30/2013, the HCN portfolio consisted of 176 facilities in 15 states with an investment balance of $2.7 billion.
Revera, headquartered in Mississauga, Ontario, is owned by Canada's Public Sector Pension Investment Board and is the second largest seniors housing operator in Canada. The company operates 209 seniors housing and long-term care facilities Canada and the United States. As of 6/30/2013, the HCN portfolio consisted of 47 private pay seniors housing facilities located across five Canadian provinces with an investment balance of $1.2 billion.
Merrill Gardens, located in Seattle, WA, is a privately held company that operates 55 private pay seniors housing facilities with over 6,000 units in nine states. The portfolio is concentrated in major metro markets on the west coast. As of 6/30/2013, the HCN portfolio consisted of 48 private pay seniors housing facilities in eight states with an investment balance of $1.1 billion.
Belmont Village, located in Houston, TX, is a privately held company that operates 24 premium private pay seniors housing facilities in seven states. The portfolio is concentrated in infill locations in major metro markets. As of 6/30/2013, the HCN portfolio consisted of 19 private pay seniors housing facilities in six states with an investment balance of $870 million.
Benchmark Senior Living, located in Wellesley, MA, is a privately held company that operates 47 premium private pay seniors housing facilities with approximately 4,000 residents with a concentration in New England. As of 6/30/2013, the HCN portfolio consisted of 37 private pay seniors housing facilities in six states with an investment balance of $855 million.
Brandywine Senior Living, located in Mount Laurel, NJ, is a privately held company that operates 27 premium private pay seniors housing facilities with over 2,400 units in five states with a concentration in infill markets in the Mid-Atlantic. As of 6/30/2013, the HCN portfolio consisted of 27 private pay seniors housing facilities in five states with an investment balance of $737 million.
Senior Lifestyle, located in Chicago, IL is a privately held company that operates premium private pay communities across the full spectrum of independent, assisted, rehabilitation, skilled, memory and continuing care in metro markets across the United States. The company operates 101 facilities in 21 states. As of 6/30/2013, the HCN portfolio consisted of 34 private pay seniors housing facilities in eight states with an investment balance of $722 million.
Brookdale Senior Living (BKD), located in Brentwood, Tennessee, is a publicly traded company that provides independent living, assisted living, memory care, and rehab services. The company operates 649 seniors housing facilities in 36 states with the ability to serve approximately 67,000 residents. As of 6/30/2013, the HCN portfolio consisted of 87 seniors housing facilities in 19 states with an investment balance of $628 million.
Chartwell Retirement Residences (TSE:CSH), is a publicly traded company located in Mississauga, Ontario, that operates approximately 222 facilities in North America, and is the largest seniors housing operator in Canada. As of 6/30/2013, the HCN portfolio consisted of 42 private pay seniors housing facilities located across four Canadian provinces with an investment balance of $470 million.
As mentioned above, Sunrise Senior Living is HCN's top Operating Partner and here is a snapshot of the portfolio:
HCN has been working to reduce the number of non-core, skilled nursing assets to lower the risk of owning properties with a dependency on government reimbursements at the federal and state levels. Accordingly, HCN has been able to achieve 3.8% same store performance (across all property sectors):
Here is a snapshot of HCN's Senior Housing Operating portfolio:
Here is a snapshot of HCN's Medical Office Building (or MOB) portfolio:
Around 93% of HCN' MOB portfolio is affiliated with a health system and 84% of the health systems are investment grade, HCN's MOB portfolio has an 80% retention rate and a 94% occupancy rate, the highest in the industry. Here is a snapshot of HCN's Top 5 MOB tenants:
Unlike Ventas, HCN has a small (1.6%) interest in Life Science Buildings. Here is a snapshot of HCN's portfolio of Life Science buildings:
One final differentiator for HCN is the relatively newer, high-quality buildings owned. Here is a snapshot that illustrates the portfolio average age of HCN and the peer group:
HCN - What Have You Done For Me Lately?
Here is how HCN's Chairman and CEO, George Chapman, explained the company (during a recent earnings call):
Our financial results bear out our investment thesis. During the downturn, our portfolio had the resiliency to provide stable growth. During the moderate upturn that has been ongoing for the past several quarters, our portfolio has grown robustly. As we enter what we believe will be a period of better economic growth, our portfolio is poised for even stronger performance. We have a well-planned mix of longer-term and shorter term leases in the form of triple-net leases and RIDEA arrangements that should allow us to capture upside as the economy picks up steam. In short, our strategic design works through all economic cycles.
HCN's balance sheet and liquidity are in excellent shape having completed a $1.7 billion equity offering in May (2013) and the company's blended cost of capital remains near historic lows. At the end of June, the company's net debt to undepreciated book capitalizations stood at 39.3%. Debt to adjusted EBITDA, interest coverage and fixed charge coverage are all in line with target levels on a pro forma basis. Adjusting for the incremental EBITDA from transactions, current run rate debt to adjusted EBITDA level is right at the 6x level, while interest and fixed charge coverage are 3.5x and 2.8x, respectively.
As of June 30, HCN had $512 million in cash and no borrowings on its credit lines - a strong liquidity position with nearly $1.7 billion of line availability having already funded $5 billion of investments this year.
For the second quarter, normalized FFO and FAD increased 4% year-over-year to $0.93 and $0.82, respectively. The company's results this quarter came in slightly better than internal expectations and as a result, HCN announced its 169th consecutive quarterly cash dividend for the quarter ended June 30 of $0.765 per share or $3.06 annually, as this represents a 3.4% increase over the dividends paid in 2012 and a current dividend yield of 4.6%. Here is a snapshot of HCN's dividend compared with the peer group:
In looking further into HCN's earnings history (FAST Graphs) we can see that the company did suffer a dividend cut in 2007 (while the other primary peers - VTR and HCP - did not):
Here is better illustration of the history of HCN and more specifically, the dividend history:
From 2004 through 2013 HCN grew its dividend by an average of 2.7%:
Here is a comparison of HCN's dividend history and the other pure peers:
Now as I alluded earlier, I fancy Ventas over HCP because the Chicago-based REIT has excelled at growing dividends. That is also the case with Ventas vs. HCN. As illustrated below, Ventas has averaged 6.9% dividend growth over four years beating the combined growth of HCN (3% per year) and HCP (3.4% per year).
A Prescription for Value?
Comparatively speaking, HCN is the most expensive of the three Diversified Health Care REITs. HCN is a Price to Funds from Operations (or P/FFO) multiple of 17.6x.
Historically, HCN has been as expensive and the chart below illustrates that trend:
The close-up of FAST Graph illustrates that there is no "margin of safety" today with HCN. The company is trading at a relatively pricey level and given the alternatives today I believe that there will be a better entry price in the future. Ventas is no bargain but given the option, I would prefer to own VTR today vs. HCN or HCP. Although I admire the recent dividend performance of HCN, one must acknowledge that VTR has a superior dividend record of not only paying dividends but also for increasing them.
While considering the long-term performance of the health care REIT sector, HCN has provided average results (281%) over a ten year period. The company is doing an excellent job of managing its capital and integrating its diverse portfolio. I will continue to monitor the performance and look for a more attractive entry point. In the interim, I'm comfortable with Ventas and this article has further strengthened my view of the Ventas management team and the reason I consider HCP and HCN to be second to best.
In my November newsletter (The Intelligent REIT Investor) I will provide a list of Health Care REITs including operating metrics and latest earnings results. HCN and HCP report earnings on October 29th and VTR reports on October 25th.
Source: SNL Financial, FAST Graphs, and HCN Presentation.
Disclaimer: This article is intended to provide information to interested parties. As I have no knowledge of individual investor circumstances, goals, and/or portfolio concentration or diversification, readers are expected to complete their own due diligence before purchasing any stocks mentioned or recommended.