Sabra Health Care REIT - Built On A Solid Foundation

| About: Sabra Healthcare (SBRA)


Sabra Health Care REIT, INC. (NASDAQ:SBRA), as of their last quarterly release, has a healthcare portfolio of approximately 123 properties, and through its subsidiaries owns and invests in real estate properties in the healthcare industry. Sabra was originally spun-off from Sun Healthcare Group Inc (NYSE:SHG). on November 15, 2010, a spin-off which included 86 owned real property assets, the assumption of debt, and mortgage indebtedness to third parties on 26 of the real property assets. Since the separation the company has acquired 37 properties, provided preferred equity financing to builders at exceptionally high interest rates, and has purchased one distressed debt instrument which has since been repaid in full, netting the company $3.0 million.

Following the spin-off of SBRA, SHG was acquired by Genesis HealthCare LLC (Genesis), a Pennsylvania based healthcare service provider. As an investor in SBRA, it's important to note that 85 of the 123 properties the company owns are leased through Genesis or one of its subsidiaries. SBRA's concentration of credit risk in another company's ability to operate their healthcare facilities is high and could potentially pose a threat to SBRA's revenue stream in the future. Luckily for investors, management has identified this potential pitfall to the longevity of SBRA's future and has been acquiring properties not operated by Genesis. Given that Genesis' lease-term in a SBRA-owned property is over 10 years with the option to extend, SBRA's management has ample time to diversify away from this systematic risk.

In 2011 Health Care REIT, Inc. (NYSE:HCN) acquired substantially all of Genesis' real estate assets. This transaction leads me to believe Genesis has close connections with HCN and since HCN is a direct competitor to SBRA, Genesis will most likely get more favorable lease terms in a HCN property once their leases expire with SBRA.

Come on already, enough with the hypothetical of what could happen in 10 years once the leases expire. I thought this article was about SBRA being built on a solid foundation? Well here it comes, remember Rome wasn't built in a day.

Capital Structure

The ability to raise capital is the nexus holding all real estate companies together. SBRA is no exception and has sought out the capital markets for a revolving credit facility, issuance of equity capital, and issuance/refinance of their debt. Listed below are some of the more recent deals.

Revolving Credit Facility

SBRA has used its revolving credit facility (RCF) like an American Express (NYSE:AXP) Blackcard. "On July 29, 2013 the Operating Partnership entered into an amended and RFC. The RFC provides for a borrowing capacity of $375.0 million and includes an accordion feature that allows the Operating Partnership to increase the borrowing availability by up to $225.0 million," according to the most recent 10-Q. From July 29, 2013 to the most recent acquisition of 3 acute hospital projects in Texas during Q4, the available credit in the RCF went from $285.5 million to $155.5 million assuming the accordion feature wasn't exercised. What does this mean to a long-term shareholder? It means having the financial flexibility of an additional $380.5 million ($155.5 million + $225.0 million) in additional acquisitions, renovations, and/or having financial stability. But like an American Express Blackcard, it has to get repaid at some point. That some point is July 29, 2016, possibly 2017 with a one year extension option. Most likely, management will refinance the RCF with the issuance of equity or issue debt and take advantage of historical low interest rates before the RCF becomes due.

Equity Issuance

If you're an investor invested in an unfriendly management team, then you probably know all too well the effects of the issuance of common stock. The dilution to common stockholders from the issuance of equity has one of two effects: either positive or negative. The last serious round of an equity offering by SBRA was on August 1, 2011, with 11.7 million newly issued shares. As a real estate investor, its easier to trace the effects of where/why the money was raised compared to a technology or bio-pharmaceutical company that invests in R&D (most likely only to see the money squandered I bet). From August 1, 2011 through Q3 2013, the company has acquired 36 healthcare facilities, while seeing their FFO increase from $24.0 million nine months ended 9/30/2011 to $40 million nine months ended 9/30/2013, with a per-share FFO/AFFO (diluted) of .89/1.13 and 1.06/1.27 for the nine months ended 2011 and 2013, respectively. The fact is the 2013 numbers would have actually been better if they didn't incur a loss on debt extinguishment related to the redemption fee of $113.8 million in notes due in 2018 of $9.8 million. But I guess since management refinanced at a lower interest rate, in the long run, more money will trickle down to investors' Louis Vuitton wallets!

As an equity investor I'm not worried with the high dividend yield, or fears that it could be an early warning sign of a dividend cut. In fact, I wish the price would go lower (all else being equal, of course), so I could buy more.

Now this section wouldn't be complete without a few words about the At-The-Market Common Stock Offering Program (ATM Program). SBRA has in place with RBC Capital Markets the right to sell common stock with proceeds of up to $100 million. (The concept is similar to a shelf registration.) In my opinion the ATM Program is just the cherry on top to an excellent management team that has shown the discipline to carry out its corporate strategy and increase shareholder value.

Debt issuance/refinance

As mentioned above the company redeemed $113.8 million in debt at a lower interest rate at a cost of $9.8 million. As a result of this refinancing, SBRA posted one of its only net income losses on a US GAAP basis. But as a long-term shareholder, I'm not worried since I'm paying a lower amount to borrow capital. In fact according to SBRA's latest press release, the company is paying an average interest rate of 6.04% on $556.7 million in debt. $33.6 million in interest expense is an annualized amount which isn't bad for a REIT with an interest coverage ratio of 3.55 (EBITDA/Interest Expense), for the three months ended September 30, 2013. In fact, the risk of SBRA defaulting on its loan is extremely low and the company would be any banker's dream to lend money to.

Aging Population

The baby boomers thought of themselves as one of the greatest, if not, the greatest generations in American history. Unfortunately old age hits us all and the greatest generation of all is slowly but surely taking those baby steps in SBRA's healthcare facilities. According to US Census Bureau statistics from 2010, 13% of the US population is over 65 years of age followed by 26% of the US population between the ages of 45-64 (based on a total US population of 308.7 million.) As a shareholder, I can't help but get excited about the growth prospects in the healthcare industry SBRA is in. As a value investor, having 26% of the population reaching retirement is the ultimate margin of safety, even though not all elderly or acute patients will ever need living care assistance.

The soon to be if not already growing need for healthcare facilities in the United States puts SBRA in a position to capitalize. My conclusion is that in 10 years the demand for healthcare facilities will be so tight SBRA will be able to renegotiate their leases at a much higher rate than the 2.5% average rent escalation per year now with most Genesis leases. As a value investor you look for the pitfalls such as 1)management's ability to execute 2) unfavorable borrowing terms and 3) Genesis credit rating deteriorates to a point of no payment. Indeed, one ripple could gradually lead to the next in causing the company's fundamentals to deteriorate. The industry's demand from a macro investor stance in the United States is, even if you don't hit a homerun in investing in SBRA, "All boats rise in a rising tide."

Disclosure: I am long SBRA. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.