- FVE benefits from the aging of the baby boomers
- Shares trade at a significant discount to competitors, though part of the discount might be apparent
- Industry fundamentals are improving
- There are significant conflicts of interest with SNH/RMR
One of the better known demographic trends is the retiring of the baby boomer generation. Frequently, this trend is used to justify investing in many healthcare segments, as the baby boomer retirees are sure to make up for increased demand over time. Retirement communities are one of the segments expected to benefit.
Five Star Quality Care (FVE) is one of the quoted operators of such communities. Hence, given the presence of this huge demographic trend, it warrants a closer look.
Five Star Quality Care operates 251 senior living facilities. In terms of revenues, the breakdown of these facilities is as follows (Source: Company presentation):
This means that 47% of revenues are for independent living/assisted living facilities (IL/AS); 36% are for skilled nursing facilities providing services for IS/AL facilities (Continuing Care Retirement Communities - CCRC) and 17% are for free-standing nursing facilities.
The services these facilities provide are paid mostly out of private funds:
This is somewhat relevant, because Medicare/Medicaid funds have been seeing reductions which impacted the senior living industry. Even FVE felt this impact in spite of the low exposure.
Finally, FVE provides its services mostly using leased communities. Its 29743 units are distributed as follows:
This is relevant because FVE leases its units from a related party. More on this later.
FVE is also well diversified geographically, though 16% of its units are in the usual "retiree State" of Florida.
Industry-wide dynamics are determined by demand from retirees, which is a function of demographics and income levels as well as the supply of retirement communities. These variables aggregate into the industry-wide occupancy rate, yearly rate of unit absorption, rent rate increases and new construction supply. The best source for this data is the National Investment Center for the Seniors Housing & Care Industry (NIC.org). NIC.org publishes regular reports on the state of the industry.
The latest publicly available report, for Q4 2013, shows the following trends:
This shows a slight uptrend in occupancy rate as well as rents. Construction slightly exceeds absorption though not worryingly so. Construction is actually running at an historically low pace (Source: Brookdale presentation)
FVE's overall occupancy is slightly below the industry's, so there's some room for improvement. Perhaps more worrisome is the nursing facilities' occupancy, visibly below the industry and still dropping.
FVE generates a substantial amount of revenues, exceeding $1.2 billion per year. This in turn leads to a low EBITDA margin, since EBITDA is barely $45 million.
The low reported EBITDA seems to be a function of FVE leasing most of its units as well as seeing somewhat low compensation for the units it manages.
On the other hand, having few owned assets leads to a low debt load, with just $63 million in financial debt.
FVE has a market capitalization of $254 million and $309 million in shareholder equity, giving it a price/book value of 0.82.
A slight warning here, these numbers are taken from the quarter which ended in June 30 2013, since FVE is late in filing the Q3 2013 quarter due to a restatement of its financial statements, though the differences shouldn't be material.
The main reason to consider FVE, or indeed its competitors, is the massive expected demographic shift happening in the U.S. with the retirement of the baby boomer generation. As these retirees get older they increasingly need the kind of services provided by FVE. This together with the present slowdown in construction will probably provide a strong tailwind to the industry as a whole.
FVE as a stock might additionally be helped by an apparent discount versus its competitors. In terms of price/book value FVE trades at 0.82 times, versus 3.5 times for BKD, 6.7 times for ESC and 3.9 times for Capital Senior Living (CSU).
In terms of EV/EBITDA, FVE trades at 6.2 times, versus 13.8 for BKD, 14.7 for ESC and 18.4 for CSU.
I say this is an "apparent discount" because these competitors have a different mix of leased/owned/managed units, and capitalizing leases narrows the EV/EBITDA discrepancy considerably.
FVE is selling distractions
Over the latest quarter FVE has sold two rehabilitation hospitals, further concentrating on senior living facilities.
It has also sold out of its pharmacy business, and pared back its exposure to senior nursing facilities.
FVE has significant relationships with two entities: Senior Housing Properties Trust (SNH) and RMR. SNH is both FVE's largest shareholder and largest landlord. It's possible for it to decide where value is created simply by moving internal prices. RMR further controls SNH as well as provides FVE with management services. Here again it's possible for conflicts of interest to emerge and lead to value being siphoned off.
RMR also employs the President and Chief Executive Officer, the Treasurer and Chief Financial Officer, and one of the Managing Directors. The potential for conflicts of interest is vast and might lead to a permanent valuation discount. A similar situation existed with the same entities over at TravelCenters of America (TA), a stock on which I wrote favorably in the past. While TA managed to break out on the upside, the valuation discount seemed quite permanent there as well.
Adjusting valuation for leases
As mentioned the apparent EV/EBITDA discount is significantly reduced when leases are capitalized. A back of the envelope calculation applying a 8% cap rate to $199 in minimum rents increases debt by $2487.5 million and leads to adjusted EBITDA of $244 million, this in turn leads to an adjusted EV/EBITDA of 11.2 times instead of the original 6.2 times.
FVE seems like an interesting equity, exposed to the large demographic shift brought about by the retirement of the baby boomers. The industry is showing improved fundamentals as well, though there is some vulnerability in the Medicare/Medicaid revenues.
FVE trades at a valuation that's lower than its competitors, though part of it might only be apparent due to different leasing/owned mixes. Finally, FVE has an image problem brought about by the fact that its largest shareholder is also its largest landlord and conflicts of interest can easily emerge where value might be arbitrarily allocated to one place or another.