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Summary

  • Healthcare REIT is the largest US medical REIT by assets, with 1,199 facilities worth $22.6 billion. The company operates in the US, Canada and the UK.
  • It has industry best nursing home occupancy rates and same store sales, yet, its other assets drag its overall performance down.
  • The company has a secure dividend of 5.5% and is growing it at 4% annually. Its projected future returns are 10.55% CAGR, below competitors Ventas and Omega Healthcare.
  • Healthcare REIT's trump card is the fact that 83.1% of its properties are privately funded and not dependent on Medicare or Medicaid. Its nursing homes are 98% private.
  • Back in the late 90s Medicare changed its reimbursement rates and 1,600 nursing home operators went bankrupt. Ventas and Omega Health were devastated but Healthcare REIT was fine.

As part of my effort to research and grow an experimental real world high-yield portfolio, I have been researching medical REITs. I've already written an article on my favorite such company which is Omega Healthcare Investors (NYSE:OHI). In that article I explain why I feel Omega Healthcare is the best in its industry and trumps its competitor HCP (NYSE:HCP). I wrote about HCP in another article. As I sat down to research Healthcare REIT (NYSE:HCN) I was initially underwhelmed by many of its growth and operating efficiency statistics. However, there are areas in which this company is very strong and one in particular that makes it a worthy investment no matter its other failings.

Company Overview:

Healthcare REIT is the largest medical REIT in the US by assets with 1,199 properties worth approximately $22.7 billion.

Source: Q4 Earnings Conference Supplemental

As seen in these tables, Healthcare REIT is very well diversified with its largest segment which is senior assisted living operated being just 39.3% of assets. This acts to both hurt and help the company. It helps to spread out rental risk but dilutes the segment's industry leading same store sales growth of 6.2%. In other words, the excellent operating results from operated nursing homes is diluted by worse performing segments.

Catalysts For Growth:

The entire medical REIT industry is riding a strong socio-economic mega trend. That trend is the aging of baby boomers and the resulting increased population of senior citizens.

Healthcare costs are projected to soar from 17% of GDP to about 35% by 2040 and governments and private individuals are going to try minimizing costs.

Lucky for Healthcare REIT senior care facilities are the most cost effective way of taking care of seniors after medical procedures.

This ensures that the population of Americans requiring and using nursing homes in the future will increase and companies such as Healthcare REIT will benefit.

Competitive Disadvantages:

Initially, I was researching Healthcare REIT and saw very little to like about the company when comparing it to competitor Omega Healthcare.

Operation Inefficiency

Company

ROE

ROA

Operating Margins

Net Margins

Current Ratio

Debt/EBITDA

EBITDA/Interest

(OHI)

5.4

14.9

63.5

41.2

5.18

5.51

4.27

(NYSE:VTR)

2.3

5.1

16.8

16.5

1.56

na

na

(NYSE:SNH)

34.7

19.9

3.2

5.6

0.47

2.86

3.57

0.4

0.8

3.7

2.7

1.55

7.4

3.14

4.9

9.1

39.7

46.2

20.74

5.02

3.96

IND AVG

2.7

5.7

34.7

19.9

5.66

(source Morningstar.com)

As seen in the above table, while Omega Healthcare is 2-3x more efficient than the industry average. Healthcare REIT's operational efficiencies are about 7-9x worse than the industry average and 13-17x worse than Omega Healthcare's.

Worse Balance Sheet Than Omega

Healthcare REIT has a decent balance sheet. In April 2013, it was upgraded by S&P from BBB- to BBB.

Healthcare REIT has higher debt levels and the lowest ability to pay than its competition. Its coverage ratio of 3.14 means that it shouldn't have problems servicing debt. However, when it comes to issuing new debt to fund investment Healthcare REIT is more limited than its competitors.

Investment Opportunities

In terms of liquidity Healthcare REIT has $1.7 billion available for new investments. Omega Healthcare has $1.5 billion. If we compare the size of each companies' asset base we see something startling:

Healthcare REIT: $22.7 billion in real estate properties

Omega Healthcare: $3 billion in real estate properties

We see that if both companies invested all of their liquidity in new acquisitions, Healthcare REIT would increase its assets by 7.5% while Omega Healthcare could increase its asset base by 50%.

This difference in relative investment opportunities has a very real effect on the growth rate of both companies.

Growth Rate Potentials

HCN Revenue (<a href=

HCN EBITDA Chart

As seen in these graphs, Healthcare REIT is an industry dominating powerhouse when it comes to revenue and EBITDA growth.

HCN Dividend Chart

However, when it comes to translating that dominance into dividend growth it falls short of its competitors.

Recent Total Returns

HCN Total Return Price Chart

Compared to Omega, Healthcare REIT has far worse total return over the last decade.

On initial glance, Healthcare REIT may not appear to stand up well to its competition, especially Omega Healthcare. After all with a lower yield, slower growth rate and much worse operating efficiencies it seems that Omega is the clear winner when it comes to medical REITs. However, this conclusion would miss some very important competitive advantages that Healthcare REIT possesses. One of these advantages is a trump card that makes Healthcare REIT a strong buy for those seeking a secure income stream.

Competitive Advantages:

  • Nature of Property Locations
  • Senior Living Operated Facility Occupancy
  • Senior Living Operated same store growth
  • International expansion potential
  • Non reliance on government funding

Nature of Property Locations:

Healthcare REIT's facilities are located in major metropolitan areas and specifically in rich areas. Here are brief descriptions from the company's latest earnings supplemental presentation.

Top Ten Operating Partner Descriptions:

Sunrise Senior Living, located in McLean, VA, is a privately held company that operates 292 premium private pay seniors housing communities with over 26,850 units in the United States, Canada and the United Kingdom. The portfolio is concentrated in infill locations in major metro markets. As of 12/31/2013, the HCN portfolio consisted of 125 private pay senior housing facilities with an investment balance of $4.0 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 12/31/2013, the HCN portfolio consisted of 177 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 senior housing operator in Canada. The company operates over 200 senior housing and long-term care facilities in Canada and the United States. As of 12/31/2013, the HCN portfolio consisted of 47 private pay senior housing facilities located across five Canadian provinces with an investment balance of $1.2 billion.

Benchmark Senior Living, located in Wellesley, MA, is a privately held company that operates 50 premium private pay seniors housing facilities with approximately 4,000 residents with a concentration in New England. As of 12/31/2013, the HCN portfolio consisted of 39 private pay senior housing facilities in six states with an investment balance of $940 million.

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 12/31/2013, the HCN portfolio consisted of 19 private pay senior housing facilities in six states with an investment balance of $851 million.

Emeritus Senior Living (NYSE:ESC), located in Seattle, WA, is a publicly traded company that provides independent living, assisted living, memory care, skilled nursing, home health and rehab services. The company operates 515 senior housing facilities in 45 states with the ability to serve approximately 54,000 residents. As of 12/31/2013, the HCN portfolio consisted of 59 private pay seniors housing facilities in 19 states with an investment balance of $820 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 2,500 units in five states with a concentration in infill markets in the Mid-Atlantic. As of 12/31/2013, the HCN portfolio consisted of 27 private pay seniors housing facilities in five states with an investment balance of $744 million.

Senior Lifestyle, located in Chicago, IL, is a privately held company that operates premium private pay communities across the full spectrum of independent living, assisted living, rehabilitation, skilled nursing, memory care and continuing care in metro markets across the United States. The company operates 107 facilities in 21 states. As of 12/31/2013, the HCN portfolio consisted of 34 private pay seniors housing facilities in eight states with an investment balance of $721 million.

Brookdale Senior Living (NYSE:BKD), located in Brentwood, TN, is a publicly traded company that provides independent living, assisted living, memory care and rehab services. The company operates 651 senior housing facilities in 36 states with the ability to serve approximately 67,000 residents. As of 12/31/2013, the HCN portfolio consisted of 87 senior housing facilities in 19 states with an investment balance of $625 million.

Chartwell Retirement Residences (NYSE:CSH), is a publicly traded company located in Mississauga, Ontario, that operates 225 facilities in North America, and is the largest senior housing operator in Canada. As of 12/31/2013, the HCN portfolio consisted of 42 private pay senior housing facilities located across four Canadian provinces with an investment balance of $453 million.

Senior Assisted Living Operated Occupancy

According to the Q4 2013 earnings supplemental, occupancy at Healthcare REIT's operated nursing homes was 89.4%. This is much better than both the industry average of 82.3% and Omega Healthcare's 83.4%

Senior Assisted Living Same Store Growth

Healthcare REIT's same store growth is 6.2% for nursing homes they operate. This compares favorably to the 4% growth at Omega Healthcare. The reason for this strong growth is the location and nature of the facilities. Healthcare REIT's facilities are located in wealthier, more populated areas, mainly on the East and West Coast. Omega Healthcare's facilities are spread out across the US and on average in less wealthy and less populated areas.

Overseas Expansion Potential

12.6% of Healthcare REIT's facilities are located in Canada and the UK. Though a small portion of its business now, during the last earnings call, management indicated an interest in overseas expansion. Compared to its peers, Healthcare REIT is the only company with the staff, experience, relationships and desire to expand internationally.

Non Reliance On Government Funding

Source: Q4 Earnings Conference Supplemental

This is Healthcare REIT's trump card. It is the single reason that makes it a great long-term income investment - despite mediocre results compared to its competitors. 83% of the company's revenues are derived from private payers and only 17% coming from the government. In addition, senior housing operating (the company's largest and fastest growing division) has 98% of its revenues coming from private sources. This is a moat of safety that no other medical REIT can claim.

Most medical REITs' operating partners depend on Medicare and Medicaid for the majority of their income. This poses an immense risk in the form of changes in Medicare and Medicaid reimbursement rates.

The last time such an event happened was with the Balanced Budget Act of 1997. This law resulted in $15 billion in long-term cuts to Medicare's senior assisted living facility reimbursement schedule. The result was over 1,600 nursing homes going bankrupt over the next few years. This represented nearly 10% of nursing homes in the US. The result to competitors such as Ventas and Omega Healthcare was devastating.

HCN Dividend Chart

Please note that the apparent drop in Healthcare REIT's dividend in 1997 was due to a pro rated dividend. This was the result of a merger with Windrose Properties. When combined with a pro rated Dec 28 dividend the total dividend that quarter was $0.64 and represents no change.

As seen in the above graphs, when one expands the time frame to include 20 years a completely different picture becomes is painted.

The failure of so many of Omega Healthcare's operating partners in the early 2000's resulted in a 74.3% reduction of its dividend from its peak of $.7/share in October 1999 to just $.18/share in July of 2004. Though Omega Healthcare has been growing its dividend by double digits in the last decade, long-term investors must remember what impact the Medicare reimbursement cuts had on Omega's dividend. Future reimbursement changes that result in similar dividend cuts are a real risk.

Why Healthcare REIT is a great long-term income investment

HCN Dividend Chart

Since 1985 Healthcare REIT has grown its dividend at a compound annual growth rate of 4.5%.

HCN Total Return Price Chart

Note the shaded lines in the graph represent recessions.

Its total returns, which include dividend reinvestment, have been stellar. In the last 30 years Healthcare multiplied investors' money 99x which results in a CAGR of 16.6%. Compare this to the market's 11.5% return and one can see that Healthcare REIT has been a standout investment.

Valuation and Future Returns:

Normally on a high-yield income stock I would run an adjusted discounted dividend model to determine fair value. The way this method works is:

Total Return (OTCPK:CAGR)=(Yield+CAGR dividend growth)*average yield

This takes into account current income, capital gains (fueled by dividend growth) and dividend reinvestment.

The discount rate is the stock market's 1871-2013 CAGR of 9% adjusted for dividend reinvestment to 11.1%. This 11.1% represents the market's promise to investors. If you park your money in a low cost index fund and reinvest the dividends, then given enough time you'll earn approximately 11.1% annually. Note that the 142-year total return included 28 recessions, financial panics and depressions. It also included two oil shocks, two world wars and the Cold War. It seems safe to say that the next 142 years should be able to return similar numbers unless one thinks the world is likely to experience an even more eventful century and a half.

In previous articles I stated that individual stocks are riskier than a market index fund and therefore only investments with projected returns superior to the market should be considered.

In my article on HCP, a competitor of Healthcare REIT, commenters correctly pointed out the flaw in my logic. Perhaps growth investors should only target stocks with projected long-term total returns of over 11.1%, but for income investors this rule does not apply.

A market index fund pays a 2% dividend - which is not enough to live on. Since many income investors include retirees, a higher yield, such as Healthcare REIT's average yield of 5.5%, is required.

In addition, consistency and security of the dividend is paramount. Omega Healthcare might have a higher yield and faster dividend growth rate, but Healthcare REIT's minimal exposure to Medicare and Medicaid means the dividend is safe, no matter what the government decides about future reimbursement rates.

Thus to value Healthcare REIT, which is truly a "buy and hold forever" stock one must simply look at its historical yield of 5.5%. Today's yield matches this indicating that Healthcare REIT is fairly valued based.

In terms of future returns, I believe that one can still use my adjusted formula and determine that Healthcare REIT will approximately return, over the long-term (5.5+4.5)*1.055=10.55% CAGR.

Meanwhile, in the short-term management is guiding for 2014 FFO/share growth of 3-6% and FAD (funds available for distribution) of 5-8%. This indicates that short-term dividend growth of 3-8% is possible with analysts projecting 4.3% CAGR over the next 3 years.

Technical Analysis:

Note that I am a fundamental investor only. I only provide short term technical analysis to help investors decide if a stock's price is likely to drop in the near future. I do not advocate technical analysis for market timing in any other way.

The short-term signals are neutral with medium to long-term signals bullish. There is moderate level 5 support at $58.45 with level 7 resistance at $61.32. The latest candlestick pattern is neutral.

All this means is that Healthcare REIT has bottomed off its recent crash and is not likely to drop lower. Interested long-term investors should not hesitate to open positions at the current price. Current shareholders can add to their positions without concern over a short-term price drop.

Conclusion:

A cursory glance at the medical REIT industry may cause potential income investors to shun Healthcare REIT in favor of the faster growing Omega Healthcare or Ventas. I feel this is a mistake. While an investment in Ventas and Omega Healthcare is a good idea as part of a diversified income portfolio, I believe Healthcare REIT deserves consideration as well.

Healthcare REIT offers opportunities that its competitors lack. An example is international expansion. In addition, the security of having 83% of its revenues from private sources means that investors can sleep well at night knowing the dividend is secure. With the mega trend of an aging society, in all of the company's markets Healthcare REIT is poised for decades of strong and consistent growth. Long-term income investors would be hard pressed to find a better or more secure REIT.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. 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.

Source: Healthcare REIT: A Great Income Investment Despite Seemingly Mediocre Results