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Summary

  • Newcastle Investment manages physical assets such as senior housing properties and golf courses.
  • Currently Newcastle owns senior housing properties worth around $1.9 billion and equity investments worth $730 million.
  • The company has maintained its dividend per share at $0.10 per share, it seems rather unsustainable due to a low operating cash flow yield.

Newcastle Investment Corp. (NYSE:NCT) is a real estate investment trust (REIT) that manages physical assets such as senior housing properties and golf courses in order to generate income to be distributed to its shareholders. The company also invests in debt instruments such as commercial mortgage backed securities, asset backed securities, commercial loans, and residential loans etc. Newcastle has to pay more than 90% of its taxable income in order to qualify for the exemption of taxes. In the past 52 weeks, the company has given a good return of 10.25% in terms of capital appreciation and it currently maintains a good dividend yield of 8.50%.

Asset Spin-Off

Newcastle operates in three main divisions; senior housing, golf properties, and real estate & other debt instruments. Recently the company has announced its decision to split senior housing and other operations into a separate company, named New Senior, which will allow more focus on these operations. This way Newcastle is expecting both operations to grow at a better rate and increase shareholders' value. Such a spin-off is not a new phenomenon for Newcastle as it has separated itself from residential and media operations by creating new companies in the past. The previous spin-offs were beneficial to the company and we expect the same from the recent one as well.

Currently Newcastle owns senior housing properties worth around $1.9 billion and equity investments worth $730 million. Moreover, looking at the pipeline we can see that Newcastle will be purchasing more properties along the way until all formalities are completed for the spin-off. In the short term, Newcastle plans to acquire between $650 million and $750 million worth of properties and has properties worth between $300 million and $350 million in other pipelines. This indicates that New Senior will have a value of around $3 billion, considering the high-end values of the properties in the pipeline.

So far, only initial news about the possible spin-off has been announced and it is expected to be completed between the third and fourth quarter of 2014. This means that we will have to wait a little while before we can ascertain how much benefit will be transferred to the shareholders through the issuance of New Senior shares. But we still believe that this spin off will increase shareholders' value amid improved efficiency of the concerned operations.

Addition to Senior Housing Properties

Newcastle is not holding back senior housing acquisitions even after the announcement of the spin-off as it bought 6 senior housing properties for $186 million, which was paid through its cash reserves. At the same time, the company has signed a triple net master lease agreement with Lifecare Companies LLC (LCS). The lease will last a period of 5 years after which Lifecare will have the option to prolong the lease for a further 5-year period twice. The asset yield from this lease will be 7.6% with an increase of 3.75% from year 2 to 4 and 2.5% from year 5 to 15.

To clarify, a triple net master lease is a lease contract in which the right to maintain the property is transferred to the lessee. This means that the lessee will have to pay net property tax, net building insurance, and net common area maintenance. Hence, Newcastle will not have to incur any expense on the properties leased out to Lifecare. However, due to such a contract, the company will be charging a lower yield compared to an agreement that does not include a triple net lease. Newcastle appears to have made a smart decision as less hassle regarding old leased out properties will enable it to focus on future growth. Moreover, we believe that even if the triple net lease was not present in the contract, the return from properties would have matched the existing yield after paying taxes, building insurance, and maintenance.

Financials

The cash flow statement of REITs is more important than their balance sheet as it shows how well the business is being run. Newcastle did not show any promising signs in the last quarter as its cash flow from operations was only $4.6 million while it paid a hefty dividend of $36.5 million. While the company has maintained its dividend per share at $0.10 per share, it seems rather unsustainable due to a low operating cash flow yield of 5.13% (compared with the dividend yield of 8.50%). This indicates that we might see a reduction in dividends if Newcastle fails to increase its operating cash flows. The reason for such a low OCF in the first quarter of 2014 was a net income of $5 million (83% lower than the fourth quarter of 2013) amid increasing expenses of $135 million (a 42% increase quarter over quarter).

Amount in $ Million

2013 (Q1)

2013 (Q2)

2013 (Q3)

2013 (Q4)

2014 (Q1)

OCF

25

21

12

49

5

Dividend

39

57

44

31

37

Recently Newcastle sold some of its finished housing portfolios for $231 million resulting in a profit of 4%. On the other hand, it purchased senior housing properties worth $186 million from its cash reserves. The company itself received only $85 million of the $231 million after paying off its debt. This means that a net cash outflow of around $99 million occurred in the second quarter, negatively impacting the already low cash reserves.

Bottom Line

Newcastle is slowly transforming into a mortgage REIT from a hybrid REIT as it is shedding off its asset holding through spin-offs. This may prove to be a good strategy as it allows more focus and will improve operational efficiencies. When Newcastle spun-off its media operations, it issued shares of the new entity to existing shareholders, which not only increased their confidence in the company but also increased shareholders' value. We are expecting the same this time around but it is too early to say how Newcastle will proceed with the spin-off transition. The financials of the company are weak and need attention otherwise, we may see a fall in its dividend per share. However, we believe that the company has the potential to give good returns to the investors.

Source: Newcastle Investment: Is Reward Enough To Justify Weak Financials?