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First Look At CTRE Health Care REIT

The Ensign Group (NASDAQ:ENSG) announced the successful completion of its spin-off of CareTrust REIT. In the spin-off, Ensign stockholders received one share of CareTrust common stock for each share of Ensign common stock held at the close of business on May 22, 2014. The spin-off is effective from and after 6-01-14, with CareTrust shares distributed on 6-02-14. Starting 6-03-14, shares of CareTrust common stock commenced trading on the NASDAQ Global Select Market on a "regular-way" market. Yahoo shows some small trades prior to that date. On 6-03-14 CTRE opened at $21.42 and closed at $21.60. CTRE closed as traded as low as $14.61 on 8-08 - and closed as low at $15.23 on 8-07 and 8-11. With 22.4 million shares - I calculate a market cap of $378 million. That compares to DOC's $489 million and UHT's $567 million.

CareTrust REIT, Inc. (NASDAQ:CTRE) Reports "run rate" FFO of $0.33/share

During the one month (the time since the IPO) ended June 30, 2014, CTRE generated FFO of $2.3 million ($0.10/share), and FAD of $2.4 million ($0.11/share). After adjusting for one-time costs associated with the spin-off that were incurred in June, normalized FFO was $2.5 million ($0.11/share) and normalized FAD was $2.7 million ($0.12/share). Net income for the one month period ended June 30, 2014, was $0.46 million, or $0.02 per diluted common share. Revenue was $14.065 million.
CareTrust issued guidance for the 12-month period following the spin-off. The guidance, which is based on assets and revenues in place on June 30, 2014, did not take into account any acquisitions during the year. It included projected annual revenues of approximately $56 million from the Ensign master leases, approximately $24 million in interest expense, and $4.5 million to $5.0 million in general and administrative expense. CTRE projected normalized FFO, normalized FAD and net income of $1.23 to $1.25, $1.33 to $1.35, and $0.24 to $0.26 per diluted common share, respectively.
CareTrust has 97 properties in ten states, with 8,375 skilled beds (SNFs), 1,494 assisted living units (ALFs), and 516 independent living units (Senior Housing) leased and in operation. Of the 97 properties CareTrust owns, 94 are net leased to its former parent (Ensign), and three independent livings are operated by the Company. (CTRE is SNF heavy - the second worst of the health care property types when it comes to RRR assessments) On May 30, 2014, CTRE's wholly owned subsidiary, CTR Partnership, and its wholly owned subsidiary, CareTrust Capital Corp, completed a private offering of $260.0 million aggregate principal amount of 5.875% Senior Notes due 2021. (Compare that to OHI's longer term bonds selling at a 4.72% yield and SBRA's bonds selling at a 4.88% yield. LTC - which is 54% SNF- locked rate at 4.50% on $30.0 million of 12 year senior unsecured notes to be held by Prudential Investment Management in a transaction that is expect to close in August 2014. Some of the yield difference is due to CTRE's lower size - and some due to a lack of a track record. I use bond yields as a major factor is assessing RRRs in other sectors. If "5.875%" is the best it could get for a rate, then you should use that as a strong omen that CTRE is "relatively risky". This is an independent judgment where the judges put their money behind where there judgment went. CTRE has not provided credit metrics in its shortened earnings release. The "5.875" number causes me to expect that CTRE is more leveraged than average.)

Playing with the valuation numbers: With normalized annualized FAD of $1.34 and assigning a sector average normalized FAD payout ratio of 82% - the projected annual dividend would be $1.10. CTRE closed on 8-15-14 at $16.89 - and the projected yield at that price would be 6.51%. There are three other SNF heavy REITs: AVIV closed at a 5.17% yield and a 75% FAD payout ratio; OHI closed at a 5.31% yield and had a 77% payout ratio; and SBRA closed at a 5.47% yield and had a 71% payout ratio. Changing the payout ratio to be more in line with OHI and SBRA, 74% of $1.34 would be $0.99/share and the projected yield would be 5.86%. The current price/normalized FAD ratio is 12.60 compared to AVIV's 14.59; OHI's 14.50; and SBRA's 13.00. But all those stats have a fault - they are comparing apples to oranges on time periods.

Summation: CTRE is selling at a discount - but given the size of the unknowns and the amount of negative information in the stats that are revealed - the size of the discount is not enough for me to see it as attractive. I do not like the fact that the Ensign Group spun CTRE out at $21.42 - or - that it accepted what appears to bad advice from those investment bankers who assisted in this spin-off. They knew a $21.42 price resulted in a 16.00 price to FAD ratio - because they knew the FAD projection. Currently, the highest price/FAD ratio for an SNF is 14.59 - and that is based on a pure "2014" FAD projection. I do not like the absence of credit metrics in the earnings release. I do not like that CTRE is too tied to Ensign - I want some diversity in its client base. CTRE does get points for providing a release on one month's worth of data. CTRE gets points for providing a FAD projection - but I take those points away when it spins off at a price that is too high given that projection. The good news is that CTRE's share price is volatile. Until CTRE declares a dividend, the price is likely to stay volatile. Until I have more information, I want a 15% discount on CTRE compared to SBRA. SBRA sells at a 13.00 price/FAD ratio. A 15% discount would produce a 11.05 ratio. A ratio of 11.05 times a FAD of $1.34 produces a price of $14.81. Even if one can get that price, you still own a suspicious and potentially inferior REIT at a great price. In other words - even if you bought it, you may not want to "hold" it. While there were a lot of good numbers and sound logic going in to this valuation assessment - it is still a speculative assessment until the time that the unknowns are revealed.

Disclosure: The author is long OHI.