I am the first to admit that when I see a REIT yielding more than 10% these days, I assume that it is for good reason and the market is correct in projecting a large dividend cut. I had seen New Senior Investment Group Inc. (NYSE:SNR) pop-up a few times on several high yield screens, and did not give it much notice. This long weekend, I finally had time to do the analysis and I was surprised by what I found.
New Senior is an investor in senior housing properties and as of December 31, 2015 owns 154 properties in 37 states. New Senior was spun off from a subsidiary of NewCastle Investment Corp. with New Senior shares distributed to holders of NewCastle's common shares on November 6, 2014. New Senior's properties can be grouped into three separate categories. Independent Living properties are age-restricted multifamily properties with central dining facilities offering meals and other recreational activities. Assisted Living properties provide similar accommodations and additional staff to assist with daily living. Continuing Care Retirement Community properties offer several levels of care on its campus including independent living, assisted living, and skilled nursing. Independent Living, Assisted Living, and Continuing Care Retirement Community properties generate 71%, 20%, and 9% of New Senior's net rental revenues respectively, as of its most recent quarter (see slide 5 of Q4 2015 Quarterly Supplement).
New Senior divides its properties into two different segments, Triple Net Lease Properties and Managed Properties. With Triple Net Lease Properties, the tenant is responsible for repairs, maintenance, capital expenditures, utilities, taxes, and insurance. With Managed Properties, New Senior collects rent and service fees from residents and pays for repairs, maintenance, capital expenditures, utilities, taxes, insurance, and payroll expenses of property-level employees. For the payroll expense, the property manager is the employee of record and New Senior reimburses its contracted property management company. All Managed Property expenses are reported in New Senior's Income Statement on the Property Operating Expense line.
Holiday Retirement is the property manager or triple net lessee generating 76% of New Senior's net rental revenue. Holiday and New Senior are so intertwined that Holiday's annual financial statements are filed alongside New Senior's 2015 10-K as an exhibit. The concentrated Holiday credit risk may be the driving factor behind New Senior's low equity valuation because New Senior's dividend seems otherwise sustainable. Based on my estimate of 2016 Funds From Operations (FFO), which assumes all existing triple net and property management contracts will be honored, New Senior's dividend is paying out 78% of FFO. Below is the model I created of New Senior's estimated 2016 financial performance.
My Performance Model (in thousands USD):
Figure 1- Anthony Breen's Model Estimating New Senior 2016 Financial performance. Details regarding assumptions and calculations found below.
Calculation of 2015 Pro-Forma Estimated Results
To estimate New Senior's performance in 2016, I began with 2015's actual performance. Since New Senior acquired $1.26B of properties throughout 2015, the 2015 Pro-Forma column is an estimate of how New Senior would have performed if all of these properties were acquired on January 1, 2015. The $463,755 2015 Pro-Forma rental revenue number comes from New Senior's 2015 10-K below.
Figure 2 - New Senior Estimate of Pro-Forma 2015 results, from New Senior 2015 10-K (in thousands USD).
To allocate the top line rental revenue number between the Managed Property and Triple Net operating segments, I reviewed the composition of 2015's acquisitions. Only one of the properties in 2015 was Triple Net, acquired on May 1, 2015 for $71.8M. The cap rate of the acquisition was not disclosed, so I assumed a cap rate of 7%. Thus, the 2015 Pro-Forma Triple Net Lease Rental Revenue is the 2015 Actual Triple Net Lease Rental Revenue plus the four months of rent that would have been received if this acquisition closed January 1st (4 months/12 months*$71.8M*7%).
Figure 3 -Table of 2015 acquisition details, from New Senior 2015 10-K.
After calculating 2015 Pro-Forma Triple Net Lease Rental Revenue, I solved for 2015 Pro-Forma Managed Properties Revenue ($350,926). I then calculated Pro-Forma Managed Property Operating Expenses assuming they increased proportionately with the Pro-Forma Managed Properties Revenues increase.
Moving onto the 2015 Pro-Forma Expenses, Interest Expense is the major differing line item from 2015 Actual Expenses. I assumed that the debt New Senior had in place December 31, 2015 was its debt for all of 2015 (December 31, 2015 debt characteristics in Figure 4 below). I kept all other cash expense items the same, except the Management Fee to Affiliate, which I calculated by annualizing the fourth quarter 2015 fee. Finally, I solved for the noncash Depreciation and Amortization Expense that would yield a 2015 Pro-Forma pretax net loss estimate of $108,782 (in Figure 2 above).
Figure 4 - Screenshot from page 30 of New Senior's Q4 2015 Quarterly Supplement.
Calculation of 2016 Estimated Performance
If you are still with me, we are ready to move onto 2016. New Senior's low equity valuation has eliminated the prospect of any property acquisition in 2016. On the fourth quarter conference call, management stated interest in selling properties to raise cash (to buy shares or pay down debt). For simplicity's sake, my 2016 estimate is based upon no property acquisitions or dispositions occurring in 2016. With this assumption, my 2016 estimate is a straightforward projection of the 2015 Pro-Forma numbers.
To estimate revenues, Triple Net Lease revenue will increase 4%, as these rental contracts have 4% escalators through 2017 (see slide 13 of Q4 2015 Quarterly Supplement). Based on informal guidance from the fourth quarter conference call, half of the Managed Properties are expected to grow revenues 4-6% in 2016 and the other half will grow revenues at a slower rate. Conservatively, this yields a blended average growth rate of 3% for the Managed Properties segment.
To estimate expenses, I increased Managed Property Operating Expenses by 3% because these expenses should grow in line with Managed Property Revenues. I increased 2016 Interest Expense by $2.2M to account for LIBOR being 25 basis points higher on average in 2016 than year-end 2015. Prospective New Senior investors should do a short term interest rate sensitivity analysis for New Senior's $874M variable interest debt, which is outside the scope of this article. I kept Management Fee to Affiliate constant from 2015's Pro-Forma results, as this line item will only increase if New Senior raises more equity. I increased General and Administrative Expense by 10% over 2015's number. Finally, I eliminated Acquisition, Transaction, Integration, Extinguishment of Debt, Other, and Income Tax expenses for 2016, as these should not recur.
New Senior currently has 82.1 million shares outstanding and is paying a $0.26 quarterly dividend. Therefore, New Senior needs $85.4M in annual cash flows to cover its dividend. Based on my model and the assumptions inherent within it, my estimate of 2016 Funds From Operations is $109.8M. Maintenance capital expenditures in New Senior's 2015 fourth quarter were $2.4M. At the same maintenance capital expenditures run rate, 2016 maintenance capital expenditures of $10M should leave an estimated $100M in cash flow available for distribution. With this sum, New Senior could cover its dividend and continue its existing share buyback program.
Since December 2015, New Senior has taken advantage of its low equity valuation by buying back 5% of its outstanding common stock. A twelve-month $100M open market buyback program was approved on December 1, 2015. In December under this program, 1.1M shares were repurchased at an average price of $9.22. In January, an additional $30M tender offer was completed at $9 per share for 3.3M shares.
Figure 5 - Screenshot from Page 11 of New Senior's 4Q 2015 Quarterly Supplement.
Going forward, $90M remains authorized on New Senior's buyback program. Additionally, New Senior appears to have at least $35 million available to repurchase shares. During prepared remarks of New Senior's 2015 fourth quarter conference call on February 25th 2016, Justine Cheng, CFO, disclosed: "We have good liquidity on the books and ended the year with a $117 million of cash. After the impact of our $30 million tender offer and working capital reserves, we will have roughly $35 million to $45 million in total available cash and 82 million of basic shares outstanding." Since this disclosure $9 has held as a floor on the value of the stock, with shares trading as low as $9.12. As I suspect that New Senior will buy back more shares if the price dips to $9 or less, I will be watching price action closely.
Disclosure: I/we have no positions in any stocks mentioned, but may initiate a long position in SNR over 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.