HCP (HCP) is one of the largest healthcare real estate investment trusts. Until last year, they were a dividend aristocrat at the same time. Dividend aristocrats are stocks which have increased their dividend payouts for at least 25 consecutive years. They were the only REIT among dividend aristocrats from the S&P 500. In this category, HCP has even been the highest yielding stock for some time.
This all changed when HCP decided to spin off their skilled nursing business including their holdings of big tenant HCR ManorCare. Quality Care Properties (QCP) was spun off. As a result of this spinoff, HCP needed to reduce its dividend as well, while until now, QCP has not started paying a dividend yet.
For buy-and-hold investors, this was a very significant moment. People who bought HCP based on their magnificent dividend history were assuming to possess a stable, dividend-growing business. The spinoff did not happen out of the blue since bad results of the skilled nursing holdings were already apparent for a longer period of time. But the subsequent dividend cut was not pleasant.
My own experience
On the 27th of May 2014, I bought HCP shares for the price of $41.74 per share. Though I am mostly a buy-and-hold investor, there were multiple moments during the roller coaster of the HCP share price when I considered selling them. I didn't.
Chart: HCP price development (note that this graph is corrected for the QCP spinoff)
As you can see in the graph, HCP shares have been in a downtrend for quite some years. But at this moment, the spinoff is well behind us and HCP is returning to calmer waters. But I cannot help wondering whether I should have done something different. To analyse this question thoroughly, let us first take a look at the dividend history of HCP.
HCP shows a beautiful dividend growth path. Corrected for stock splits, they increased their dividend from $0.16 per quarter in 1988 to $0.575 per quarter in the beginning of 2016. They had an average long-term yearly dividend growth rate of 4.7%.
Chart: Quarterly dividend of HCP
Then the year 2016 brought the spinoff of QCP with their biggest tenant HCR ManorCare business. HCP was on track to pay out $2.30 in the year 2016 but never reached this level. After the spinoff, HCP reduced their quarterly payout to $0.37. It cannot be underestimated how significant this was for many long-term buy-and-hold investors. The dividend payout suddenly dropped to the level of Q3 of the year 2000. This was 16 years before the dividend cut, and investors had to swallow a 36% reduction in their yearly income.
After the dividend cut, this dividend is expected to grow again on a yearly interval, but it will take a decent while until investors can expect the same yield as the stock had in 2015 prior to the spinoff. But since investors in HCP also received QCP shares, we need to include this spun-off business in the dividend calculation. Until now, QCP has not started paying a dividend to shareholders, but we can expect them to do this in the future. When the company starts doing this, the combined dividend of HCP and QCP will be recovering more quickly.
As a case study, let us analyze how investors performed which sat through the dividend cut all the way. I will analyze the performance of investors who bought HCP shares at different moments: May 2014, when I bought the shares, and investors who bought 5, 10 and 20 years ago. Included in the calculation is the price paid on the first of October of the year they bought the shares, the accumulated dividend, and 1/5th part of a QCP share at current market value. With the spinoff, for every 5 HCP shares, investors received 1 QCP share. Until now, QCP has not started distributing a dividend to their shareholders, so we can ignore that.
|Invested on 27th of May 2014||Invested in 2012||Invested in 2007||Invested in 1997|
|Price paid per share|| |
|Dividend received per share||6.56||10.25||19.63||35.34|
|QCP (1/5 share)||3.12||3.12||3.12||3.12|
|Current market value (1st oct)||26.71||26.71||26.71||26.71|
|% per year||-3.7%||-2.3%||3.6%||6.2%|
Table: profit or loss of investment in HCP when bought in different years
In the table, we can see that if you would have bought HCP on the 24th of May 2014 like me and held the shares until today, you would have loss of 12.8%. My yearly average loss is thus 3.7%, not a good result at all.
When accounting for longer holding periods, you can see that the high dividend of HCP contributes more and more to the overall result. Investors who bought in 2007 are already 42.2% up in their investment. People who bought the shares in 1997 and held them all the way to 2017 would have a profit of 233.7%, which translates to a more modest looking yearly annual result of 6.2%. This is still far less than the average annual report of the S&P, which is about 9.8%. But it is still a much better result than I would expect based on the dividend cut and the share price drop over the last couple of years.
We should also compare the historical performance of the S&P 500 with the total return of global REITs, as measured by S&P global REITs index. From this graph, two interesting things become clear:
- REITs have historically outperformed the S&P 500, at least since 2003
- The performance of HCP during the last couple of years is even worse when we compare it with the Global REITs index instead of the S&P 500
So HCP has underperformed compared with the S&P 500, but even more when compared with other REIT shares. Given the recent history of the company and the spinoff, this is not surprising. Also, its glaring underperformance compared with the global REIT index can be partially explained by the fact that HCP has been a relatively large company. This means that it has had relatively little scope for growth when compared to other, smaller REITs. The latter are usually able to grow their operations at a quicker rate since they start from a much smaller base.
What about QCP?
Since HCP investors were provided with a single new share of QCP for every 5 shares of HCP they owned, it is imperative to also include QCP in this analysis. At the moment, the current price of the shares of QCP is $16.06, which translates to $3.21 of dollar value per share of HCP.
Chart: QCP price development
When we look at the share price development of QCP, we can see that it has been fluctuating quite a lot since the shares started trading on the stock exchange. In the graph we can identify two big sell-offs, the first one happening right after the spinoff. At this moment the share price seems to be recovering from the second sell-off.
But we should not assess QCP only on its current dollar value, and also consider its future with regard to growth and dividend payments. At the moment, the main tenant of QCP, HCR ManorCare, is in trouble. Challenges in the post-acute space led to litigation and earnings decline for HCR ManorCare. A possible lease default could lead to insolvency for QCP since QCP depends for almost all their EBITDA on rent income from HCR ManorCare.
But this does not mean that without rent income from HCR Manorcare, QCP is doomed. QCP has stated that 'potential active asset management strategies' are considered, which could mean the selling of assets or finding new tenants. It is relevant to note that future rental rates of HCR Manorcare are not clear yet, so the situation remains uncertain for the moment. QCP is thus a relatively risky investment.
In 2016, the total taxable income of QCP was $98.6 million. I will assume that this taxable income will not drop dramatically, and QCP is going to pay out 90% of this income to shareholders. Since new lease prices need to be predetermined, let's stay on the safe side and assume that the pre-tax income of QCP will be something around $80 million. With the current 93.8 million shares, this creates the following expected dividend: ($80M*90%)/93.8M = $0.77 per share. This translates to a quarterly dividend of $0.19 or $0.20 per share, which is a yield of 4.8% against current share prices.
With regard to the future dividend for shareholders which have been holding both HCP and QCP shares, I will calculate the expected yearly dividend payout based on the following assumptions:
- The HCP dividend will grow with their long-term dividend growth rate of 4.7%.
- The quarterly QCP dividend will be $0.20 per share from 2018 onward, and will not be hiked during the years after that. For my calculation, I will take 1/5th of the total dividend since every HCP investor received 1 QCP share for every 5 HCP shares he or she owned at the time of the spinoff.
In this table, we can see that the total dividend payout in 2025 can be equal to the dividend which investors expected from the pre-spinoff HCP in 2016. Of course, this is only valid if QCP does not get into deeper problems and HCR ManorCare issues will be solved. Also, I am assuming that QCP will not hike its dividend, which is likely to happen if the business will start becoming more profitable again.
Holding or folding?
Should I have sold my shares at $34.50 when HCP announced in May 2016 that they were going to spin off their skilled nursing facilities? Or maybe even in February 2016, when they reported a loss due to dismal results within their HCR ManorCare portfolio? On that day, the share price dropped 28%, until share value reached $26. Probably not. Selling the shares just after the announcement would have been no use. The shares were already down, and have actually recovered since then.
But a couple of months after the announcement that they were going to spin off their skilled nursing facilities, there was a rally which took the shares to about 40 dollars. By then, it was already clear that the dividend of HCP would be getting a cut, but it was not certain that the total yearly dividend from HCP + QCP would be lower, though this was very plausible. This might have been a decent exit point when I could have sold the stock to minimize my loss.
As a buy-and-hold investor, I am glad I held onto my shares at these moments. Trying to time the market at the moment might have led to me selling the shares on a bottom. I did sell my QCP shares when it became clear the company would not start paying a dividend in 2017.
The bottom line
In hindsight, it is always easy to point at moments where selling or buying would have been best. But I am not a trader, and although I usually try to buy shares which are undervalued, timing the market is not my aim.
Until now, I have lost money on my HCP investment. When taking a long-term view though, things will likely level out over time. Since HCP is a profitable and growing business, time is on our side, especially coupled with a juicy dividend. I sold my QCP shares a couple of months after the spinoff, but I think investors who held on to their shares can expect the combined dividend of HCP and QCP to return to the value of 2016 in the year 2025.
More people are aging and the business models of HCP and QCP will likely benefit from this. Also, as nicely mentioned in this article, HCP became a more steady business by spinning off QCP and has good diversification with regard to property types. QCP is a risky investment at the moment, but when the issues of HCR ManorCare are solved, it can become a decent income machine.
Also, as a positive side effect of the spinoff, the basis from which both HCP and QCP can grow is smaller now. Compared to close peers Ventas (VTR) and Welltower (HCN), HCP seems undervalued at the moment. If I would not own HCP already, I would consider initiating a position at this moment.
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Disclosure: I am/we are long HCP, VTR.
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.