Ventas: Dividend Hike?

Summary

• Ventas is expected to announce a dividend hike this month.
• The long-term growth prospects of the company are promising.
• On the other hand, the company is facing some headwinds in the short term.

Ventas (NYSE:VTR) is the second largest healthcare REIT, with properties in the US, Canada and the United Kingdom. As the stock offers an attractive dividend yield, which currently stands at 4.9%, most of its shareholders are holding the stock for its generous dividend. Therefore, as the company is expected to announce a dividend hike this month, many shareholders are wondering what dividend raise they should be expecting.

First of all, Ventas benefits form a series of favorable secular trends. More precisely, as the baby boomer generation ages and the average life expectancy is on the rise, the senior population of the US is expected to markedly grow in the years ahead. More precisely, the group that is above 75 years old is expected to grow by 70% until 2030. In addition, senior citizens spend much more on healthcare than the rest of the population. Even better, the group that is above 75 years old has huge spending power, with an average net worth in excess of $640 K. Thanks to these facts, the healthcare spending is expected to grow by 5.8% per year until 2024. All these trends certainly bode well for the future growth prospects of Ventas.

It is also worth noting that the healthcare real estate market is highly fragmented and hence it is only in the early innings of consolidation. To be sure, its size is estimated around $1 T while no REIT has a market share greater than 3%. Moreover, less than 15% of the total market is REIT-owned. This is a much lower percentage of ownership than the one witnessed in other categories of real estate, such as malls and hotels, which have an approximate 50% REIT ownership. Therefore, there is ample room for Ventas to continue to grow its portfolio.

It is also remarkable that Ventas is shedding its portfolio of skilled nursing facilities [SNF] due to their unfavorable profile. As these facilities are being harmed by the changes in the medical billing procedure, Ventas has decided to essentially eliminate its exposure to this type of facilities. To this end, it expects to sell its whole portfolio for $700 M. Consequently, SNF will then represent only 1% of its operating income while its private pay revenues will climb to 94%. In this way, the company will increase the predictability and reliability of its future cash flows.

Ventas also has an excellent record of growing its funds from operations. More specifically, the company boasts of having grown its funds from operations at an average annual rate of 11% since 2001. Thanks to this growth, the company has been able to raise its dividend by about 8% per year on average during this period. However, the good news end here, as the above statement may greatly mislead most investors. While the above growth rate is true, the major portion of the growth was realized between 2001 and 2007. On the contrary, during the last decade, Ventas has grown its funds from operations by only 3% per year on average. In addition, it expects essentially flat results this year. Therefore, investors should ignore the great performance of the past and focus on the lackluster growth that is currently prominent. It is also quite concerning that the management tries to mask its poor recent performance with such a misleading statement, which may be true but can lead to false conclusions.

It is also important that the company is now facing increasing competition in some areas that do not have high barriers to entry. While the company performed well in high-barrier markets, such as California and Canada, the second quarter saw the highest number of new units coming online in recent years. The heating competition is certainly a headwind for the company. As it limits the optimism for its growth prospects, it is likely to limit the upcoming dividend hike.

Finally, Ventas is facing a strong headwind, namely the rising interest rates. As the Fed seems determined to continue to raise interest rates, the cost of rolling the debt is likely to significantly grow. This increased cost will certainly burden the company. To be sure, the net debt (as per Buffett, net debt = total liabilities - cash - receivables) of Ventas currently stands at $12.8 B, which is about 10 times the annual funds from operations of the company. Moreover, the interest expense has "eaten" 42% of the operating income in the last 12 months. Therefore, higher interest rates will certainly exert pressure on the company. As a result, its management is likely to be cautious when it announces the imminent dividend hike.

To conclude, while the long-term prospects for healthcare REITs are promising, the above mentioned headwinds are likely to cause Ventas to be conservative in its upcoming dividend hike. Therefore, it is likely to raise its dividend by less than it did last year, when it raised its quarterly dividend by $0.045 or 6%. Consequently, I expect the company to raise its quarterly dividend from $0.775 to approximately $0.80 this month. Such a raise will result in a 5.1% dividend yield at the current stock price.

Analyst’s Disclosure: I/we 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.