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CareTrust REIT is a healthcare REIT originally spun off from The Ensign Group (ENSG) to separate its real estate from management of its health care facilities. While it has only paid a dividend for a short time, CareTrust is well on its way to becoming a solid dividend growth company. At the current market price, I think the shares offer a good opportunity for dividend growth investors.
Is CTRE a good investment partner?
CareTrust REIT (CTRE) is still fairly new, so it doesn’t yet produce nice fancy annual reports, so to get long-term numbers I will have to look elsewhere.
This YChart shows both increasing revenues and increasing FFO. Of my 4 keys to finding a good dividend growth company those are my first two: growing markets or revenues, and growing profits. While it is still small, CTRE shows a very nice uptrend in revenues. The trend in FFO is also upwards but more modest. There are also 2 downward spikes that will require more investigation. Looking at the SA earnings page for CTRE I see an uptrend in both revenue and what the page calls earnings (looks like normalized FFO to me).
One thing to watch, especially in younger REITs, is secondary sales of shares. And CTRE is definitely issuing a lot of shares. That makes its growth in normalized FFO more impressive. There is still a good cushion between FFO and the dividend, but I won’t expect huge dividend growth over the next few years.
The screen shot above shows the entire history of CTRE with Moody’s. CTRE started at B2 in 2014 and is now at Ba3 as of October 2017 - a nice, steady improvement that shows management is handling the debt well. At this time all the debt CTRE has is a $400 million revolver credit facility and a $300 million issue of bonds that was issued in 2017 and matures in 2025. This bond issue was used to redeem a prior bond issue from 2014 and improved the coupon rate by 625 basis points and extended the maturity.
Next I look at the Q3 earnings presentation to resolve several questions.
One question that has been driving results for several REITs that have SNFs (skilled nursing facilities) is rent coverage. The slide above shows rent coverage for each type of property that CTRE has. Sabra (SBRA) is a REIT in this space that I like and own, but it has a lower rent coverage ratio than CTRE’s 1.65 average. In fact, CTRE has a coverage ratio of SNFs of 1.75 that is nearly as high as SBRA’s strongest tenants. I think these rent coverage numbers are a big plus for CTRE.
Looking at the earnings call transcript for Q3 2017, it looks to me like the drop in FFO for that quarter was due to a large equity issuance that was used to make a large purchase. Since the shares were issued in the quarter, but the revenues didn’t start till the next quarter, that timing difference lowered FFO for the quarter. So this too doesn’t indicate a problem in the quarter.
The slide above provides details about the top 5 tenants of CTRE. It also shows what I think is the greatest risk for CTRE, which is the fact that 80% or so of its rents come from just 5 companies. In part that is a legacy of CTRE being a spin-off of its largest tenant, Ensign Group. The foot note is interesting as it gives a window into how management might be handling issues with a tenant.
The slide above is the pro-forma rent after 7 properties were transferred from Pristine to Trillium. This was clearly an issue about rent as the new rent numbers are about $2,000 below the prior numbers. That’s about a 10% cut in the rent paid by the two tenants, so I am not happy with it, but given the over-all rent coverage of the whole tenant group it seems manageable.
Earlier I noted two quarters where FFO decline significantly. So the slide above covers the most recent quarter with such a decline. It looks like the big decline was caused by paying for some unsecured notes. I am not going to fault a company that paid off debt, especially if based on the next quarter’s performance it looks like it could well afford to do so. Based on other information, this was when a bond issue released in 2014 was paid off and eventually replaced with a new issue that saved the company 625 basis points in interest costs. This information satisfies me that Q2 wasn’t a bad quarter.
How is Ensign doing?
The Ensign Group still represents a large percentage of the rent payments CareTrust receives, so I think a quick look at how it is doing will help in understanding how CareTrust is doing.
The YChart above shows that over the last 5 years Ensign has had growing revenues, a slight uptrend in earnings and a growing dividend. The recent issues with earnings are mostly the result of rapid acquisitions, so I think that the positive earnings over this period shows that Ensign shouldn’t have trouble paying its rent to CareTrust.
The above slide is from the latest 10-Q. This lets us estimate rent coverage for Ensign. Using the adjusted EBITDAR we get a rent coverage ratio of ~2.15. Using the EBITDA to calculate EBITDAR yields $70.726,000 and a ratio of ~2.09. Because Ensign owns 50 of its facilities and only leases 166, I think this somewhat over-states the coverage at the individual facility level, but it looks pretty good to me. I don’t think Ensign will have trouble paying the rent unless something significant changes going forward. Generally although the fast pace of acquisitions has some negative impact on short term earnings, it also drives increases in occupancy and thus eventually profitability.
What’s a good price?
To figure out a good price, I do a DDM calculation using my Excel-based DDM calculator (pictured below, you can see the web-based calculator I based it on here and read a discussion on how the formulas were developed here). Normally I would look at the David Fish’s CCC List (which contains a data on companies that have raised their dividend each year for 5 or more years) to get data on the dividend history for CTRE, but it only started paying a dividend in 2014. Skipping over the big payment at the end of 2014, each year since 2015 CTRE has increased the dividend payments. So while it hasn’t yet qualified at a Dividend Challenger, I think CTRE is well on the road to becoming one.
I think it’s reasonable to assume that for the first payment in 2018, the dividend will go up a penny from the current dividend. Using that I project that the next 12 months will see dividend payments totally $0.77. While that is around 6% a year, I will use the manual entry function of my DDM calculator to increase the dividend 4 cents a year for the next 2 years after the coming year. I will use 2% as the terminal dividend growth rate based on the current yield of just under 4%.
Using those parameters I calculate that the NPV of the predicted dividend stream is $20.96. Because CTRE is a fairly small company and has a short history, I will take a 5% discount to the NPV to provide me with an additional margin of safety. For risk management purposes, I like to cap my position sizes to around 3% of my total portfolio. Because CTRE is so small and has only 3 annual dividend raises, I will initially limit my position to a maximum of 1% of my portfolio. As CTRE continues to perform well and increases its dividend I will slowly raise that cap to 3% by the time CTRE has 5 years of annual dividend increases.
CTRE is a small healthcare REIT concentrated in skilled nursing facilities. What I like best about it is that its current tenants have much better rent coverage that the tenants of larger REITs like Omega Healthcare (NYSE:OHI) and SBRA. I think the risk reduction that this higher rent coverage provides more than compensates for the additional risk of CTRE’s small size and short history. At the current market price which is under $18 I think its dividends are a good deal.
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Disclaimer: This article is intended to provide information to interested parties. As I have no knowledge of individual investor circumstances, goals, and/or portfolio concentration or diversification, readers are expected to complete their own due diligence before purchasing any stocks mentioned or recommended. The price I call fair valued is not a prediction of future price but only the price at which I consider the stock to be of value for its dividends.
Disclosure: I am/we are long SBRA.
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.