HCP, Inc. (HCP) CEO Tom Herzog Presents at Citi 2019 Global Property CEO Conference (Transcript)

|
About: HCP, Inc. (HCP)
by: SA Transcripts
Subscribers Only
Earning Call Audio

HCP, Inc. (NYSE:HCP) Citi 2019 Global Property CEO Conference March 6, 2019 8:10 AM ET

Company Participants

Tom Herzog - Chief Executive Officer

Pete Scott - Chief Financial Officer

Scott Brinker - Chief Investment Officer

Conference Call Participants

Nick Joseph - Citigroup

Nick Joseph

Welcome to the 8:10 a.m. session at today’s 2019 Global Property CEO Conference. This session is for investment clients only. If media or other individuals are on the line, please disconnect now. Disclosures are available up here and on the webcast on the Disclosures tab. For those in the room or the webcast, you can sign on to liveqa.com and enter code Citi2019 to submit any questions if you do not wish to raise your hand.

I’m Nick Joseph with Citi Research. We're pleased to have with us HCP and CEO, Tom Herzog. Tom, I'll turn it over to you to introduce the company and the management team and provide the audience three reasons why investors should buy your stock today. And then we'll get into Q&A.

Tom Herzog

Okay. Thanks, Nick. And actually for day three, if you can provide three reasons why people shouldn’t buy Ventas and Welltower that would be fun too.

Nick Joseph

Oh! I'll be glad to add those.

Tom Herzog

Okay. Thank you. To my immediate left, Pete Scott, our Chief Financial Officer and also In-Charge of our Life Science Group. To my right, Scott Brinker, our Chief Investment Officer and In-Charge of Senior Housing. And further to my left, Andrew Johns, VP, In-Charge of IR.

So I'll start with a high level overview of HCP. HCP owns a $20 billion plus balanced portfolio of real estate across the three segments of Senior Housing, Medical Office and Life Science, which our portfolio is 95% private pay. 55% of our NOI comes from medical office and Life Science and roughly 40% from Senior Housing. We also have a $1.2 billion development pipeline and a strong land bank focused primarily at life science and on-campus MOBs.

Our balance sheet is strong and rated BBB+ and Baa1 by S&P and Moody's. We’re widely recognized as an industry leader for our decade long focus on ESG. As I was flying in, I was reflecting on conversations I had at the Citi Conference one year ago and thought I would contrast that for the conversations that we had over the last couple of days.

So a year ago, Brookdale was 28% of our total concentration. Last year, we had announced plans to get that concentration down to the mid-teens, which has since been accomplished. And we do plan to make further progress on this over the coming years, opportunistically, over time. Our net debt-to-EBITDA a year ago was at 6.8 times, today it's in the mid 5s. And we’ll manage it back up more toward the upper 5s which we consider the sweet spot considering our portfolio.

We had a very strong development pipeline back then primarily in life science and delivered some great projects during the year at strong yields. We also added a number of development projects during the year in life science and added the development program with HCA, which we're very excited about.

Two of our businesses, Life Science and MOBs were doing great, and they're still doing great today. One of our businesses, Senior Housing had experienced a number of challenges, some of which we've worked through, but we certainly are working through some challenges yet today. But Scott Brinker and his team are hard at work repositioning the business, the portfolio, the operators, the infrastructure to capture significant upside that we see ahead in that business.

In the year ago at this conference, Scott Brinker was on his third day on the job literally. So, as I look back a year later, our senior team has just extremely pleased with the way the team has lined out. The leadership over the three businesses are led by Scott Brinker, Pete Scott and Tom Klaritch, along with Tom Klaritch leading our development program.

Our Board also underwent a significant refreshment. In total, four of our Board members either departed or will retire this May given our newly implemented 75 year old age limit. And we added three new talented board members to our Board.

In summary, a year ago, when we met with your conversations were around restructuring, many aspects of our business and playing defense. As we sit here today, now that we have stability in our portfolio and our balance sheet and our team, the work we're doing now is to grow the company accretively over time.

So Nick, I guess I'll go to the three reasons to own HCP today, to buy.

Nick Joseph

Yes.

Tom Herzog

Okay. So these restructuring activities that we completed over the last couple of years eliminated the non-core parts of our company, which were many, leaving us with a clean and balanced portfolio, all in real estate and the three private pay segments of Medical Office, Life Science and Senior Housing, all clearly benefiting from the baby boomer demographic that's in front of us right now.

The second one is we're creating value and future earnings growth through our development and redevelopment pipelines. And we also have a robust shadow pipeline with our land bank that can support another $1.5 billion of development in the future. Not that we're in a rush to do that, we'll take our time and do it as demand and supply makes sense, as our capital makes sense, but it is a strong opportunity in front of the company.

And third, HCP offers a fully covered current dividend in the 4.5% to 5% range, along with a growth profile inherent in our high quality portfolio that's diversified and we do expect it to produce strong TSRs over time.

So I'll turn it back to you.

Question-and-Answer Session

Q - Nick Joseph

Great, Tom. So we've been asking each company what is the biggest potential disruption to your business and what are you with the management teams doing to either take advantage of that disruption or to mitigate the risk of it?

Tom Herzog

If you'd have asked me that question a few years ago, I would have pointed to the high healthcare costs in the United States that get higher every year and the risk of government reimbursement. We have eliminated this risk largely as a result of the restructuring and what we've done with our portfolio.

So as I look at it today, I would say absent some geopolitical type issue that arises probably no different than any other real estate, I would say it's probably new supply. But I will tell you that when I think about new supply, our Life Science business in San Francisco, San Diego and Boston does not lend itself easily to add in new supply. And our on-campus medical office portfolio, which is 82% on-campus, which is a big differentiator for HCP, also is relatively immune to new supply on-campus.

Nick Joseph

So Tom, you mentioned last year was defense, reorganization, restructuring. Now it's a period of growth and offense. How do you take that from an investment -- I mean sometimes cleaning up and fixing is easier than getting giddy with external growth and buying things. So now with that renewed cost of capital and being able to do that, what sort of structure do you have in place to be able to underwrite things in the right way and not get carried away on that?

Tom Herzog

But we do have a very robust investment trainee process. We have been able to raise intelligent capital and we do have growth across all three lines of our business and maybe Scott I will turn that to you to address how you see the three lines of business.

Scott Brinker

Yes, the investment strategy for each of the three segments is a little bit different. Medical office, on occasion, we find an acquisition that makes sense. But in general, I think our preference is to grow that business through redeveloping our older on-campus properties and then raising the rents and occupancy to get a nice return. We'll do 50 million to 100 million of that type of activity each year, at least for the foreseeable future, and then through development. A couple of quarters ago, we announced on-campus development program with HCA, the big for-profit hospital company to $80 billion enterprise, there by far our largest health system tenant. Most of our MOBs are on the campus of their hospitals and they're actively growing their footprint oftentimes within their core markets. So we're going to build out on a number of their hospital campuses over the next couple of years additional on-campus MOBs. So that's probably $100 million or so of new products substantially pre-released by HCA to reduce the risk, to your point, and then a stabilized return on cost of at least 7%. So we think a very nice attractive return given the producing -- and the commitment by HCA.

And in Life Science, Tom mentioned the active development pipeline, which today is in the range of $1 billion, slightly above. A lot of that is life science. The pre-releasing in that pipeline is significant. We just put a couple of additional projects into the pipeline. Those won’t deliver for another two years. So they're not quite pre-released yet. But overall, that pipeline is roughly 65% pre-released.

So substantially de-risking that pipeline and the sources and uses is built out to make sure that we can adequately fund all of that development without breaching through the sort of high 5s leverage that we target.

And then Senior Housing we've been quite focused on 16 new existing portfolio. I think we've made a lot of progress. Of course, the financial statements are backward looking, so it's going to take some time for those changes to translate into earnings results. But we do think 2019 will continue to be a bit of a challenge as we work through a lot of the moves that we proactively made to fix that business. Supply and demand are probably still in an imbalance in the wrong direction in 2019. We think that starts to turn looking into 2020 and then certainly into 2021 and beyond. So we're still positive about that business long-term. It's been a great business over the years but it is cyclical. In the last couple of years, there’s just been a supply demand imbalance in addition to higher labor costs, but we are committed to that segment.

And as we look to grow it in the future, it would likely be very focused on more modern properties. Our portfolio is a little bit older, about 22 years on average. And we think most of those properties can perform quite well over time. But we'd like to have a sort of counterbalance some of those older products with some newer more modern properties. So I think when you see us start to invest into that segment, it will be almost across the board with newer product.

Nick Joseph

May be we can start on the MOB side, you mentioned the partnership with HCA and additional on-campus development. So what's the opportunity there in terms of the size of the capital you can deploy and what sort of returns you're targeting?

Pete Scott

I can handle that, it's Pete here. We'll probably deploy about $100 million a year for the next three to four years. It's hard to predict how much further would go beyond that but we do have some targeted assets that we would hope to put into our active pipeline pretty soon. We think the returns on that from an initial yield perspective are probably around 7 or below 7, which actually stacks up quite well when you think about cap rates on Class A product, on-campus product, especially a lot of it being pre-released to HCA.

Nick Joseph

When we think about the existing portfolio, you're still working to fill some of the vacancy. I mean what sort of demand are you seeing on -- I guess both the on-campus for the 80%, 82% as well as the off-campus side, maybe seeing different demand between the two?

Pete Scott

It's a good question. We haven't really seen different demand currently but remember we're primarily 82% on-campus, a vast majority and will stay a vast majority of our portfolio on-campus because one of the concerns we do see and it hasn't really manifested into occupancy yet is the proliferation of urgent care centers. And we think that could impact off-campus MOBs much more significantly than on-campus. We actually think we're well insulated from urgent care centers or other areas where healthcare services could get provided. We’ve talked a bit about CVS and Aetna and that merger and healthcare getting provided within pharmacies. That's just beginning. And so as we look at where we want to invest capital in that space, if there's an off-campus portfolio that we're looking at, we will most likely not be interested in that or if there's a portfolio where a lot of it is off-campus we will likely pass on it.

Nick Joseph

And for that 18%, that's off-campus. We’ve see in cap rates compress a lot of interest in MOB. I mean is there an opportunity to sell into that strength?

Pete Scott

Maybe I'll take this one. If you think about our $500 million of dispositions. This year, we’ve talked about the various pockets, some of that is the UK, some of that is closed and with some land, as well as some senior housing assets. Of the balance, $300 million, some of that is definitely MOBs and off-campus MOBs. So we will certainly look to recycle some of our MOBs to the extent we can.

Tom Herzog

And Nick I would just add, we do have 15 years of data on that Medical Office business and through the years pretty consistently the on-campus occupancy is much higher, the retention rate is much higher, the renewal rates were mark-to-market on new leases, is much higher. So there's a reason the data that we prefer the on-campus product and we think that to go off-campus does require a pretty significant yield premium.

Nick Joseph

You re-categorized Medical City Dallas this year as MOB. Tom, I think you mentioned that being a gem of the portfolio maybe a little misunderstood. Can you walk through, I guess, I’d ask that the thought of re-categorizing that in the plans for going forward?

Pete Scott

Yes. I can handle that, it’s Pete again. That campus, if you look there's a picture in our investor deck, it’s one integrated facility, where you've got on campus MOBs, as well as a hospital component. And so we don't really differentiate between that entire campus. We have previously surgically split out the hospital piece from the MOBs. We really don't think that that's a fair characterization. The coverage on that was like 14 times on the hospital. We really look at that truly as one integrated facility and it would not trade for hospital type cap rate, which is why we wanted to move it into the medical office bucket. We think that’s a more appropriate cap rate. There was no real pick-up at all on same-store growth or guidance would have been the same if it was in hospitals versus within MOBs. But we really think it's appropriate for that NOI to be in that bucket from an NAV perspective.

Nick Joseph

It's been a big focus I'd say across sectors on data analytics and how it impacts the business both in terms of capital allocation and just making smarter investment decisions. How do you think about that? How do you use data analytics in your -- in the day-to-day business?

Tom Herzog

I can cover it. In at least two of the three segments we have, I referenced earlier, 15 if not more years of portfolio data that we can use to help underwrite future investments, whether it's an acquisition or a development or redevelopment. And we do that for sure. We also have extremely experienced teams in each of those two segments that I think intuitively just know all of that data in a way as they try to make investment decisions.

Senior Housing, we have not been in that segment for as long. So the in-house data is not as robust as the other two segments. But we do now have some of the experience, individuals that, again I think intuitively have a lot of that data, we can use it to help inform decisions. And then when we think about external information that we use in our investment decisions or portfolio management decisions, it's quite robust, in fact some of our competitors talk. And I have seen a lot of their materials that they’ve provided publicly in a lot of those data sources and analyses sound quite familiar. And we're doing very similar things across all three segments using external data to the best we can to inform investment decisions.

I would also say with a bit of a disclaimer that healthcare is quite indecision as a business and sometimes the data and an inefficient business is not always as helpful as it could be. So I think over time that that data and analytics will become more and more insightful, but it is quite an inefficient business today. So I think there are limits to how important or how much you should be using data like that to make or drive decisions. And we think it's helpful at the margin. We don't think it's the primary way to make decision in the segment.

Nick Joseph

How long will it take to build out that capability on the senior housing side?

Tom Herzog

So we have completely filled out the team. The team is set and we're hard at work now on building out the process, procedure and information technology. And I think within the next year we will get there. We know exactly what we'd like to build and it's just a matter of doing the work to get there.

Nick Joseph

Once we -- with senior housing, there’s a question that comes through here on liveQA. What in particular do you have to do to fix the senior housing business?

Tom Herzog

I wish that was a short answer.

Nick Joseph

We have 15 minutes and 16 seconds.

Scott Brinker

I won’t us all of it. But I'll give you a couple of things. One is, obviously it would be important for the supply demand fundamentals to be in better condition. We do think there's objectively looking forward two to three years that that will be the case. And then in terms of things that we can control, on the operator front, senior housing is unique and that it's a real estate business and it's important to have good locations and good real estate. But it's also important to have a really good operating partner. And today we still have a bit of a barbell is how we've described it with pretty dramatic concentration on one end of the barbell and then a lot of small relationships on the other end of the barbell. So in our view, that's a bit risky on one end and inefficient on the other and we're working hard to better balance the operator mix, so that we've got critical mass with people, so that we're important to them and vice versa and not overconcentration because it's never good to be dependent on a third-party who you can't control. So that's one of the initiatives.

A second initiative is to improve the real estate quality. I mentioned earlier that the average age in our portfolio is more than 20 years old. Most of that product can still compete, but it does require a lot of capital to do so. We sold all the assets that we did not think could compete effectively, but it's one reason that you see us redeveloping a number of campuses right now, there are 10 live redevelopment projects, we’ll spend about $80 million. That will by necessity be an important part of our senior housing business plan going forward. And as we look to do acquisition and development, and mentioned that we would try to acquire more modern properties.

Then we're also transitioning a number of properties, 39 in total that were formerly operated by Brookdale. We like the real estate but didn’t think we necessarily have the right operator for that particular community and you saw last year and you will see a bit this year that we had to take at least one step back, we think we will eventually take two steps forward and there's a lot of NOI to be recaptured by putting that right operator in each of our properties was an important part of the turnaround plan.

And then maybe the last thing I would mention beyond just building out the IT infrastructure that I mentioned earlier, is that two-thirds of our senior housing portfolio today is triple-net, it’s one-third SHOP. We think over time that will flip and the majority of that senior housing portfolio will be in the SHOP structure. And we've got some really, really good assets in triple-net. Good real estate, good operating partners that we think the quality of that SHOP portfolio will actually improve pretty dramatically as we sort of cherry pick the best triple-net assets and operators to put into the SHOP structure.

Pete Scott

And I would add just a few things in the big picture. As we look at fixing our senior housing business, the first order of business was to get the right team. And with the addition of Brinker and Jeff Miller and the folks that they’ve hired, we can put a checkmark behind that one for sure.

Second, was to build the right systems within the infrastructure. A lot of that work has been done, there is still some to be completed, as Scott mentioned, that will be done within the year. We -- the second area was the operators and we have done a lot to modify concentration and add some new high quality operators.

The third was portfolio. We have sold about $3 billion of the senior housing assets that were previously on our books. And then finally, transitions is something we did a lot of in 2018 that naturally causes a downturn in performance for a period of time and there's a lot of for us to recapture as we recover the operation ability of those assets as we go forward. So I think, if I was to choose one part of our business that has the most upside over the next two to three years, it’s our senior housing business.

Nick Joseph

With that upside there's also a continued supply risk as well. The healthcare space has got a lot of companies that are specific to one vertical, whether it's MOBs, skilled nursing, hospitals, life sciences. Why does it make sense to be in the three and does it make sense to be a life science MOB company and monetize in some way the senior housing portfolio if someone is willing to pay you for that growth?

Tom Herzog

I think that's a very fair question. So we have thought a lot about at the management level and at the Board level. As we think about the three businesses and the synergy that's created with the three, I think about it this way. All three businesses are going to benefit from this explosion of baby boomers that are coming within the market. From the life science side there will be greater and greater need and desire for more drugs to be produced. And a lot of that’s -- some are biotechs, those biotechs resides in San Fran, San Diego and Boston.

In MOBs, outpatient is what's going to -- outpatient treatments what's going to help contain healthcare costs. Our assets are on-campus for the specialists to reside. As Scott said more immune to the urgent care centers. And then in senior housing even though there has been a lot of new supply and wage growth has caused difficulties, there are still irrefutable huge surge of seniors coming at that business, and I do see it as an inefficient business, meaning there will be some winners and some losers in this game. And I do think we've put together a team of people that can be on the winning side of that equation. I like the 40:30:30 split, 40% Senior Housing, 30% MOB, 30% Life Science. Because when I think about Medical Office, it's a slower and steadier business especially on-campus that creates a reliable cash flow stream of same-store growth typically in 2% to 3%, 80% retention et cetera.

Life Science is more volatile but has a lot of demand coming out of the, especially in those three primary markets, which we like. But at the same time, neither of those two neither of those two segments have explosive growth potential of senior housing. So we do like having 40% Senior Housing to give more upside to this business. So the blend of the three all benefiting from the same baby boomer demographic we think is a winning combination. But within this whole thing, I repeat we have preferred in our strategy to stay away from government reimbursed product which the stroke of the pen risk is one that we don't think they’re tall as a REIT, at least not our REIT.

Nick Joseph

And just want to make sure I understood Scott your comments on senior housing. Are you saying there be more triple-net restructuring to RIDEA or you saying you will buy RIDEA?

Scott Brinker

Yes, I mean, what I am saying is it's possible to do conversions from triple-net to SHOP that are proactive and I wouldn't characterize them as restructurings, that sounds like you're doing it by necessity. I'm suggesting we have some very high quality triple-net portfolios. We really like the real estate and the operating company where we might proactively try to convert to SHOP.

Of course, we can't do that unilaterally, but we have ongoing discussions with a number of our triple-net tenants, who may actually also prefer to be in the SHOP structure. So you may see some of that happen. And not all those have to be dilutive, some of them may actually be accretive. So, more to come, nothing has been done yet. But I think that is something that over time you'll see us be proactive about and then as leases mature over the next five to 10 years at times, some of these leases, especially those with tight payment coverage, the lease will not be renewed by the tenant. And I don't think that you should expect to see this management team defensively convert assets to SHOP. If we like the real estate and we like the operating company, then they would be a candidate for SHOP. But if it's low quality real estate or an operating partner that we don't have a lot of confidence in, you're much more likely to see us dispose of that asset over time.

Nick Joseph

You’ve talked about $25 millions of incremental NOI on the senior housing assets that are transitioning now. I mean how do you capture that? And what's the timeframe for getting that uplift?

Scott Brinker

Yes. It's 39 properties that we transitioned away from Brookdale to fix different operators and they didn't all transfer at once. So I think back a year ago, that's when the first wave of those properties was transitioning. But a good portion of them, almost half, didn't transfer until the second half of 2018. And what we've seen is that it does take six to 12 months to start recapturing some of the loss in performance. And in many cases, that performance actually deteriorated for the first six months or so for a couple of reasons. One is that for the most part, the teams are being changed, the leadership teams at the communities, that's quite disruptive to occupancy, so our census fell quite a bit. And we had a number of what we would call transitory expenses. We had massive elevated expenses like contract labor, or agency labor, repair and maintenance, bad debt that’s written off, all of which should normalize as we move forward. It actually started to happen in 2019, and then by the 2020 and beyond certainly a lot of those should no longer be running through the financials. We didn't normalize any of that. It all runs through our financials. We’re quite transparent about it. But that's not quite half but it's about a third of the $25 million, it’s just eliminating what we would call sort of one-time expenses, they ran through our books last year. And then the balance is occupancy.

The 39 properties about a year ago had occupancy near 90%. They dipped into the high-70s, today it’s in the low-80s. And in a relatively low margin business, when you lose occupancy, it tends to have a multiplier effect on NOI of 3 to 4 times, but generally speaking that works in the opposite direction as well.

So as you improve occupancy from 80% to hopefully back to 90% in the coming years, we have a multiplier effect on NOI, so that you'll continue to see some big numbers in our earnings reports. But hopefully that will be a positive number or plus 9s in front of those numbers rather than a negative. But the timing is harder to predict. We know the upside is there to be recaptured. Some of those assets are now being redeveloped. So the timeline is pushed out a little bit, but we do think over sort of the second half of '19, into '20 and '21 that there's some real upside to be recaptured to benefit shareholders in that portfolio.

Nick Joseph

So if there’s Tom sit here next year, you will be able to say that we've recouped 90%, by this conference?

Scott Brinker

Let's hope.

Tom Herzog

Not 90%.

Scott Brinker

Putting you that as a goal.

Nick Joseph

Maybe just quickly on the life science side. You mentioned the three markets that you are targeting. What's the opportunity to go deeper into those markets versus expanded into additional life science markets?

Pete Scott

Yes, I'll handle that. It's Pete again. A couple years ago, we weren't in the Boston market. We've been able to acquire two nice campuses, one in Lexington, the other one in West Cambridge over the last few years and they each have a development opportunity within them. So as I think about growth within our markets, Boston is clearly a market that we'd like to target and do more within South San Francisco we have acquired, as well as done development in the last two years and we own some assets outside of South San Francisco. But our primary focus is in South San Francisco. And I really think most of that is going to be through development.

The product within that market that's built and stabilized is heavily concentrated. But I do see an opportunity for more industrial to get converted to life sciences over the next five to 10 plus years.

And in San Diego, it's a little bit more of a fragmented market. We have had some success in acquiring office and converting it to lab. We acquired a building that Qualcomm was actually a tenant within and we’ve converted that over to lab and had some success working towards leasing that up. And we also have a few development opportunities. We haven't done a lot of development in San Diego. It's mostly been focused within South San Francisco. We see an opportunity to develop some land that we have down there that we've had for quite some time, it's a strong market. It doesn't get as much attention as Boston as well as San Francisco. But we certainly see a lot of demand to the extent that we increase some supply within that market. And most of that’s in Torrey Pines, which is the best sub-market down there.

Nick Joseph

Great. So we're going to go to rapid fire and I'd like to point out how special our industry is and probably how good of a colleague for a stock is to have your former management team from UDR sitting in the audience supporting you.

Tom Herzog

I appreciate, it’s my pleasure. Thanks, guys.

Nick Joseph

I think it's a wonderful thing to see. Brinker I don't know why the Welltower team didn't show up. Much better on the play. Okay. So rapid fire. Will the healthcare sector have more or fewer public companies a year from now?

Tom Herzog

Fewer. Same-store NOI growth for -- why don't we take the pieces for SHOP in 2020 and for reference 2019 is negative 1.1% for the sector.

Nick Joseph

I’ve actually put them in -- I’ve grouped the three if that's okay?

Tom Herzog

Okay. Well then that average is 1.4. So it sets a reference as you pivot off of that.

Nick Joseph

Okay. So I’ve put the three of them together.

Tom Herzog

I’ve grouped them at 2.5% to 3% across all three segments.

Nick Joseph

10-year treasury a year from now 2.75.

Tom Herzog

May remain flat about 2.7%.

Nick Joseph

What year will the US centre a recession?

Tom Herzog

Hard to predict but we're encouraged economists see as having GDP growth through 2021.

Nick Joseph

Thank you.