Ventas: You Just Made 35%, Sell And Wait

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About: Ventas, Inc. (VTR), Includes: WELL
by: The Investment Strategist
Summary

After a 35% total return over the last 12 months, we suggest investors take a break from VTR.

The company is still well positioned in the healthcare space, but the decrease in NOI could weigh on further price increases.

While the dividend seems stable, we don't see much upside in the near term. Wait for a pullback.

Relax, Slow Down, Breath, Take it Easy, Enjoy Life, Smile. You just made 35%!!

In the last article, we talked about how Ventas (VTR) has adapted to the changing healthcare landscape by focusing on multiple sectors like Senior Housing, Medical Office Buildings, IRFs/LTACs, Life Science, Health Systems, Loans, and Skilled Nursing. We believe this change has positioned the REIT to better compete in an environment witnessing four major macro trends: the rising number of seniors, the boom of luxurious senior living, the growth in outpatient hospital services, and the growing demand for specialized life science real estate. On the other hand, it is intentionally limiting its exposure to market segments like skilled nursing that are heavily dependent on government reimbursement.

Source: VTR Investor Presentation, November 2018

Additionally, VTR has differentiated itself from its competitors by deliberately focusing on geographical markets that have high barriers to entry, high-income households, and sturdy home values. Moreover, VTR’s alliance with key partners enables the company to provide high-quality facilities to its top tier customers.

VTR owns about 1,200 properties, and it has emerged as one of the leaders in the healthcare REIT sector. It is important to note that VTR’s leadership status is not due to its scale of operations but due to its low-risk investments in subsectors which are poised to benefit from changing demographics and healthcare trends.

Investment in Medical Office Buildings (MOB)

Due to advances in medicine and technology, services are steadily migrating from hospital settings to outpatient environments. An increasing number of patients are being served through outpatient care, and the migration to outpatient care is growing gradually and in significant numbers. The movement is likely to continue in the future prompting VTR to continue to invest in attractive medical office buildings and outpatient facilities. VTR’s MOB-based properties comprise 26% of its portfolio.

In Q4 FY 2018, VTR plans to invest about $100 million in MOBs and outpatient facilities. The company will be executing its investment plan along with its two key partners, Ardent Health Services and Pacific Medical Buildings (PMB). A part of the investment will be utilized to purchase a $21 million MOB that is 100 percent leased to Ardent and located on-campus of an existing VTR-owned Ardent hospital. The remaining part of the investment will be used to make a purchase of four on-campus MOBs for $79 million from PMB. VTR will make an additional investment of more than $15 million to purchase a fifth MOB from PMB.

In addition to buying several buildings from PMB, in Q3 2018, VTR also extended its exclusive real estate development partnership with Pacific Medical for a further 10-year period. This will help the company continue to benefit from Pacific Medical’s extensive experience, expertise, and knowledge.

Source: VTR Investor Presentation, November 2018

Due to its alliance with PMB, VTR has an opportunity to work on yet another MOB development project that is attached to California-based Sutter Health. The project involves the development of new flagship hospitals in downtown San Francisco, and the property will be open in early 2019.

In Q3 2018, VTR’s MOB business grew same-store NOI by 1.1%, and its same-store cash NOI increased by 3.5%. The growth was primarily due to rent escalation and tenant retention. In Q3, Ardent rent coverage remained strong and steady at 2.9 times, which indicates that the business is performing exceptionally well at Ardent. The REIT forecasts a 1.5% to 2.5% full-year increase for its medical office portfolio.

Penetrating the University-Based Life Science Sector

The robust growth of life science industry is providing yet another growth opportunity to VTR. Innovation within the life science sector has generated the need for specialized life science real estate that will provide a mix of office and lab space. Moreover, collaborative life science and technology campuses are emerging in North America with major universities partnering with real estate development companies to build high-quality properties.

Source: VTR Investor Presentation, November 2018

In addition, the growing aging population and an increase in NIH (National Institutes of Health) funding are providing an impetus for University-based research programs in the life science sector.

Source: VTR Investor Presentation, November 2018

VTR continues to scale up investment in life science innovation centers that are based in leading universities. VTR is a capital partner of Wexford, a real estate developer that has earned a reputation for creating and developing powerful knowledge communities on university campuses. In Q3 2018, the alliance achieved another important milestone when its newest life science research and innovation property opened at the University of Pennsylvania. The property is 90% leased, and it further builds VTR’s footprint in the attractive life science subsector. Very recently, Ventas and Wexford have opened another science and technology building at Washington University’s Cortex Innovation District in St. Louis, and the property is expected to be 100% leased soon.

Source: VTR Investor Presentation, November 2018

In Q3 2018, VTR’s life science portfolio grew NOI by about 23% due to the new projects at Washington University, Duke University, and University of Pennsylvania. Previously, in Q2 2018, VTR’s NOI had grown by 24% due to its projects at Brown University, Washington University, Duke University, and Wake Forest University. As a result of the strong lease-up activity in the life science segment, VTR’s office segment grew same-store NOI by 12.4% in the third quarter. The company expects its university-based life science portfolio to grow same-store cash NOI by 3% to 4% in FY 2018, and the company predicts that its same-store cash NOI guidance for its combined office portfolio of life science and MOB assets will grow by 1.75-2.75% in 2018.

Source: VTR Investor Presentation, November 2018

Developing the Senior Living Housing Market

REITs like VTR are seeking lucrative opportunities in the SHOP (Senior Living Housing Operating Portfolio) subsector due to an increase in senior population. A rising senior population and growing longevity are not only increasing demand for medical services but also senior living real estate. Since 2011, approximately 10,000 baby boomers per day have been entering the above-65 age category, and the trend is likely to continue beyond 2030. The ageing baby boomer population has revved up the demand for MOBs, senior living housing, and assisted living facilities (ALF). Moreover, most of the baby boomers have the necessary paying capacity, equity and assets to spend on a living that is luxurious and well-contented. They want to have the homes of their choice, and they wish to stay in neighborhoods where they can spend their retirement life comfortably.

Source: VTR Investor Presentation, November 2018

Real estate builders are developing senior housing properties and single-family homes that adapt to end-user expectations and lifestyles. Recently developed senior housing has a less clinical feel and more condo-like environment. Previously, senior living housing provided amenities that were more need-based, but recent developments are providing more luxurious amenities that will provide more comfort and choice-based living to affluent seniors. The same trend can be seen in assisted and independent-living communities. This trend has created huge opportunities for VTR which is beefing up its presence in the luxury senior living sector.

VTR’s one-third ownership stake in Atria Senior Living, the Louisville-based senior housing has enabled the REIT to establish its presence in the affluent markets of California, New England, Boston, and the New York metropolitan region. In Q3, Atria entered into a joint venture agreement with Related Companies, a luxury real estate firm, to develop more than $3 billion worth of senior living housing projects. The projects will be owned and operated by Atria, and they will be launched across major urban markets that include New York City, San Francisco, Boston, Los Angeles, Miami, Washington D.C., and other metropolitan regions. These luxury senior housing projects are focused on primary markets that have stable economic outlooks and strong absorption trends. VTR will be benefiting from these upcoming projects as a general partner.

In another development, VTR announced the rollout of operational initiatives of Eclipse Senior Living (ESL), a newly-formed company in which VTR holds 34% stake. Earlier in 2018, VTR had taken over the management of 76 private pay senior housing communities from Elmcroft Senior Living and transitioned the management of these communities to Eclipse Senior Living. These 76 properties were under triple-net leases with VTR; however, the portfolio has been transitioned to a joint venture structure. During the Q3 2018 earnings call, VTR’s management provided an update on ESL’s progress regarding the transition of the 76 properties. The transition has impacted NOI, and the positive impact of the initiatives will be realized after the operations have stabilized.

Source: VTR Investor Presentation, November 2018

In Q3, new construction starts and new store starts were reported at the lowest level in five years, and net absorption in assisted living in primary markets was reported as the strongest. New communities are expected to continue to open due to the anticipated demographic demand; hence, VTR expects another year of elevated deliveries in 2019. This is the reason that the same-store NOI will evidence a year-over-year percentage decline in 2019.

In the longer term, VTR is poised to benefit from the positive trend of lower new starts and continued accelerating demand in the space. Due to this favorable trend, there will be greater demand for VTR properties once new supply growth slows.

Source: VTR Investor Presentation, November 2018

In Q3, VTR reported SHOP NOI that was in line with its expectations even though the same-store cash NOI decreased by 2.7% in comparison to previous year. It must be noted that the growth from the life science properties and NNN properties caused VTR’s overall NOI to increase by 1.3% in comparison to previous year. The revenue growth due to the SHOP sector was reported to increase by 1.2% in the third quarter. The occupancy for the SHOP sector exceeded expectations, and it improved in the third quarter to 60 basis points below the occupancy level that was reported in Q3 2017. Occupancy reached 88% in the third quarter, and it showed a sequential improvement of 80 basis points. The improvement is better than normal seasonal trends and better than the overall industry figures that are reported by NIC. VTR’s full-year same-store NOI guidance for the SHOP sector is projected at minus 1% to minus 3%. Strong NOI growth is expected in Los Angeles and San Francisco, while lower NOI growth will be witnessed in Atlanta and Chicago. Low NOI growth rates will be seen in regions with increased competition.

Progress within the NNN sector

With regard to the triple-net lease segment, VTR’s same-store cash NOI increased by 3% in Q3 2018. Lease escalations were the main cause of this increase. In its NNN same-store seniors housing portfolio, VTR’s trailing 12-month EBITDAR on rent coverage ratio remained steady at 1.2 times. The same rent coverage ratio was reported in Q2 2018.

Source: VTR Investor Presentation, November 2018

In a move to establish its leadership in the high-end Manhattan market, VTR acquired premier independent living seniors housing community located in the appealing Battery Park City neighborhood of downtown New York City for $194 million from Brookdale Senior Living (NYSE:BKD). VTR has been in the senior living market since 2011, and the pricing of this asset is well below the replacement cost. VTR foresees a stabilized net operating income growth from the asset due to its unique positioning and also due to the attractive demographics in New York. Moreover, the asset has the potential to provide more opportunities for redevelopment.

VTR has also achieved progress with the asset sales that were announced as a part of Brookdale transaction. Earlier, in 2018, VTR had entered into a master lease agreement with Brookdale to restructure a portfolio of 128 communities. As per the lease agreement, Brookdale is to receive a yearly rent credit of $7 million in 2020 and $5 million from then on till 2025. Additionally, VTR is free to sell up to 15% of its Brookdale assets to diversify and improve the quality of its portfolio and to also reduce leased assets. Ventas is set to receive all of the net sale proceeds, and Brookdale will receive a 6.25% rent credit for any sales. Moreover, VTR and Brookdale have together identified a group of non-strategic Brookdale assets that are fit to be sold. VTR expects the first tranche of these sales to occur in 2019.

During the Q3 2018 earnings call, VTR’s management provided an update on ESL’s progress regarding the transition of the 76 properties. As of now, ESL management is formulating an operating model by the introduction of best practices which will appeal to various communities that it caters.

In Q3, VTR’s cash flow coverage ratio for its triple-net post-acute portfolio has remained steady at 1.4 times even in the third quarter. For its triple-net portfolio, VTR expects its 2018 same-store NOI guidance range to grow between 2.5% and 3%.

Financial Performance and Guidance

For the third quarter, VTR reported normalized fund from operations of $0.99 per share. The result was due to two important factors. Firstly, $0.03 per share fee was received from Kindred go-private transaction in July 2018. As mentioned in the previous article, VTR had minimized its exposure to skilled-nursing facility segment by selling 36 of its skilled nursing facilities that were operated by Kindred Healthcare Inc. Secondly, $1.3 billion was received due to dispositions and loan repayment proceeds, which were received in the first half of 2018 and which were used to reduce debt.

In Q3 2018, VTR’s book of loans stands at 4% of NOI, and it is down from 7% due to the repayments of profitable loans. The company expects further reduction to its loan investment book due to the maturities on existing loans in the second half of 2019. VTR continues its proactive and successful efforts to reduce risk and build financial strength through debt refinancing and maturity expansions. Moreover, the company expects same-store cash NOI to grow by 1.3%.

Source: VTR Investor Presentation, November 2018

At the quarter end, VTR’s fixed charge coverage ratio was reported to be 4.6 times, and the REIT’s net-debt-to-EBITDA ratio was reported as 5.4 times less. VTR’s net debt to EBITDA ratio is lower than that reported by competitors like Welltower (NYSE:WELL) and HCP (NYSE:HCP). 12% of the company’s debt matures in the next three years, and it enjoys a liquidity of about $3 billion. During the third quarter, VTR has lowered its outstanding debt by 8% to $10.5 billion. Since the end of 2017, VTR has refinanced or repaid $3.2 billion of debt.

Source: VTR Investor Presentation, November 2018

For the entire FY 2018, VTR forecasts that its full-year outlook for normalized FFO per fully diluted share will lie in the range between $4.03 and $4.07. As of this writing, VTR’s dividend yield is reported as 5.3%, and its Q4 2018 dividend has increased to $0.7925 per share. Based on its dividend history and due to favorable demographic trends, VTR is well-prepared to maintain steady dividend payments in future.

However, as we approach the February 8th earnings announcement, we urge investors looking for capital appreciation to take a pause for the time being. The stock is up over 17% over the last 12 months, and we believe that returns in the short term will be limited to the dividend and any increase associated with that, which we believe will not be increased substantially for several quarters at least. If you're less concerned about price appreciation and instead are holding the stock primarily for the dividend, I do not see considerable risks of a price drop.

For now, we are recommending a general selling of the stock based on valuation, with a potential reentry once NOI growth resumes and/or the stock price declines.

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.

Additional disclosure: Disclaimer: This article is meant to identify an idea for further research and analysis and should not be taken as a recommendation to invest. It does not provide individualized advice or recommendations for any specific reader. Also note that we may not cover all relevant risks related to the ideas presented in this article. Readers should conduct their own due diligence and carefully consider their own investment objectives, risk tolerance, time horizon, tax situation, liquidity needs, and concentration levels, or contact their advisor to determine if any ideas presented here are appropriate for their unique circumstances.
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