Ventas Looks To Unlock Value Through Its Scale And Cost Of Capital Advantages

Summary

• Ventas' 2020 guidance was weaker than expected: Normalized FFOps guidance of $3.56-3.69.
• Ventas introduced a new business line: The Ventas Life Sciences & Healthcare Real Estate Fund.
• Ventas just hired a newly created role of executive VP of senior housing (starting April 1).
• Given the latest initiatives outlined by management, we’re optimistic that the company can successfully navigate its risks and generate attractive returns.
• Looking for a portfolio of ideas like this one? Members of iREIT on Alpha get exclusive access to our model portfolio. Get started today »

My first investment in diversified healthcare REIT Ventas (NYSE:VTR) was in December 2013. Since that time, my stake has returned an average of 15.1% per year.

During the last six or so years, I’ve bought and sold those shares a few times in varying degrees. Currently, I have around 4% exposure in the company within my REIT portfolio.

My last sell was in July 2016, when shares stood at $76.16. And my last purchase was back in November 2019, when shares were trading at $57.41.

Since that late-year buy, the stock has traded up around 8%. That’s thanks in large part to the recent earnings results, which I’ll discuss at length in this article.

Source: Yahoo Finance

Keep reading to find out what that filing showed.

Management Means Business

One of the things that’s attracted me to Ventas over the years is its management. This team has been able to utilize various levers to optimize performance by investing in the highest-quality operators.

Of course, it should be no surprise that one of its primary subsectors – senior housing – has struggled. That’s most evident in the stock’s less-impressive price performance during the last 12 months.

Source: Yahoo Finance

You may recall that, in November, I explained how:

“We’re fine with that potential ‘risk’ because we know that short-term volatility is the greatest friend to the disciplined and patient value investor concerned with fundamentals and valuation, instead of stock prices.”

At the time, we recognized that Ventas was a long-term play that could take quarters to properly play out. So let’s see how it played out last quarter and last year.

That way we can better determine whether we need to maintain the status quo, or make a change in our position.

The Business Model

For starters, let’s talk about how Ventas is an S&P 500 company that provides capital to leading seniors housing facilities, healthcare companies, and research institutions. Based on net operating income, its diverse portfolio of approximately 1,200 properties includes:

• Senior Housing Operating (32%)
• Office (27%)
• Triple-Net (36%)
• Loans (4%).

Source: VTR Presentation

We’ll explore Ventas’ various investment pillars below. But it’s worth mentioning here how the company has around 25% exposure in U.S. senior housing operating properties (SHOPs) and ~7% exposure in non-U.S. SHOPs.

This means about 25% of its income is concentrated in the most volatile healthcare property subsector around right now. And while that’s significant, the remaining 75% of VTR’s NOI is somewhat healthy.

(More about that later.)

Source: Yahoo Finance

While we recognize there are risks to being a senior housing landlord, there are advantages to being a medical office building (MOB) landlord – like Healthcare Trust of America (HTA) – or a life science landlord – like Alexandria Real Estate (ARE).

I was guest lecturing at Cornell last week, and one of the students asked me a great question. What were the advantages to investing in pure-play REITs like those two vs. diversified REITs like Ventas.

The answer: Over time, investing in a diversified business model can be quite profitable. With “can be” being the key words.

Source: Yahoo Finance

To be sure, investors made out better owning Vanguard Real Estate ETF (VNQ) than Ventas over the last five years. Investors must pay very close attention to the risks involved before they determine whether this REIT is right for them.

Let’s take a closer look:

Source: Yahoo Finance

Start With Senior Housing

As illustrated below, Ventas owns 400 SHOP assets that generate 57% of annualized revenue and 32% of NOI. Throughout most of last year – and definitely in the last quarter – its U.S. SHOP portfolio was not impressive.

Q4-19 same sale NOI results were -7.5%.

Source: VTR Presentation

In addition, 2020 guidance was weaker than expected: Normalized FFOps guidance of $3.56-3.69, the midpoint of $3.63, implies a 5.8% decline year-over-year and below consensus ($3.71), although this guidance does not include the impact of 2020 investments.

Source: VTR Presentation

That’s no doubt why Justin Hutchens – formerly of National Health Investors (NHI) – was just hired for the newly-created role of executive VP of senior housing. Starting April 1, he’ll oversee the senior housing business in North America, which amounts to 700 properties and 60,000 residents.

Hutchens brings more than 25 years of senior housing experience with him: A very welcome addition to the Ventas team.

Of course, we know that one new employee, no matter how highly placed or recommended, won’t turn the tide alone. Ventas’ SHOP portfolio has been waiting on aging demographics to do that for a while now. But that factor might be finally coming together as well.

On the recent earnings call, Ventas CEO Debra Cafaro offered these positive words:

“We are especially encouraged by the favorable supply demand trends in the national senior housing market and in our submarkets that bode well for our future. In the top 99 markets, absorption in the fourth quarter outpaced inventory growth for the second consecutive quarter, driving 2019 absorption to the highest level on record.

“Across Ventas submarkets, we expect 2020 deliveries of new communities to improve year over year. Although operators are still digesting the cumulative supply delivered over the past couple of years, the power of this upturn in senior housing is undeniable and inevitable.”

So far, so intriguing.

The Triple-Net Sector

Ventas owns 404 triple net properties that generate 19% of its annual revenue and 36% of its NOI. In full-year 2019, those locations generated same-store cash NOI growth of 2.2%.

On a same-store basis for 2020, Ventas expects that number to grow again, this time by 1.5%-2.5% year over year. Those increases will be driven by in-place lease escalations in healthcare assets.

Source: VTR Presentation

The Office Sector

Let’s now move on to its office-reporting segment, which represents 21% of annual revenue and 27% of NOI. For the full year, same-store cash NOI increased by 2.6%.

That beat the high end of its revised guidance range of 2%-2.5%, fueled by its R&I (research and innovation). That portfolio grew 2019 same-store cash NOI by 6%, with average rent per square foot up 5.5% and occupancy approaching 97%.

Cafaro had this to say on that subject:

“Strong performance at our university-based developments, affiliated with Duke and the University of Pennsylvania, fueled growth in Q4 and the full year in R&I. The benefit of lease-up of our attractive R&I developments will continue to boost same-store growth in this segment in 2020.”

Source: VTR Presentation

The company also introduced a new business line: The Ventas Life Sciences & Healthcare Real Estate Fund. It invests in mainly life sciences properties, as well as MOB and senior housing real estate.

The fund plans to launch later in Q1-20, with around $700 million in assets under management, as well as third-party equity capital of about $650 million.

Ventas will own a 20% stake in the fund, contributing five life science/MOB buildings at a 4.9% cash cap rate. As Cafaro pointed out, this will provide it with more access to new products and enhanced capital funding alternatives:

“At inception, we also expect the fund to enjoy nearly $0.5 billion of incremental buying power to acquire additional assets. And we expect the fund's gross assets under management to grow over time.”

Nor is that the only development worth mentioning.

The Balance Sheet

During 2019, Ventas was proactive in refinancing debt. At the end of the year, it had average debt duration of around eight years on its senior notes. And the average cost of debt was approximately 3.5%.

As illustrated below, debt maturities through 2021 are minimal:

Source: VTR Presentation

Ventas also announced, closed, or commenced nearly $4 billion of new investments expected to yield between 6% and 7%. These included the LGM portfolio and partnership in Quebec. That and a commitment to fund nearly $1 billion of high-quality R&I ground-up development projects with leading research universities.

Meanwhile, the company is marketing more than $600 million in non-strategic senior housing assets and proceeds for sale. Those will be recycled into the growing R&I pipeline with leading research universities.

Again, we don’t expect the pendulum to change overnight. However, it’s clear that Ventas is working hard to diversify away from senior housing to better diversify its holdings.

It completed around $128 million of investments last quarter. Some of that went for a $122 million expansion in the R&I development at Drexel University College of Nursing. That alone is projected to have a 10% generally accepted accounting principles (GAAP) yield.

Also, Ventas disposed of $78.1 million of properties and loan repayments during that same period, including around $65 million of various SHOP assets.

The Sum of the Parts

Back to what it does have though, at least for a moment…

Ventas’ full-year 2019 same-store SHOP NOI declined 4.4%. The larger company, however, delivered solid funds from operations (FFO) results of $3.85 per share. This was at the high-end of its guidance range, as issued in February 2019.

The company has since introduced 2020 normalized FFO guidance of $3.56-$3.69 per share. Cafaro said this ”also reflects expectations for continued strength and reliability in the office and healthcare verticals, continued pressures in the senior housing portfolio, and no capital markets or investment activity.”

Source: VTR Presentation

We’ve modeled FFO per share as follows:

As you can see, at the 2020 midpoint, FFO is flat vs. 2019. However, we believe that the SHOP business is stabilizing.

Dividend growth has been extremely modest as it relates to tightening senior housing pressure. Yet we anticipate Ventas will continue with a small hike in 2020 simply to keep its growth record intact.

After all, Ventas didn’t cut its dividend in 2008 or 2009.

Then again, its current guidance might not cover its annualized $3.17 dividend. Investors and potential investors alike have to keep both facts in mind.

As illustrated below, the dividend payout ratio has increased to 82% in 2019:

Source: VTR Presentation

We expect to see the payout ratio be maintained in the low 80% range during 2020, as viewed below:

More From the Ventas Earnings Call

With regard to the dividend, Cafaro used the earnings call to say this:

“… obviously, the dividend is an important component of our total return. And we feel good about where the dividend is because we feel good about investing in our portfolio this year, which has increased FAD this year so that we can realize the benefits of the upside in our portfolio.

“So as we look forward, we do see the benefits of senior housing turning up. We also see the benefits of the R&I development pipeline that we have been heavily investing in, with those assets starting to come online and contributing to cash flow and EBITDA as they open in later 2021 and into 2022… they will make a significant contribution at that time. So the combination of and then the steady growth of the office and healthcare portfolios all combined make us feel comfortable.”

With regard to growth, Cafaro added the following:

“As you know, we have created a history of accretive acquisitions through basically really high-quality, relatively lower cap rate assets, such as (the) 1030 Mass life science building. We have our kind of right down the middle investments, such as our successful LGM investment last year, which is performing well in both the stable assets as well as the lease-up assets. So generating kind of between a 5% and 6% unlevered return.

“And then we have a smaller category of higher yielding that could include development. It could include healthcare, government-reimbursed assets and so on, where we allocate a certain amount of capital and the overall combination of those investment activities is what has driven the accretion from investments historically. And we would continue to stick with that framework.”

Source: VTR Presentation

In Conclusion…

All things considered, we believe Ventas’ management team is doing a good job of managing the ship. And although SHOP results in Q4-19 were weaker than expected, Cafaro and company seem to be taking the appropriate initiatives to put the company back on track to generate strong returns.

Given the current valuation (i.e., the dividend yield below), we see shares as attractively priced:

As you can see below, Ventas trades at a discount to the MOB and life science REITs due to its “associations.” But going forward, it should begin to trade at a higher multiple as the senior housing picture gains more clarity.

The only real questions is when the SHOP business will begin to improve.

In short, we maintain a Buy here, recognizing that it could take two, three, or even four quarters to see our faith pay off. SHOP occupancy should ramp up in Q3-20, but there's the possibility of the stock taking off before then.

Given the latest initiatives outlined by management, we’re optimistic that the company can successfully navigate its risks and generate attractive returns. Given its soundly-valued shares, we consider this healthcare REIT to be a long-term buying opportunity.

Source: FAST Graphs

Author's note: Brad Thomas is a Wall Street writer, which means he's not always right with his predictions or recommendations. Since that also applies to his grammar, please excuse any typos you may find. Also, this article is free: Written and distributed only to assist in research while providing a forum for second-level thinking.

Disclosure: I am/we are long 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.