LTC Properties: More Tenant Issues Cloud Outlook
Summary
- LTC Properties reported a big miss in its Q1-2021 results.
- The miss came as our thesis began to play out.
- We update the risks and rewards of owning this REIT.
- I do much more than just articles at Conservative Income Portfolio: Members get access to model portfolios, regular updates, a chat room, and more. Learn More »
When we last covered LTC Properties Inc. (NYSE:LTC) it sat on the cusp of our Neutral and Sell zones. We fleshed out our thesis as follows.
The next two quarters will tell the extent to which its operators can survive and thrive without CARES Act funds. While many of LTC's properties were not eligible for those funds, do remember that its operators have other properties that were eligible and the only way they made it through was because of the CARES Act. We continue to see this as a difficult area for investors to make money and LTC is now moving to the upper end of our Neutral valuation range.
Source: LTC Properties Is Getting Close To A Sell
LTC just reported its Q1-2021 results and we dived in to see if we could make a trade.
Q1-2021
LTC missed across the board as funds from operations (FFO) and funds available for distributions or FAD, both came in below expectations.
FFO per diluted common share was $0.62 and $0.74 for the quarters ended March 31, 2021 and 2020, respectively. Funds available for distribution were $24.6 million for the 2021 first quarter compared with $28.5 million for the 2020 first quarter.
Source: LTC
The quarter was an interesting one and captured our central reasons for staying away from these REITs, except at compelling valuations. LTC had a large revenue drop in the quarter.
Source: LTC
The drop in revenues is just as steep if you compare quarter over quarter as well. This was slightly offset by lower interest expenses. Revenues fell as LTC provided significant help to its operators. This was in line with what we expected post the CARES Act.
Source: LTC
At present, the deferrals and abatements appear to be modest for the next quarter, but that assumes things remain at status quo. All knowledge in the public sphere suggests that things continue to deteriorate. For example, Senior Care, a major tenant of LTC, emerged from bankruptcy in 2020 and now is back in Chapter 11.
Concurrent with their emergence from bankruptcy, in accordance with the order confirming Senior Care’s plan of reorganization, Abri Health Services, LLC (“Abri”) was formed as the parent company of reorganized Senior Care and became cotenant and co-obligor with reorganized Senior Care under our master lease. In March 2021, as a result of Senior Care’s and Abri’s (collectively, the “Lessee”) non-payment of rent and additional obligations under the master lease, we sent a notice of default and applied the Lessee’s security deposit under the master lease to delinquent rent. Furthermore, on April 7, 2021, we sent the Lessee a notice of termination of the master lease to be effective April 17, 2021. On April 16, 2021, the Lessee filed for Chapter 11 bankruptcy. At the time of the April 16, 2021 bankruptcy filings by the Lessee, we were in the process of transitioning the portfolio to HMG Healthcare, LLC, with a goal to complete the transition by the end of the second quarter of 2021.
Source: LTC
Senior Lifestyles, another major tenant, stopped paying rent in 2020 and LTC is working hard to find replacements.
During 2020, Senior Lifestyle paid us $13.8 million of their $18.4 million contractual rent and we applied their letter of credit and deposits totaling $3.7 million to past due rent of $3.6 million and to their outstanding notes receivable of $0.1 million. Accordingly, we recognized $17.4 million of rental revenue from Senior Lifestyle in 2020. To date in 2021, Senior Lifestyle has not paid rent or its other obligations under the master lease.
Source: LTC
LTC has found solutions for many of these properties with new operators moving in. The company does not disclose property by property data, but we think this involves rent cuts and better terms for the new operators. Even that process is not yet completed.
For the remaining 11 assisted living communities, three communities are expected to be transferred to one of our existing operators by the end of the second quarter of 2021, three are expected to be sold by the end of the second quarter of 2021, subject to timely completion of due diligence, one is 28 expected to be transferred to an operator new to us by the end of July, one has been closed and will be sold for an alternative use, and options are currently being evaluated for the remaining communities.
Source: LTC
LTC is also likely to face turbulence from Genesis Healthcare (OTC:GENN) down the line. GENN is current on rent payments but has entered into a reorganization plan. We already saw that GENN's moves so far hurt Welltower Inc. (WELL) and LTC will likely have to concede some ground. These are all large operators and individually represent big headaches for LTC.
Source: LTC
We would argue that none of these operators will go unscathed with what the occupancy levels look like currently.
Skilled nursing property occupancy decreased in the first month of this year to a new low of 71.2 percent. That level stood 13.8 percentage points below pre-COVID levels of 85 percent in February 2020. The fresh lows were also 46 basis points below the 71.7 registered in December.
Source: Multi Housing News
Over the years we have seen defaults and distress in the skilled nursing sector even with occupancies in the mid-80s. The current levels are absolutely catastrophic without government aid and while we expect a slow and steady bounce in occupancies, many operators won't make it in the interim. Senior housing is just as bad and while occupancies are moving up, they remain far below comfort levels.
Dividend
LTC recognized that the FAD payout ratio will go past 80% in 2021.
It has been our Board's practice to support a dividend payout ratio of approximately 80% of FAD. As a result of the financial support, we are providing some of our operators and the significant lease defaults of Senior Lifestyle and Senior Care.
Our 2021 dividend payout ratio will likely exceed the 80% target. However, we see our 2022 FAD recovery as we are able to totally transition the Senior Lifestyle portfolio to more stable operators and the issues involving LTC in the Senior Care bankruptcy are resolved.
Source: Seeking Alpha
In Q1-2021 the payout ratio reached 92% so things are getting tight from that perspective. But LTC's credit metrics still remain good and it could run a 100% plus payout ratio for 1-3 quarters without cutting its dividend. This has to be counterbalanced by the fact that its operators are likely to come to LTC one by one and ask for further rent relief in 2021. LTC thus enjoys the second-lowest danger level rating on our proprietary Kenny Loggins Scale.
A Moderate danger rating implies a 15-33% probability of a dividend cut in the next 12 months.
Conclusion
LTC's trailing 12 month revenues are back down to 2017 levels and the GAAP debt to EBITDA ratio is getting high.
Now LTC reports the current quarter's debt to EBITDA far lower.
At the end of the 2021 first quarter, our credit metrics remain strong with net debt to annualize adjusted EBITDA for real estate of 5.1 times and annualized adjusted fixed charge coverage ratio of 4.6 times and a debt to enterprise value of 28.6%.
Source: Seeking Alpha
The key difference here is the word "adjusted" vs what Y-Charts is pulling up. Even if you accept this 5.1X ratio, do remember that LTC has dialed up the leverage over the years.
Source: LTC
Despite that dial up, FAD this quarter was lower than the 2014 run-rate.
Source: LTC
This explains why the stock is 7% lower than what we saw exactly 8 years back.
LTC has used up its leverage cushion and plenty of its operators will probably create problems for the REIT in the coming years. This remains on our avoid list and we would consider a short position over $45.00.
Please note that this is not financial advice. It may seem like it, sound like it, but surprisingly, it is not. Investors are expected to do their own due diligence and consult with a professional who knows their objectives and constraints.
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Analyst’s Disclosure: I/we have no positions in any stocks mentioned, but may initiate a short position in LTC over 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.
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