I didn’t do anything with my portfolio this week, and I don’t think we’ve had significant news that changes my opinion about any of the stocks I wrote about in our Annual Review about ten days ago, so today I’ll just dig into a teaser pitch for your Friday File edutainment.
Here’s the intro to the latest teaser pitch from Contrarian Income Report:
“Lock in 7.2% Dividends and 15% Gains from the Biggest Demographic Shift in U.S. History
“Three companies are reaping huge profits from this unstoppable mega-trend and payouts are set to increase every year for the next 3 decades.”
Sounds like a tonic for our times, right? High dividends, good gains, mega-trend. What more could a spooked investor want? So I went digging to figure out which stocks he was talking about.
The “mega-trend,” as you’ve probably guessed, is “the population is getting older” …
“There’s a bull market unfolding as Americans get older, and it will run for at least two or three decades. Here’s what’s driving profits in the America-is-getting-older trend:
- 77 million Baby Boomers, born between 1946 and 1964, make up nearly 28% of the entire US population.
- We’re living longer than ever before thanks to healthier choices and advances in medical technology. That means the 65+ population will double and the 85+ population will triple in the coming years.
- Americans over 65 are three times more likely to be admitted to a hospital, and for longer periods of time and for more expensive types of care.”
All of that remains true, regardless of the fact that the broad healthcare sector has corrected and is off 15-20% over the last six months (thanks in large part to the fact that the most volatile segment of the healthcare sector, biotechnology, is down more than 30% during that time). This is not news to investors or demographers, who’ve been aware of a little group we call the “baby boomers” for quite some time… and that’s why health care before that had been such a long-term outperformer (over ten years healthcare broadly is up more than 100%, biotech more than 200%… with most of those gains coming in just the past five years).
But what’s the big dividend/gains opportunity being teased about here by Brett Owens? More from the ad:
“The Bull Market in 65+ Healthcare Will Continue for Decades…Are you getting our free Daily Update
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“Older adults spend 5-times as much on healthcare as other adults. They visit physicians offices 2.5-times more than other adults.
“Also, those 65 or older are spending 3-times as much time in a hospital than their counterparts 45-64 years of age, on average….
“I like two avenues the best – skilled nursing facilities, and hospitals. There’s no scenario you can draw up for the future that doesn’t heavily involve both types of providers.
“And the economics for those running both types of facilities today are better than you’d ever imagine.
“Believe it or not, as early boomers move out of their suburban homes and into retirement communities, they don’t have many viable options when increased levels of care are required.”
Ah, so if it’s yield we’re focused on, and think skilled nursing facilities and hospitals are key properties, then it must be health care REITs he’s teasing. Maybe even some of the ones we’ve covered before (or those that I own, like DOC or MPW).
Why these particular asset classes? Here’s a little more from the ad:
“SNF Supply is Actually Decreasing as Demand is Booming
“Skilled nursing facilities, or SNFs, provide the highest level of care an older adult can receive while still living independently. Whether its for a long-term stay, rehabilitation following a surgical procedure or to manage a specific medical event, residents generally get their own room, their own bed, and a private bathroom.
“While demand for SNFs is heading steadily up, supply—surprisingly—is constrained. Many states limit new SNF construction. As a result, there are now 94 fewer U.S. facilities than there were in 2008….”
OK, so falling supply and rising demand sounds like a reasonable rationale for buying into an asset class. And we’re told that in the case of skilled nursing facilities, government and other insurance programs (Medicaid, mostly) pay most of the bills and are incentivized to push skilled nursing over more costly options (hospitals and rehab facilities, mostly).
Then we get into teasing some of the specific ideas from Owens’ Contrarian Income Report:
“Rising demand, government-restricted supply, and access to Uncle Sam’s pocketbook means the rent will keep going up. It’s a great business to be in – which is what attracted me to my first two favorite healthcare plays….
“Healthcare Income Buy #1 Pays 6.7%
“Firm #1 has increased its dividend by 138% over the last decade….
“The company owns more than 900 properties in 41 states, making it the leading investor in skilled nursing facilities in the U.S. And it doesn’t have to worry about actually running the facilities it owns. Instead, it partners with the leading operators in the space and shares in the consistent profits….
“The firm has increased its payout for 13 consecutive quarters and counting…
“The dividend growth is being powered by good old fashioned cash flow growth. Revenues have risen 20% year-over-year for the last 3 years.
“The good times should continue for years, as this highly fragmented industry is consolidating – with firm #1 likely to be a big winner. A full 84% of all skilled nursing facilities will be ‘up for grabs’ in the years ahead.”
So which one is this? Thinkolator sez it’s Omega Healthcare Advisors (OHI), a REIT that specializes in long term care facilities. Omega has indeed hiked its dividend each quarter for several years, though it’s 14 quarters now (they hiked in January, probably after the ad copy was written) — that’s obscured a little bit because of special dividends, but the base dividend has gone up consistently. Currently the yield is 7.2% if you annualize the most recent payout (that is, 57 cents times four, divided by the current share price of $31.70).
Omega has had nice top line growth over the last five years, their revenue per share is up by more than 40% over the past five years (you usually need to look at things “per share” for REITs, because they almost all issue shares to fund expansion) and the dividend has tracked with that increase in revenues, rising almost 40% since 2011. They’ve also levered up quite a bit in recent years, total debt has increased by more than 50% in that same time period.
Some people have been conditioned to fear stocks that continually issue new equity, but that’s common for REITs and doesn’t mean they’re necessarily diluting existing shareholders — it depends on what they do with the cash. REITs can’t generally grow without also growing the share count and growing the debt burden, because they’re obligated to pay out essentially all of their earnings as dividends (and, in practice, pay out much more than what their taxable earnings would be, thanks to depreciation). They don’t have a lot of cash left over to invest in building or acquiring new buildings, and they can’t really grow without increasing the portfolio of properties they own — they grow by raising more money, usually either from investors or bondholders, and trying to invest that cash in properties that will provide a return that’s greater than their cost of capital. If they issue new shares and have an expected dividend yield of 7% due to those new shareholders, the acquisition they make with that money needs to have a “cap rate” of over 7% or a strong likelihood that it can increase the cap rate fairly quickly (by upgrading the building, perhaps, or raising rents, or whatever)… if that new building has a return of less than 7%, then the new equity that was issued may be dilutive for existing shareholders (“cap rate” is the annual cash profit a building generates, and is a term commonly used in real estate investing).
That’s oversimplifying — often REITs will issue both shares and debt, and manage their balance sheet pretty actively — there’s a reason why REITs are classified in the “financial” sector — but it gives you the basic idea. The added value REITs create comes from buying properties that provide a return that’s at least a little bit higher than the cost of the capital needed for the acquisition, then growing the returns from those properties at a rate high enough that funds from operations per share can rise over time and fund a rising dividend. Rising dividend equals happy shareholders.
The most commonly-used metric for REITs is Funds From Operations (FFO), which is essentially a way of adjusting earnings to account for the fact that depreciation is not likely to be a real cost for most real estate operations (since real estate doesn’t actually lose value, despite the fact that it has to be depreciated). So it more closely approximates “ongoing cash earnings” — you take net income and subtract any gains from sales of properties, then add back in the non-cash depreciation and amortization charges. Some REITs further tinker with that by reporting “adjusted funds from operations” (AFFO), but there’s not as much of a consistent application of that “adjustment” — often they’re adjusted to take away the impact of one-time problems (like a tenant going bankrupt), and sometimes they’re just used to more conservatively adjust for real ongoing expenses that are required for continuing operations but can be classified as capital costs… like maintenance and upgrades of facilities.
So Omega has a growing FFO per share, which is good, and a strongly growing dividend that has gone up, on average, close to 10% a year, which is also good. There’s no particularly sexy growth spurt that I’ve noticed, but analysts do expect them to increase FFO by about 5% for last year when the final numbers come in, and to bump FFO per share up another 7% in 2016. With the stock trading at about 10X FFO and with a dividend that is high and growing and sustainable, that’s reasonable even if you’re a bit worried about interest rates going up.
The risks I’d look for here would be in their financing, if they happen to have a large cash need for a bond maturity or new acquisition at a time when the stock is not well-priced (that has hurt REITs I’ve owned in the past, including my current position in Medical Properties Trust (MPW)), and in their sector specialization.
The debt maturity schedule doesn’t look worrisome to me, most of the debt is non-secured (meaning it’s corporate debt, not mortgages), and most of it is cheaper than their equity (5-7%) and matures in manageable annual amounts over the next ten years… and after their large acquisition of Aviv last year, I doubt they’re on the verge of a big fundraising to acquire facilities right now (though you never know).
And on the sector risk, because OHI owns primarily skilled nursing facilities, they have at least some regulatory risk related, more than anything else, to changes in the way that Medicaid pays these facilities. I don’t have any special insight into that, but it’s a risk — and, unlike the other segments of health care REITs like hospitals or medical office buildings, there’s a non-trivial chance that the skilled nursing business could become 20% less valuable overnight because of a change in government policy.
Omega is pretty big ($6 billion market cap, $10 billion enterprise value) and is much more concentrated in a specific sector (skilled nursing) than the other large healthcare REITs, so it’s got that “sector risk” to consider, but the actual concentration of tenants is not worrisome — they work with dozens of different operators of these facilities, and none of the operators account for more than 10% of revenue. Their recent acquisition of Aviv, another skilled nursing REIT, should help them a bit because the larger size will mean they can make the Aviv properties a bit more accretive by cutting their borrowing costs, and they still appear to believe that they can keep the dividend growing at 10% a year. That’s not a guarantee, of course, but it’s an appealing company that has a reasonable balance sheet and some potential for continued steady growth… and it’s down about 30% over the past year, so, in my book at least, it’s no longer too expensive to consider.
What else is Owens recommending with his teaser talk?
“Healthcare Income Buy #2: The Upstart Competitor Pays 7.5%
“Firm #2 is the second-largest player in the fragmented space with 355 properties that include skilled nursing, senior housing and specialty hospitals.
“It’s a recent spinoff from a larger (and very well respected) company also in the healthcare industry, which is why it’s still flying under the proverbial radar. But that’s about to change, as a major investment bank just initiated analyst coverage on the new company.
“… our second healthcare income buy has a clean balance sheet, and generates over $230 million in annual operating cash flow. It entered the world on its own with just $1.4 billion in outstanding loans versus real estate valued above $2.6 billion – an excellent ratio – and it picked up another $2.7 billion in cash from issuing shares at the spin.
“Firm #2 pays an amazing 7.5% dividend and I see no point in choosing between these two stocks. Both have the same great business model, and both can continue to grow and dominate this market.
“That’s why I recommend buying both stocks and collecting these big dividends.
“It’s only a matter of time before income-focused investors trade in their paltry 2% and 3% yields for these income cows. I believe both will see their stock prices appreciate by at least 10% this year. Which means, if you buy today, you’re locking in secure gains of 17% or better.”
This one is Care Capital Properties (CCP), which is the skilled nursing/long term care business that was spun out of the large diversified healthcare REIT Ventas (VTR) about six months ago. It is now, by most measures, the second-largest publicly traded REIT in this sub-sector, behind OHI, and it yields slightly more (almost 8%) and might have the opportunity to grow a little bit faster since it’s smaller and newly imbued with new management that’s focused on just this sector (we can call that the “spin off effect” — companies that get focused management and freedom to grow often do blossom when separated from a company that had myriad other priorities).
The debt burden is similar to OHI, and valuation is broadly similar (CCP is just a little bit cheaper on most metrics), but they also have a potentially worrisome level of tenant concentration, there are two tenants that make up more than 20% of their revenue. Given all of that, I would have a hard time buying CCP over OHI given OHI’s proven dividend growth and their much more experienced management (and proven ability to integrate acquisitions).
Buying either of those stocks is, to at least some degree, a bet on Medicaid reimbursement for long-term care and skilled nursing facilities, and I’d have to conclude that regulatory risk is the primary reason that the stocks look pretty cheap compared to other healthcare REITs. Might be worthy of some exposure, given that higher yield and what does look to be a solid growth environment and potential for consolidation, but I would keep that exposure relatively small given the regulatory risk and diversify into other health care REIT sectors as well (mostly medical office buildings and hospitals) if the general idea appeals to you.
Which leads us to the third pick teased by Owens, which is indeed in a different subset of the healthcare REIT world:
“Healthcare Income Buy #3: The Only Financing Option for Hospitals Pays 7.7%
“Until several years ago, pure mortgage financing didn’t exist for hospitals. And traditional corporate loan packages would typically force hospitals to lock up all of their asset value as collateral.
“Our third healthcare income play stepped into the void, and today it’s the largest financier to hospitals in the U.S.
“Now it doesn’t actually run the hospitals – it invests in them. The company provides capital to the operators, particularly proven ones. They, in turn, use the money to improve their facilities, upgrade their technology, hire more staff, and expand their complex….
“The dividend payout is already growing by 5% annually, and this growth is likely to accelerate as the company’s skyrocketing cash flow drops straight into the pockets of its investors. The firm has already
“Increased its asset base by 332% since 2011…
“These assets produced an 82% increase in cash flow over the same time period…
“The dollars dropping to the bottom line are accelerating – the firm saw a 30% year-over-year increase in revenue in 2015…
“And the latest acquisition spree – $1.5 billion in 2015 – will continue to increase value for shareholders in 2016.
“With a current payout ratio below industry averages, and accelerating future cash flow growth dropping straight to the bottom line, I wouldn’t be surprised to see dividend growth rate climb into the high single-digits.”
From his mouth to God’s ears, I hope, because this is a stock I already own and have written about many times for you — Medical Properties Trust (MPW), which is indeed the only substantial “pure play” in hospital real estate. They have been on an acquisition spree, including a big acquisition in Germany, but the per-share performance has not caught up with the overall growth — and they are at the top end when it comes to the amount of debt they want to carry, so they are caught in a little bit of a hard place: They would like to raise more equity to help cover their big acquisition spree, and that equity should get a decent return, but investors have not lately been interested in paying a decent price for the equity. That led to a disappointing equity raise last year (and more debt), and the stock has not yet recovered from that.
Here’s what I wrote about MPW in my Annual Review a couple weeks ago:
“Medical Properties Trust (MPW) $10.75, personal cost basis $11.50, suggested to Irregulars at $12. Sentiment: Buy. Triggered Trade Stops “smart stop” at $12.50 last year, is right around a stop loss alert on my personal holdings now, but I’m resisting selling at this valuation.
“Medical Properties Trust has been a very weak performer for me, much worse than expected — I’ve written about it a few times as the year progressed, but I remain surprised that it is trading at such a steep discount to the other health care REITs… and that the healthcare REITs, as a group, have fallen apart to some degree. MPW does not have the dividend growth history of the bigger healthcare REITs (they actually cut their dividend several years ago, and income investors have long memories), but it has begun to gradually increase their dividend in recent years and the current yield is exceptionally high — the current yield is 8.2%.
“So why is it so cheap? It’s not just that all health REITs are down and trading at higher dividend yields, though they are. MPW is trading at a bigger premium yield versus the “steady eddie” Healthcare REITs than it has seen in 3+ years (ie, MPW’s yield of 8% is three percentage points higher than Ventas’ (VTR) yield of 5%, whereas a year ago the difference was one percentage point). This is company specific. Why? Well, partly it’s access to capital and leverage — MPW had a failed (“disappointing” is a better word) secondary offering over the Summer, and instead did a debt offering, so their debt levels are higher than they’d like right now. Partly it’s the hospital business, I expect — the hospitals have been grumbling about bad numbers for several quarters, and people trickle that fear down to the hospital landlord (MPW owns primarily acute care and rehab hospitals, not the medical office buildings and nursing facilities that dominate most healthcare REIT portfolios). Hospitals aren’t in such bad shape that there will be a massive wave of bankruptcies, as far as I can tell, and they’re paying their rents and should easily, according to MPW, be able to pay in the future given their coverage ratios — and hospitals are unique properties that are not easily replaced or built (unlike nursing homes or medical office buildings). And MPW is not getting any credit for the fact that they’ve diversified and expanded overseas, largely in Germany — mostly because that means they’re getting hurt a bit by the falling Euro (though, wisely, they also issued a bond in Euros to help with that acquisition, so that cuts the impact).
“My shares did technically hit a sell stop last week on the low close of the week, but they recovered a bit right away and I let the stop alert pass unheeded. I will give this one a bit more room because I think this price is irrational — and I think there’s a good chance that it will recover if, as management is indicating they will, they are able to clean up the balance sheet a little in the next few months. That will probably be through asset sales, which should help both to ‘fix’ their leverage ratio and to make clearer to investors how valuable these hospital assets are. That’s obviously not a certainty (if it were, the shares would be higher), but I’m buying a little bit more here to draw a line in the sand: absent a full-on crash of everything, I think MPW trading at a 9% yield is stupid cheap. Those who are religious about stop losses and momentum trading will laugh at me for this, many people live by a rule that you should never average down, and that you should never ignore a stop loss — but, well, if I were a machine this wouldn’t be any fun at all. I won’t let MPW go down a lot further, certainly no more than a 20-25% stop loss on my actual cost (if I’m still holding as it hits $9, I’ll have to concede that the market and I might never agree on this stock), but I’m going to add marginally to my position here and give them a bit more space because I’m pretty confident that improving their balance sheet is eminently do-able and likely to happen in the near future. The biggest risk here, I think, is if they have to raise equity at this depressed price because they’re unable to do any worthwhile asset sales — if that happens, the price could certainly fall and I’ll take another look. They should report their next quarter in a few weeks, and the conference calls will be important to listen to for their commentary about the balance sheet and possible asset sales.”
That’s still how I feel about MPW, and the price hasn’t changed much in the past month or so. We’ll know quite a bit more about the company’s plans, I expect, after their conference call next week — the earnings release will be on Tuesday morning, the conference call at 11am that day.
And Owens closes with two more arguments — first, that big, smart investors are buying into this sector:
“George Soros Bought Bigger Players in the Space in Q3
“Legendary investor George Soros – co-founder of the Quantum Fund, which returned 4000% to investors in the 1970s – just declared in November that he bought some of the bigger players in the space we’re discussing.
“Unlike you and I, Soros has a ‘problem’ that limits him to the big dogs and doesn’t let him purchase the under-the-radar companies that I prefer. You see, he has so much money under management that he needs to put a significant chunk of it to work on any investment.
“The 3 companies we’re looking at are too small for him to buy big chunks of.
“Fortunately, unless you have $6 billion or so to deploy, you can take advantage of the better bargains and buy the smaller companies that Soros would love to buy if he could.”
And second, that the fears of interest rate hikes are either misplaced or simply exaggerated:
“Firm #1 Soared During the Last Round of Rate Hikes
“Frantic investors are blindly selling all income investments in an all-out ‘rate hike panic.’ But contrarian income investors know that we make money buying panics rather than selling into them. And this time it’s no different.
“Conventional wisdom says income stocks will perform poorly in a rising rate environment. That’s a lazy blanket statement that just hasn’t been the case historically.
“Let’s rewind again to June 2004, when Fed chair Alan Greenspan began boosting rates from then-historic lows. Over a two-year period, he increased the federal funds rate from 1% to 5.25%.
“Firm #1 was the only company of the three trading publicly at the time. And as Greenspan hiked rates, it rewarded its investors with a 52% total return over the next 24 months.
“No matter the interest rate environment, income investors want to own stocks that are consistently increasing their dividends by meaningful amounts. I’m not talking about nominal 3-4% increases. I’m looking for gains that’ll double the payout in a decade or less, which requires annual increases of 7.2% or better.”
That’s generally true, I think, fears of rising interest rates almost always bring REIT stocks down at least for a little while, but an actual period of rising rates for a couple years is not necessarily bad news for these kinds of companies — mostly because, to oversimplify, rising rates have also coincided with inflation in the past, and real estate has been a good place to be during inflationary times as long as the companies aren’t too overextended with hard-to-refinance debt.
I keep holding out hope that we’ll see a real crash in REITs because of interest rate chatter from the Fed, but it looks like expectations of the pace of rate rises continues to be so moderate that we’re not getting that real washout crash… instead, it’s been a generally slow decline for the health care REITs, either because of the health care sector’s recent weakness or because of worries that “REITs are bad during rising rates” concerns (or, more probably, for both reasons).
And yes, Soros’s fund did add to positions in a bunch of different REITs late last year — the ones that are in similar businesses that he bought are Brookdale Senior Living (BKD), Ventas (VTR), and Welltower (HCN). Ventas and Welltower are two of the mega-stocks in the health care REIT sector, so those are more liquid and easier for large institutions to get in and out of, but they’re also more diversified and easier “one stop shops” than these more specialized healthcare REITs being teased today. Brookdale living is about the same size as MPW, and a lot smaller than OHI, so he obviously could have bought those if he wanted to — Soros has not necessarily shied away from midcap stocks in the past, it’s certainly just as likely that he doesn’t like OHI, CCP or MPW.
As for me, I’m tempted to add a bit of OHI to my portfolio at these prices as a way to diversify my healthcare REIT portfolio (my largest holding is MPW in that area, but I also own shares of Physicians Realty Trust (DOC), which is building up a portfolio of medical office buildings), but I’ve also been keeping an eye on Ventas to see if that gets “stupid cheap” sometime soon. I can’t buy anything immediately, now that I’ve written about these I’ll have to wait at least three days… but I also don’t see any particular urgency.
So that’s what we’ve got for your consideration today — a couple nursing facility REITs, and a re-check on our hospital REIT, all of which are down along with the entire healthcare REIT sector and could be, I think, generally attractive in a long-term, diversified portfolio (as are some other REITs that have a solid current yield and reasonable probability of meaningful dividend growth). If you’ve got favorites in this business or sector, or thoughts on the stocks we’ve dug up here, feel free to comment — thanks!
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