The “Rabbi’s Secret” — Healthcare Cash Machines

Steve McDonald is trying to get us to subscribe to his Sound Profits newsletter by telling us that he’ll share the “Rabbi’s Secret” for making money in the markets.

Now, in my experience McDonalds rarely have Rabbis — but it sounds like this is all based on a cute nickname for a broker that worked next to McDonald years ago who McDonald says was named William Peterson, and apparently this “Rabbi” carried a black book of investing ideas what made our good editor wealthy, and reading a bit between the lines it sounds like most of the focus of the “rabbi” was on corporate bonds … which makes sense, since it sounds like Sound Profits and McDonald’s other service, The Bond Trader, are focused largely on corporate bonds and other income-focused investments, with a dollop of “safety” (if anyone really knows what that means anymore) thrown in for good measure.

We last looked at Mcdonald’s Bond Trader back in December, when they were teasing their “top secret” TD-Circ 570 strategy for investing in corporate bonds … but today, for Sound Profits they’re teasing stocks.

But not just any kind of stocks — these are high income stocks, and they’re a very particular subsector.

They call these “income distribution plans” in the teaser:

“The truth is there is no telling when the economy and the stock market are going to get better. That’s why I think it makes a lot of sense to take advantage of this income distribution plan right away.
For it enables you to capitalize on some little-known government-regulated companies that are mandated by Federal law to pay 90% of their profits to people who are on the check distribution list.

“In exchange, the companies get a generous tax break. They pay zero Federal income taxes at the corporate level, providing that they abide by all the rules. Yes ZERO! The catch–they must distribute profits to shareholders. They have no choice. If they don’t make these prescribed payments they will lose their tax-exempt status.

“Not many companies work this way. Normally companies keep most, if not ALL of their profits. This is a massive giveaway being handed out thanks to government regulations. And all, but a tiny minority of people are completely oblivious to it.”

So that’s not a shocking revelation, I expect — these are Real Estate Investment Trusts (REITs), pass-through investment vehicles that use investors’ money to buy properties (often using heavy leverage and mortgages, too, as we’ve seen for some bankrupt REITs lately).

But McDonald isn’t touting just any kind of REIT — these are related to healthcare. Here’s a bit more of the pitch:

“The Automatic Cash Machine That Churns Out Big Dividends, Safely and On Schedule

“These companies invest in medical and healthcare infrastructure. Health infrastructure is of vital importance to the U.S. government. Americans are aging and the demand for healthcare is about to skyrocket. Yet the supply of decent health care facilities is inadequate

“That’s where these companies come in. They provide the capital for healthcare infrastructure. And the government helps them do this by giving them enormous tax breaks. That’s why they can reward shareholders with huge cash payouts.

“And as my mentor, the ‘Rabbi’, used to tell me ‘Stocks are not cash. Dividends are cash. Steve, always make sure you get paid.’ This is an investment that would have made the “Rabbi” proud. Because these government-regulated companies are like cash machines.”

OK — so REITs that invest in medical and healthcare infrastructure. Got it. There are enough of these companies that “Healthcare REIT” is considered a subsector of the REIT universe by many folks (about a dozen of them, last time I checked), and they do basically do what the ad teases — they buy hospitals, medical office buildings and research labs, nursing homes and similar kinds of properties, and they lease them to tenants. Often, as the ad teases, they use triple net leases (meaning they don’t maintain or pay taxes on the property, the tenant does all that) and have some kind of rent escalator built in, but of course that can be different for every company and every deal.

We’ve looked at Healthcare REITs in this space a few times over the last couple years — it does have a nice logical sound to it, you get the relatively conservative structure of a REIT (as long as they don’t use too much leverage), and it’s in a sector that everyone assumes will be in huge demand — after all, it seems logical to assume that there probably aren’t enough hospital and nursing home beds to accomodate the baby boomers if they have the same health problems as their parents over the next 20 years. About a year and a half ago, right at the most recent top of the market, there was a pretty big ad campaign pushing these same kinds of investments as “Healtcare IRAs” with the made up “HIRA” acronym — the three companies from that ad are down around 20-30% or so since then, so they’ve probably outperformed the broad market but not exactly proven themselves to be “bulletproof” just yet.

And of course, we’re not told to go out and buy the baker’s dozen of these companies — that would be admitting that the newsletter can’t tell you anything unique and fabulous. No, they’ve picked out three of them that are the picks for Sound Profits that you should buy now, and if you’ll just pretty pretty pretty please subscribe, they’ll tell you all about ’em.

Or of course, you could just join me as we sleuth through the clues, and give each one a little bit of the ‘ol Stock Gumshoe treatment. Shall we?

“‘Cash Company’ #1: with only 198 employees it made $448 million in 2007. The company had to distribute 90% of that money to participants. It currently pays an 8.7% dividend, and sells below book value. It’s paid 151 consecutive quarterly dividends since it opened its doors in 1970. Based on data reported in Yahoo Finance, from November 1998 to January 2007 this “cash company” returned an amazing 434% in capital gains, plus 155% in dividends…Get involved now and you could collect your first “paycheck” on May 20, 2009.”

That one is Healthcare REIT (HCN) — they’re the granddaddy of the Healthcare REITs, they did indeed start trading in 1970 and they did have 198 employees in 2007. They mostly own nursing home-type facilities, including assisted living and independent living, but also do have a sizable number of medical office properties. They no longer trade below book value, but they did dip down that far briefly (book value is about $28 a share, currently the stock is about $33.50).

Compared to some REITs, the debt is not particularly terrifying — they have about as much debt as equity. The dividend was just announced for the quarter at 68 cents, which means this is the first time they haven’t done a dividend raise at this time of year since 2003 (that dividend is the same one they paid for the last four quarters). That gives a current yield of about 8.2%.

This week is prime time for talking about these companies, because almost all of them are releasing their quarterly earnings reports over the next few days (though most of them have already announced dividend payouts for the current quarter) … HCN’s earnings will come after the close today or early tomorrow morning.

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Oh, man — just realized there are five of these. Guess I better keep my blathering to a minimum. Next!

“‘Cash Company’#2: is based in Chicago. With only 63 employees the company made $573 million in 2007. Founded in 1983, it now owns 380 healthcare-related facilities in 42 states. If you act quickly you can lock-in a generous 9.6% dividend, at a price near its 52-week lows. Pick up this “cash company” now and earn a 30% return in the next 36 months. That’s not counting the ample capital gains it’s likely to return. If you sign up today you’ll get your first “paycheck” by July 23, 2009.”

This is another of the big ones, Ventas (VTR). Has a substantially lower yield now thanks to a recovery in the stock price, but still yields 7.3% — Ventas is considered to be pretty solid and stable by many folks, which is why it trades for closer to 2X book value and with a lower dividend than most of its competitors. Investors clearly don’t know what to think about healthcare REITs right now, and this is one example of that — since November, it has bounced from $35 down to $20 and back up to where it now stands, about $28, that after a year when the shares were very consistently trading in the low-$40s. They just made a big dealt to extend the leases for about 100 of their properties that are managed by a big client, Kindred Healthcare, so rates aren’t climbing to the moon but they do seem to be able to keep at least this client happy. They’ll be releasing earnings before the market opens tomorrow.

Moving right along …

“‘Cash Company’ #3: is located in Maryland, and owns a portfolio of investments including 236 healthcare facilities in 27 states. This company makes a fortune thanks to this government loophole. And does it all with only 19 employees. It currently pays an 9.2% dividend. During a recent 5-year period this “cash company” paid 1,298% total returns… including 198% in dividends. Scoop this up now, and you’ll get your first “paycheck” on May 20, 2009.”

This one is Omega Healthcare Investors (OHI). They are indeed in Timonium, MD, and they do have 236 facilities in 27 states, including both the properties and mortgages they own. The shares have recovered a bit here as well, so the yield is down just below 8% at the moment … this is a smaller firm than the others and may have more of an investment focus than a property management focus. There was a good little profile of them at the Motley Fool a couple months back. They’ll be releasing their earnings on Thursday morning if you’re interested in catching up on their current business performance.

Closing in on the end …

“‘Cash Company’ #4: was founded in Newport Beach, CA. This company’s market cap is $2.5 billion, yet it only has 28 full time employees. It churns out profits renting 447 facilities in 39 states. It paid dividends 80 straight quarters for twenty years since 1988. Folks who were involved from November 2003 to November 2008 made a 250% gain, including 68% in dividends. We’re going into a similar period now. It sells near its 52-week lows, which leaves a lot of room for an exceptional capital gain when the healthcare sector takes off. And it pays a hefty 8.8% dividend. Your first ” paycheck” will arrive on June 5, 2009 if you apply now.”

This one is Nationwide Health Properties (NHP) — like most of these companies, they bounced nicely off the March lows but are still way off their highs of last year, and the yield is currently 7.3%. They release their earnings report on Thursday evening.

“‘Cash Company’ #5: This 10-year-old Boston-based company has made hundreds of millions of dollars tapping into this government boondoggle. It makes money even when the stock market is risky. Remember these “cash companies” must payout 90% of their profits. During the 5-year period from June 2000 to July 2005, they paid 195% in dividends, with a 342% capital gain to boot. If you act quickly you can capture a fat 8.2% dividend yield. You’ll receive your first healthy ” paycheck” on May5, 2009.”

That one must be Senior Housing Properties Trust (SNH), which is technically outside Boston (Newton, MA … close enough). They are about ten years old, having been formed by a spinoff from HRPT Properties in 1998 … which HRPT might regret, since SNH has dramatically outperformed the parent over that decade and is now about twice as large. This one trades at about book value and has less debt than most of the others as a percentage of market cap, though I haven’t checked on whether there’s anything scary in there (like debt maturities coming up this year).

So … there you have it, five healthcare REITs for your consideration that would apparently do the “Rabbi” proud and put cash in your pocket.

Big picture considerations for all of these might include:

Do they rely on one big client? If so, there are plenty of unhealthy (or at least, unprofitable) hospitals and nursing home operators, and a bankruptcy would rarely be good news for the landlord.

Will they generate enough cash to repay their debt? Many REITs dramatically overleveraged themselves over the last ten years, and if debt is a bit portion of the capital structure a bad mistake or a bad year can leave the equity holders holding nothing but a mortgage. Debt levels are not generally as high for these healthcare REITs as they can be for some of the retail or office REITs that have gotten into trouble lately, but their debt payments still command a substantial portion of current and future cash flows. Funds From Operations (FFO) is the most common metric for “earnings” from REITs, but investors in these should also always look at the debt and, in this environment at least, it would be good to know if lots of the debt is coming due in the next year or so, or if they borrowed heavily in the last several years to buy or build facilities that are now overpriced.

Most of these healthcare REITs don’t seem, at a quick glance, to fall in the same category as the really scary REITs that overleveraged in the office and mall building boom, but it’s still important to check.

How is Federal health policy going to change? Landlords are a bit insulated from the operations of hospitals, medical office buildings, and nursing homes … but just a bit, and the government’s role in health care is going to increase dramatically as the baby boomers retire, whether we see real health care “reform” or not — Medicare and Medicaid will, by virtue of an aging population, become an even larger part of the consumer base, and since those programs are also expected to be the largest single part of the federal budget problem, it’s hard to imagine that the status quo will be maintained. If Medicaid can’t afford nursing homes for all the people who might need them, then you might assume that something has to give … if it means lower reimbursements, then maybe rents need to find a way to come down, too. There are often worries that annual increases will be paused for medicare payments, for example, and even those worries give nursing operators hives — so actual cuts or more dramatic changes could mean material adjustments in the future … nothing is definite, as far as I know, it’s just something to think about.

Those are a few things to consider when you think about investing in healthcare REITs — I’m sure there are other important points to address, too … and as always, I can’t tell you that they’re good or bad investments. It’s true that the logic of “aging population needs more healthcare infrastructure” seems to play in their favor, but logic can be easily warped, especially when you’ve spent a few years growing with borrowed money — check ’em out, and let us know if you’re interested.



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Robert J
Robert J
May 4, 2009 3:00 pm

Enter what ticker? Don’t see what you mean about enter a ticker to read abouy Rabbis Secret.

clairmont faille
May 4, 2009 9:16 pm

hi,there; is some of these stocks trade on canadian market?thanks,

john sloan
May 5, 2009 2:39 pm

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