Over the coming decades, the aging of the U.S. population is going be one of the largest demographic and economic megatrends, creating potential investment opportunities for long-term dividend investors.
Let’s take a look to see if Ventas, America’s second largest medical Real Estate Investment Trust, or REIT, could be a sensible choice for low risk investors to ride the coming financial wave of growing medical spending.
Ventas stock has slumped nearly 20% over the last three months and offers a dividend yield near 5%, potentially providing an appealing entry point. Let’s take a closer look at the business for consideration in our Conservative Retirees dividend portfolio.
Ventas is one of the two dominant players in medical real estate assets. After the 2015 spinoff of its skilled nursing facility, or SNF, properties into a separate REIT, Care Capital Properties (CCP), its business is dominated by 1,275 properties, mostly in the senior housing, medical office buildings, and hospital sectors.
As seen below, the company’s largest assets by net operating income (NOI) are seniors housing – operating (31%), seniors housing – NNN (24%), and medical office (19%). Ventas also has several large operators, with Atia, Lillibridge, Sunrise, and Kindred accounting for 19%, 11%, 9%, and 9% of NOI, respectively.
Source: Ventas Investor Presentation
The medical REIT industry is over $1 trillion in size and highly fragmented, with only about 15% of U.S. medical assets owned by medical REITs. Compared to other industries, healthcare REITs control a relatively small percentage of real estate assets and should have opportunities for consolidation.
Source: Ventas Investor Presentation
This means that sales and cash flow growth (specifically free cash flow, or what Ventas calls Funds Available for Distribution, or FAD) can be lumpy. This lumpiness is reflected in Ventas’ solid, though volatile, growth track record.
Most recently, the company’s quarterly revenue grew by roughly 5%. Note that two of the most important metrics to watch, growth in FAD/share (which funds the dividend) and the FAD payout ratio (how safe the dividend is), were the result of two countervailing deals.
|Metric||Q3 2016||Q3 2015||YoY Change|
|Revenue||$866.6 million||$827.6 million||4.7%|
|Normalized FAD||$314.2 million||$231.6 million||35.7%|
|Shares Outstanding||354.2 million||336.3 million||5.3%|
|Dividend Payout Ratio||82.3%||106.0%||-22.4%|
Source: Earnings Supplement
The first deal disposed of over $4 billion in skilled nursing facilities (SNFs) by spinning them off into a new REIT, Care Capital Properties (CCP). The CCP spin off resulted in a decline in cash flow that resulted in last year’s Q3 payout ratio rising above 100%. However, the spinoff strengthened Ventas’ portfolio, improving its mix of private pay contributions, reducing its exposure to SNFs, and boosting occupancy.
Thanks to a stronger balance sheet, Ventas, unlike its rival HCP (HCP), which is also spinning off its SNF properties into a separate REIT, was able to maintain its dividend.
In comparison, HCP just announced that the loss of cash flow from its spinoff would require a 36% dividend cut, ending its streak of 30 consecutive years of dividend increases, and its dividend aristocrat status.
The big differentiator between Ventas and HCP was in its balance sheet and the quality of its management team.
For example, Ventas has continued to grow through acquisition, with over $1.4 billion in net investments during the first three quarters of 2016. This is mainly made up of the $1.5 billion acquisition of Wexford Life Sciences, which consists of 25 current, and under construction research labs used by some of America’s most prestigious research institutions such as Yale, Duke, and Washington University.
It also gives Ventas about a 10% market share in the fast growing, $38 billion university R&D industry, itself part of a far larger $259 billion global R&D industry. Better yet, this industry is only set to grow as drug makers race to create new drugs to treat the world’s increasingly older citizens.
Of course, all these growth acquisitions could hurt long-term dividend investors if management were to go overboard with debt, as HCP’s did in recent years, and create a balance sheet that threatened its ability to grow, or even maintain the current payout.
However, Ventas’ world class management team, led by Chairman and CEO Debra Cafaro, (who has generated 27% total returns since she became CEO in 1999), has done an exemplary job of balancing growth with a strong, and steadily improving balance sheet. As seen below, Ventas maintains a reasonable total debt to enterprise value ratio of 31%, and its fixed charge coverage sits at 4.7x.
In fact, Ventas has one of the strongest balance sheets of not just any medical REIT, but any REIT period, which allows it to access debt at super cheap levels; including its revolving credit facility which has an interest rate of just 1.5%.
This gives Ventas a low weighted average cost of capital below 5% and allows management to generate more accretive investments (i.e. that grow FAD/share quickly and allow for a highly secure and growing dividend).
Overall, Ventas has a portfolio of diversified healthcare properties run by best-in-class operators who should collectively benefit from favorable demographic trends over the coming decades. Management has shown capital allocation skill over the last 15+ years, and the large and fragmented nature of the market provides numerous opportunities for continued growth.
However, there are risks to every investment.
There are two big risks with investing in any medical REIT: government changes in healthcare spending policy, and interest rates.
Because of the rising cost of treating America’s aging seniors, changes in Medicare policy, away from a fee-for-service model and towards one based on outcomes, can be a risk to Ventas’ tenants and operating partners.
This is especially true given that certain sub sectors of the industry, such as SNFs, run on razor thin margins. This can result in some long-term care providers running into hard times. For example, Kindred Healthcare, (KND), just reported a horrible quarter and announced it was exiting the SNF industry all together.
Now Kindred represented 9% of Ventas’ net operating income, or NOI, and management is confident that it will be able to come to a mutually beneficial agreement in which it sells the properties operated by Kindred and further de-emphasizes the importance of SNFs to its cash flow.
After all, this was the main reason why Ventas opted to spin off Care Capital Partners