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Don’t Overthink It: A Rare Sale On The Best Healthcare REIT, Ventas

Quick Summary

  • Ventas Inc. (VTR) paid an annual dividend of $0.41 in 2001 and now pays $3.15 annually. That 8% compound annual growth rate has translated into substantial investor returns over time.
  • The cost and effectiveness of a REIT's leverage is one of the most important aspects to its success. Ventas is no exception.
  • Ventas has a net debt-to-EBITDA multiple of 5.4x, which easily beats not only HCP, Inc. (HCP), the largest healthcare REIT, but even industry stalwart Welltower's (WELL) 6.3x.
  • Ventas's fixed charge coverage multiple of 4.6x is also peer-leading, with HCP and WELL both under 3.8x.
  • Short-term maturities (<3 years) also measure up at <12% of its total debt, while those of nearly all peers exceed 20%.
  • Performance? Management? The stock is up 2,389% during CEO Debra Cafaro's 19-year tenure.
  • Ventas recently improved its 2018 normalized FFO, yet trades at a reasonable valuation (finally).

Portfolio

Source: Ventas, Inc.

The portfolio consists of 31% senior housing operated, 24% senior housing under triple net leases ("NNN"), 19% medical office building ("MOB"), 7% university-based buildings, 7% long-term acute care and inpatient rehab facility, and smaller allocations to health systems (6%) and loans (4%). Ventas is targeting 3-4% cash net operating income ("NOI") growth in its university-based facilities, 1.5-2.5% for its medical office buildings, and 1.75-2.75% average same-store cash NOI growth. The company keenly spun off the vast majority of its skilled nursing properties into Care Capital Properties, Inc. (ticker CCP at the time) before it merged with Sabra Health Care REIT Inc. (SBRA). This allowed it to escape the pain experienced by Omega Healthcare Investors Inc. (OHI) due to squeezed rent coverage and tenant issues.

Omega Healthcare Investors (above) recently outperformed almost all other REITs by climbing from $26 to $38 per share in only two quarters. That, however, was only because it had already fallen so far from grace (>$40 per share in 2015).

Ventas' MOB and university assets represent 20 million sq. ft. and 6 million sq. ft., respectively. Both segments yield approximately 7%. The REIT has carefully constructed a portfolio with excellent tenant metrics. A REIT is only as strong as its tenants' rent paying capabilities.

MOB Facilities

In Ventas Inc.'s case, its tenants are of exceptionally high quality and remain well-diversified, with less than 20% of rents coming from its top five tenants. Why are these aspects so critical? A strong balance sheet, coupled with excellent tenants, is what make a REIT's income durable and resilient over market cycles. Let's ensure the other portfolio segments are as rock-solid as the MOBs.

University-Based Facilities

These properties are relatively new at seven years old, with excellent occupancy (>97%) and a high allocation to AA rated, established universities.

This segment of VTR's portfolio has performed exceptionally well due to smart acquisitions and quick lease-ups, including those at Washington University, Duke, and Penn State.

Ventas is an unusually large player in this area, making up 11% of all expenditures in University Life Science R&D. A risk here would be a shrinking of university budgets or the transfer from this type of work away from universities.

The increase in healthcare spending associated with the aging population (who, by the way, have the bulk of U.S. assets) continues to drive additional spending. For the time being, Ventas is increasing its already impressive market share in this highly profitable area.

Senior Housing

The company's partners in this space are among the best, but that doesn't mean they are particularly strong. Only a few years ago, Sunrise Senior Living, LLC, announced that Health Care REIT, Inc. (previous ticker HCN, re-branded to Welltower ticker WELL) had to recapitalize the firm through an increased equity interest. I continue to monitor the health of the senior housing operators and management companies closely, though the worst seems behind us.

I reviewed the smaller segments consisting of the loan portfolio, post-acute care, and health system assets as well. These areas of the portfolio, as well as the underlying triple net lease structures and economics, are heading in the right direction, with no issues material to the broader portfolio.

Leverage and Debt Profile

I reviewed smaller, more agile healthcare REITs Healthcare Trust of America Inc. (HTA) and Physicians Realty Trust (DOC) for a comparison as well. HTA's fixed charge coverage ratio of just over 4.0x is good but not as strong as VTR's. HTA's stated 5.3x Net Debt/Adjusted EBITDAre is not quite apples to apples with VTR's figure, as it includes two adjustments specific to real estate, but overall, it's in line with its big brother.

Debt maturities are well-staggered, meaning less sensitivity to near-term interest rates, minimal solvency risk, and greater flexibility. Note the green portion of the bars - these represent fixed-rate Senior Notes. VTR gains a competitive edge through its excellent debt profile that pays dividends literally and figuratively over time.

Performance

The University division posted above is likely to be the primary driver of growth going forward. Ventas has managed to produce 8% compound annual dividend growth since 2001 due to its smart portfolio allocations among the health care segments and careful asset selection.

While one quarter is just that, Q3 demonstrated strong growth in the triple-net and office areas, with a small decrease in operating senior housing. As shown below, VTR stock has increased from the single digits to recent highs above $60 per share, while paying an increasingly large distribution along the way.

Distribution History, Payout Ratio and FFO

VTR's dividend track record is excellent, growing from approximately 40 cents to over $3.0 since its inception. Historically, and across multiple market cycles, provided entries and exits are timed appropriately. Obtaining VTR with a dividend yield of 5.5-6.0% has resulted in consistent capital gains and a highly favorable total return. Ventas currently yields 5.4%. Of the last 68 quarters, excluding those associated with the CCP spin-off, only four ended with dividend yields exceeding 6.0%. In terms of payout ratio, I modeled them going back to 2016 on a quarterly basis, and both FFO and Normalized FFO were at least $0.90 and averaged just above $1.0 per share. The dividend, however, has never exceeded $0.79.

It is worth mentioning, however, that the payout ratio has slowly climbed from the low 70% range to 83% last quarter. Ventas has been reducing leverage over that time period, which gives the appearance of less coverage. In addition, its investments in the University R&D and MOBs have superior long-term metrics (less variable costs, more growth potential, and much stronger rent coverage) but require upfront investments. Williams Equity Research will be carefully monitoring VTR's leverage profile and dividend coverage in the coming quarters. For the time being, the 83% is higher than we'd prefer, but not alarming or causing a risk to the existing dividend.

Here's a less tedious way to absorb the key elements of the above chart:

This is in the context of recycling $1.3 billion in capital, principally to retire debt. Remember, Ventas is currently paying out $3.16 in annual cash distributions, yet is expected to earn $4.03-4.07 over the same period. If this, in fact, occurs, dividend coverage will improve back into the 70s or approximately 77%.

Summary and Recommendation

  • Among healthcare REITs, Ventas is best, or ties for the best, in effectively every important category, including leverage, interest expense, management quality, and debt ratios.
  • We need to monitor, however, for improving distribution coverage and the organic growth required to support it.
  • The company's portfolio is extremely stable, and management focuses on steady, durable growth over flashy headline numbers. Over time, this has produced highly favorable long-term total return for clients.
  • Ventas is on the doorstep of the 5.5% yield that has historically generated excellent results.

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