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Stocks  | February 12, 2019

Ventas Inc. (VTR) reported Q4 2018 results. We examine them below and explain why we are now less optimistic on its future prospects.

2018, A Year Better Forgotten

For its extremely well-hyped portfolio and management, VTR's annual results were far from riveting. The portfolio produced a 1.2% same store growth.

The Senior Housing Operating Portfolio, or SHOP as VTR likes to call it, was down 2.1% year on year, sucking joy out of overall results. While those results look bad from an annual perspective, Q4 2018 numbers were horrendous.

At a 3.5% annual decline, this quarter was the worst in the year, with Q3 2018 coming in at a modest 2.7% decline. It is important to note two things in this context. First, this is same store sales, so takes out any impact of property sales for good comparison. Second, VTR's SHOP portfolio has been down 5 straight quarters and the declines appear to be accelerating.

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VTR's struggles on its SHOP portfolio have sharply contracted its EBITDAR and EBITARM margins.

With same store margins higher than total portfolio, one can conclude that the newer acquired properties are not yet gaining traction. There is possibly some light at the end of the tunnel here as quarter over quarter showed some improvement in occupancy in this area. Margin pressures also abated.

We will have to see if this translates into better results in the next few quarters.

Senior Housing Triple Net, Looking Ripe for Rent Cuts

While VTR's operating side looks to be struggling on senior housing, its triple net continues to produce decent results. Q4 2018, as noted above, produced a 2.1% increase in same store income. But underlying those is the deterioration in the rent coverage of its tenants.

If one buys into the argument that VTR is the best there is, best there was and best there ever will be in the healthcare space, and if they are showing 3.5% declines in same store sales, how are its tenants, who don't have this amazing management, going to fare? The short answer is "not very well". We can see this below as a full 16% of VTR's total cash flow has a sub 1.2X EBITDAR coverage.

Is that bad? Well, for starters, this percentage was under 8.5% in Q2 2017.

Also the amount of rent under 1.0X rent coverage has exploded by almost 10-fold. This is now coming front and center and is part of the guidance VTR gave for 2019.

Rent escalators are assumed to be partially offset by expected lease modifications with certain smaller senior housing operators where rent coverage and credit is challenged. Though we have multiple potential approaches to these situations including operator and business model transitions, our guidance at this stage assumes a $10 million NOI reduction in our triple-net same-store pool equating to 130 basis points year-over-year same-store impact. In addition, the lapping of the 2018 Brookdale lease modification lowers triple-net same-store NOI growth by 70 basis points in 2019. On these assumptions, we forecast that our overall triple-net portfolio same-store cash NOI will increase between 0.5% and 1.5% in 2019. I would highlight that guidance does not include any of these modifications for our portfolio of 26 communities managed by holiday. These assets represent only 3% of our company's NOI with approximately $60 million in annual contractual rent, which is fully current.

The Other Part of VTR portfolio

The office portfolio has long been hailed as the reason to own VTR and we have been guilty of said "hailing" as well. Q4 2018 results here were also lackluster.

Key problem was from both occupancy declines and rising cash costs.

Overall Numbers, Nothing to Write Home About

While VTR reports tons of different numbers including funds from operations (FFO), adjusted funds from operations and net income per share, we pay a lot of attention to one other metric, funds available for distribution (FAD). This is normalized FFO adjusted for capital expenditures that VTR has to bear.

This metric has continued to deteriorate rather sharply. For 2018 VTR produced just $3.57 a share. We would stress that normalized FFO was $4.07 in the year. For Q4 2018 FAD was $0.77 a share. We bring this up because of this fun fact.

Coverage for the dividend is getting rather tight. For 2019, VTR is guiding for $3.80 in normalized FFO and that would likely translate into $3.30 of FAD. With an annualized dividend at $3.19, FAD coverage is looking rather ominous. It is important to note that we are not remotely forecasting a cut, just making a point that it is perhaps best that dividend hikes are now stopped before things get more out of hand.

Downgrading to a Sell

The "mea culpa" here is while we identified the senior housing problem early, we thought the stock price decline and VTR's other side of the portfolio was enough reason to own it. We did make make good money on this name via covered calls and cash secured puts even though the stock price itself meandered. At $65 a share, VTR is trading at 17X 2019 normalized FFO and we see downside to their guidance for sure. Our rationale here is that VTR's cycle of rent cuts is just beginning and rent coverage is substantially worse than it appears. What we mean by that is a 1.2X in Q4 2016 is significantly better than a 1.2X in Q4 2018, as the coverage is measured on a EBITDAR basis and that "I" in EBITDAR, interest expense, is now significantly higher for tenants due to rate hikes that have been put into the systemWebsites such as Finviz continue to project 6.9% growth for the next 5 years, just as they did 18 months back.

We think that VTR will likely report a sub-$4 normalized FFO this year, the next and most likely even in 2021. Those feasting on the dividend are likely to be happy and we cannot blame them as it is one of the better yields out there. We also expect other authors to reiterate the "but balance sheet is awesome" argument because that has not been said this week. But we think it is a sell at this point and we will be more interested in buying at a sub-$55.00 price.

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