HCP Inc - A Dividend Stock is Undervalued
Feb 28, 2018 by InvestorDestination Team
While S&P is dancing around an all-time high, HCP Inc (NYSE:HCP) stock is trading near multi-year lows. HCP is not alone, the entire healthcare REIT sector is struggling, and it can be blamed on rising interest rates and challenges facing senior housing sector and skilled nursing homes.
HCP is a Real Estate Investment Trust (REIT) that invests primarily in real estate serving the healthcare industry in the United States. HCP owns a large-scale portfolio diversified across life science, medical offices and senior housing.
The American senior population is growing rapidly. According to some prediction, American senior population is expected to be approximately 84M by 2050 which is almost double from the 2012 levels of 43 million. The U.S elderly population growth has created a strong demand for the skilled nursing home sector. Many REITs, financial institutes, etc. have raced to address this need and created an oversupply. Apart from that, Affordable care act has forced skilled nursing homes to deal with lower reimbursement rates, shorter lengths of stay and lower occupancy rate and created challenges.
Like its peers, HCP wanted to serve the growing senior population and ride this rising tide. So, in 2011, it acquired assets to cater for the skilled nursing home sector. As a REIT, the company is required to pay 90% of its NOI to its shareholders. To acquire assets, it needs to tap into equity or debt market, and its acquisition has resulted in increased debt.
As the skilled nursing home sector has deteriorated, the company decided to cut its exposure to that sector and, in 2016 it spun off its skilled nursing home assets. The resulting company, Quality Care Properties (NYSE: QCP), is now an independent, publicly traded entity.
Investors expect stability and consistent dividend rise from REITs. HCP has delivered that to its investors by consistently raising dividend over the years. However, when it spun off a significant portion of its properties, there were simply fewer income-generating assets left. So, in 2016, the company slashed dividend payment for the first time in 25 years.
The company’s struggles didn’t end with spinning off Skilled Nursing Home properties. The growing aging population means there is an increasing demand for senior housing. Over the years, real estate investment trusts have increased investments to address this need and created an oversupply in senior housing. Apart from that, baby boomers are expecting better quality, so there will be less demand for older properties and also an increase in operating costs. While there is a long-term tailwind for the senior housing, currently this industry is facing challenges.
Brookdale, a senior housing operator, is HCP ’s largest customer and accounts for 27% of HCP’s cash net operating income (CNOI). In recent years, Brookdale’s financial performance has deteriorated. Industry challenges along with its legal owe and merger with Emeritus have contributed to Brookdale ’s deterioration. In 2017, HCP has decided to reduce its exposure to Brookdale and perform a series of transactions to achieve that goal. These included the outright sale of six properties to Brookdale, the buyout of Brookdale's stake in a pair of joint ventures, termination of management agreement on 36 senior housing operating properties ("SHOP") and leases on 32 triple-net communities. These transactions will help the company to strengthen its balance sheet and reduce that 27% share of CNOI to less than 16%.
Recently HCP has handed over management of 24 senior housing to Atria as part of its 2018 transactions. According to the company, Brookdale manages a wide variety of senior housing properties, and these 24 properties are very similar to properties managed by Atria. There will be uncertainties during this transition and occupancy rates might drop. In the short term, these uncertainties will not have a direct impact on HCP. However, if uncertainties persist for a long time, then HCP will be negatively impacted.
The company is using proceeds from assets sale and spin-off to repay debt and strengthen its balance sheet.
The REITs’ strength lies in quality and locations of the properties they own. HCP owns properties in desirable locations such as SanDiego, Sanfransisco, Boston, etc. Even though senior housing is HCP’s largest property, it has diversified its asset portfolio and has exposure to life science and MOB (medical office building). While the company is reducing its exposure to Brookdale, it is not planning to exit the senior housing, and according to us, it is a right decision.
Even though currently the senior housing sector is facing challenges as we mentioned earlier, the long-term outlook for this sector is bright. RIDEA—the REIT Investment Diversification and Empowerment Act—passed in 2008, allows senior housing REITs such as HCP to share in the operating income generated by their owned properties. The company owns RIDEA as well as triple-net lease properties and can participate in the eventual uptick in senior housing.
Right now life science and MOB sectors are performing well. However, these are cyclical industries and diversification is a good strategy.
The REIT's all-important dividend has been stable since the company slashed it in late 2016. The current $0.37 per share is at least sustainable. At the current stock price, it offers approximately 6.5% dividend yield.
So we think this company is worth considering.
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