Published February 9th, 2017 by Bob Ciura
Care Capital Properties (CCP) is a relatively new dividend-payer. It was spun off from healthcare REIT giant Ventas (VTR) in 2015.
Since Care Capital has only been trading independently for a little over a year, it has not yet established a long dividend track record.
But it has potential: Care Capital has a high-quality portfolio and should benefit from a structural advantage going forward, which is the aging U.S. population.
As a result, it’s possible Care Capital could eventually become a Dividend Achiever, a group of 272 stocks with 10+ years of consecutive dividend increases.
You can see the full Dividend Achievers List here.
Care Capital stock has a current dividend yield of 9% – this is more than four times the average dividend yield in the S&P 500 Index.
The company is committed to maintaining and growing the dividend over time, and has taken several promising steps to secure its hefty payout.
Care Capital is a real estate investment trust, or REIT. It operates in the healthcare industry, with a focus on skilled nursing facilities.
Care Capital has an extensive portfolio that stretches across the U.S. It operates 311 nursing homes, 15 specialty hospitals, and another 14 senior housing facilities.
Source: November 2016 Investor Presentation, page 17
Over the first nine months of 2016, funds from operation, or FFO, declined 12% to $2.18 per share. This was primarily due to higher interest expense.
In the first nine months of the year, interest expense increased to $35 million from $4 million in the same period of 2015.
Higher expenses are likely to suppress FFO for the full year. For 2016, the company expects FFO in a range of $2.85-$2.89 per share. At the midpoint, this would represent a 13% decline from 2015.
After a strong performance in 2015, in which FFO increased 7.8% from 2014, Care Capital is likely to take a step backward in 2016.
If interest rates continue to rise in 2017 and beyond, it will be a continued headwind for Care Capital. REITs rely on debt financing to acquire new properties.
Care Capital has a fixed-charge-coverage ratio of 8.0, and a 4.5 net-debt-to-EBITDA ratio. The company has a BB+ credit rating from Standard & Poor’s, with a stable outlook.
Going forward, the company needs to stop FFO from declining further, in order to preserve the dividend. Management’s plan to restore growth involves higher rents, and industry consolidation.
The growth prospects for Care Capital are promising, based on favorable demographic changes. The U.S. is an aging population—there are 75 million Baby Boomers in the U.S.
Over time, the population of those 65+ is only expected to increase. According to the U.S. Census Bureau, by 2029 the 65 and over population will represent more than 20% of the total U.S. population.
This is likely to generate higher levels of healthcare spending, which would be a long-term tailwind for Care Capital.
For example, from 2015-2025, Medicare and Medicaid spending is expected to increase 7% and 6%, respectively. These growth rates would exceed expected GDP growth in the same time frame.
Source: November 2016 Investor Presentation, page 11
In addition, the company sees decreasing property supply in the skilled nursing facility segment, due to moratoriums on new building in several U.S. states.
Source: November 2016 Investor Presentation, page 14
This could support higher rents for skilled nursing facilities. Care Capital generates approximately 91% of its rental revenue from skilled nursing properties.
And, skilled nursing is a fragmented industry. Part of Care Capital’s growth strategy will be acquisitions. The company would like to increase its presence in skilled nursing facilities.
Source: November 2016 Investor Presentation, page
And, it could leverage its size and expertise to produce cost synergies over time. Rent increases and industry consolidation could support margin expansion and long-term FFO growth.
Valuation & Expected Total Returns
Investors should value REITs based on funds from operation, or FFO, instead of traditional earnings-per-share. Earnings-per-share are typically much lower for REITs, which is why REITs usually emphasize FFO as a better gauge of operating cash flow.
Based on FFO expectations for 2016, Care Capital stock trades for a price-to-FFO ratio of approximately 9. This could be viewed as a substitute for the traditional price-to-earnings ratio.
The low valuation indicates weak investor sentiment and uncertainty. This is not surprising, given the fundamental deterioration in 2016.
As is typically the case with value stocks, the higher level of uncertainty presents elevated risk, but could also present an opportunity for strong returns.
If Care Capital’s growth strategies materialize as intended, the stock could provide attractive returns moving forward. A breakdown of possible future returns is below:
- 1%-2% rent increases
- 1%-2% revenue growth through property acquisitions
- 9% dividend
Even under a relatively modest scenario for revenue and FFO growth, Care Capital could generate 11%-13% annualized.
At 9%, Care Capital’s dividend is likely to account for the vast majority of its total returns. It is a very high yield, given that the S&P 500 Index on average has a roughly 2% dividend yield.
Care Capital’s current dividend is $2.28 per share. The company generated FFO of $3.01 per share, over the past four quarters. This represents a payout ratio of 76% based on FFO.
The dividend was covered in 2016. And if the company can return to growth, the dividend should be sufficiently covered by cash flow moving forward.
That said, investors should monitor the company closely moving forward, as Care Capital needs to stabilize FFO. Based on the company’s full-year outlook, the 2016 payout ratio is expected to rise to 79% at the midpoint of guidance.
Further declines in 2017 could put the dividend in jeopardy, given that the company is already distributing more than three-quarters of its FFO.
REITs are looking at higher interest rates moving forward, which is a challenge for Care Capital. Higher interest expense caused FFO to decline at a double-digit rate in 2016.
But overall, the long-term outlook for Care Capital is positive.
Care Capital has a high-quality property portfolio, and is likely to generate growth thanks to demographic changes.
For investors willing to stomach a heightened level of risk, its 9% dividend yield could be attractive as a high-yield stock.