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HCP: Is The Dividend Safe?


HCP (HCP) released its 4th quarter and full year results on February 9th.

The market did not like the results. HCP stock fell from $34/share down to $28/share in one day. The company’s stock has declined ~28% over the last week.

HCP Price DeclineSource: Finviz

The company’s stock has a dividend yield of 8.5%. If HCP can pay steady or increasing dividends it is an absolute bargain.

If it doesn’t, it is a ‘yield trap’ – a stock or REIT that lures in income investors with its high dividend – only to slash the dividend later.

HCP’s price decline is a result of its post-acute/skilled nursing segment posting poor results. Specifically, the segment’s HCR ManorCare assets are performing poorly.

HCP generates around 25% of its income from the post-acute/skilled nursing segment. HCR ManorCare operations are responsible for 72% of the post-acute/skilled nursing segment. This means HCR ManorCare is around 20% of HCP’s total business.

Knowing the percentage size of the underperforming asset is important in determining what will happen with HCP’s dividend (and earnings).

At ~20% of the company’s business (based on income), HCR ManorCare is important to the company.

Changes in payer mix from traditional Medicare to Managed Care plans have reduced both rates and patients to post-acute/skilled nursing facilities. The company has reduced the book value of its HCR ManorCare holdings from ~$6 billion to $5.2 billion reflecting the deterioration in these assets.

The HCR ManorCare division is no longer profitable. The division is not able to cover its fixed payments. Fixed Charge Coverage Ratio over the last 6 months is at 0.97x. Anything below 1 means fixed charges are not being covered. The ratio was likely significantly lower in the 4th quarter.

According to HCP’s management, the 4th quarter is supposed to be an ‘up’ quarter for HCR ManorCare (emphasis added):

The level of performance was below expectations and uncharacteristic for the fourth quarter, which has historically been strong due in large part to increased census and the annual Medicare rate increases on October 1.”

HCP’s management did see this coming to some extent. The company is in the process of selling 50 ‘non-strategic’ facilities for $350 million. The company has closed on $280 million of these sales. The remaining $70 million are expected in mid 2016.

HCP has also adjusted its payout ratio downward over the last several years.

HCP Payout ratio
Source: JP Morgan Presentation, slide 13

In 2015, FAD (funds available for distribution) per share was $2.72 and dividends per share were $2.26. This comes to an 83% payout ratio. The company is expected to pay $2.30 in dividends in fiscal 2016.

HCP is not new to dividend increases. The company is the only REIT Dividend Aristocrat. HCP’s dividend history is below.

HCP Dividend History
Source: JP Morgan Presentation, slide 14

Will HCP Cut Its Dividend In 2016?

Take a look at HCP’s 2016 forecast versus 2015:

“HCRMC’s 2016 forecast anticipates their normalized EBITDAR at $577 million before the temporary impact from the pending asset sales and legal and regulatory defense costs, which adjusted for the impact of these items is estimated to be $555 million. Furthermore, HCP reviewed sensitivities regarding certain key assumptions in HCRMC’s forecast, which primarily affected census, to arrive at a potential range of projected outcomes for HCRMC’s 2016 EBITDAR. HCP’s forecast of HCRMC’s 2016 EBITDAR ranges from $505 million to $555 million, resulting in a 2016 FCC range of 1.06x to 1.16x.”

Notice there is no mention of FFO (funds from operations) per share or FAD per share. These metrics are the standard for REITs. Instead the company focused on EBITDAR which is a far less useful measure. For reference, the company’s 2015 forecast is below:

“We expect 2015 FFO per share to range between $3.14 and $3.20, representing a growth rate of 6%; FFO as adjusted per share to range between $3.15 and $3.21, representing a growth rate of 5%; FAD per share to range between $2.73 and $2.79, representing a growth rate of 7%; and EPS to range between $1.98 and $2.04. These estimates do not reflect the potential impact of future acquisitions or dispositions, and year-over-year growth rates are based on the mid-point of 2015 estimates over their comparable 2014 amounts.”

The 2015 outlook was clear and straightforward. The 2016 outlook is vague and does not break out relevant numbers.

HCP’s management did discuss 2016 FFO per share numbers in its quarterly call:

“We expect full-year 2016 FFO to range from $2.74 to $2.80 per share, which reflects placing our HCR ManorCare portfolio on a cash basis. FAD to range from $2.62 to $2.68 per share.”

In 2016 the company is expecting FAD per share of $2.62 to $2.68, with $2.30 in dividends per share.

The company’s payout ratio is creeping up, but the dividend is still safe.

Final Thoughts

HCP is the only REIT Dividend Aristocrat.

I believe HCP to be a quality high yield business based on an analysis of the company’s operations and dividend history.

What stands out about HCP is its ability to pay rising dividends through the Great Recession – when many non-health care REITs struggled. The company has slowly reduced its payout ratio as well. The company is able to continue paying rising dividends because of management’s foresight to do so.

What has caused the company to struggle is changes in the health care industry. This is reducing demand for the company’s properties and hurting the bottom line.

The long-term growth driver for HCP is still present. Namely, rising elderly populations in the Western world.

It is very likely that HCP will maintain its dividend in 2016. I believe the company recover in the medium term as long-term growth drivers offset temporary troubles.


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