I recently published an article entitled “The Best Monthly Dividend Stocks” where I evaluated 17 C-corporation stocks that pay dividends monthly. In that previous article I covered the benefits of monthly dividends and provided the reader with a red/yellow/green recommendation on investment potential and a brief rationale for the recommendation on each of the 17 stocks.
To provide more granularity on those stocks ranked green in the previous article, I’m covering in more detail the four stocks I consider “The Best of the Best Monthly Dividend Stocks”. I previously covered STAG Industrial and Chatham Lodging Trust in the first and second articles of this series. This latest article covers the third stock in the series, LTC Properties, Inc. (LTC).
Introduction To LTC Properties, Inc.
In the spirit of providing currently actionable investment recommendations, I chose to cover the four “Best of the Best” monthly paying stocks in order of most undervalued to least undervalued.
Many investors view the REIT sector as a fairly uniform group of companies (trusts) that own property or make loans on property with the investor focusing on the highest yield in the sector. This approach to primarily looking at a REIT’s yield is a mistake. All REITs are not created equal and equity REITs and mortgage REITs are as different as apples and oranges.
When selecting a REIT for investment, it is important to interpret dividend yield through a qualitative (versus strictly quantitative) lens looking at the underlying risk adjusted performance to ensure the overall metrics such as the balance sheet, diversification, earnings growth, and payout ratios support continued growth of the REIT and its dividend. Consistent with this approach, the investment thesis for LTC is laid out in the following paragraphs and charts.
LTC Properties, Inc. is an internally managed REIT which invests primarily in senior housing and long‐term care related properties through facility lease transactions, mortgage loans, and other investments.
LTC is a well diversified health care equity REIT with respect to the type of facilities it owns, the geographic location of those facilities, and the tenants to which it leases properties. The chart below shows LTC’s diversification by property type both in terms of capital invested and in terms of revenue generated.
Source: LTC Properties, Inc.
Roughly 51% of LTC’s capital is invested in skilled nursing facilities (SNF) and that group of properties generates 57.5% of LTC’s revenue. Most of LTC’s remaining capital invested in assisted living facilities.
LTC has also achieved diversification geographically with facilities in 30 of the 50 states in the US. The chart below shows LTC’s US footprint.
Source: LTC Properties, Inc.
The chart above shows the types of facilities LTC owns in each state. It is clear that LTC is not overly concentrated in any one state or geographic region in the US.
LTC’s tenant diversification is probably the most important of the three metrics ensuring that LTC is not reliant on any one tenant for a significant fraction of its revenue and earnings. The chart below shows LTC’s current tenant list and the fraction of revenue provided by each.
The tenant/operator with the largest revenue contribution is Prestige Healthcare at 14.1% with all other operators contributing smaller fractions. Diversification of tenants is important as has been demonstrated recently by HCP, Inc. (HCP).
HCP had a very heavy reliance on HCR Manorcare in 2012 when it provided 34% of HCP’s income. Manorcare became the focus of a Department of Justice (DOJ) investigation for potentially overcharging the government for Medicare and Medicaid reimbursements. HCP has focused on minimizing its reliance on Manorcare over the last couple of years and it now contributes 24% of HCP’s income. However, the DOJ investigation is still ongoing, Manorcare’s business operations are still suffering, and HCP recently announced plans to spin off the Manorcare SNF properties into an independent REIT. I liken this decision to severing a diseased limb. Through the whole debacle, HCP’s valuation has suffered and they just now have started to recover.
So, LTC is a well diversified healthcare equity REIT with properties located in 30 states. How has it performed up to this point?
How Has LTC Properties Performed?
The short answer is “pretty darn well”.
LTC’s stock price has appreciated over the last 5 years from $31.71 to $46.02 or a little over 45%. The dividends paid out during the same period totaled $8.13. For the investor buying in on May 20, 2012 that would equate to a total return of nearly 71% or 11.3% annually. The chart below shows LTC’s stock price between May 20, 2012 and May 20, 2016.
Source: Yahoo Finance
As you can see in the graph, LTC has marched higher over that time with a bit of volatility in the stock price; a little more volatility than I expected given the roughly 0.45 – 0.55 Beta LTC carries. For that reason, LTC probably would not be considered a SWAN (sleep well at night) investment but, the stock’s volatility has provided more frequent opportunities to “Buy the Dips“. Being a long term investor, I can easily live with a little additional volatility.
LTC’s funds from operations (FFO) has also grown at a decent clip over the period and the company has translated FFO growth into higher distributions to its investors. The chart below shows LTC’s FFO growth and dividend growth.
LTC’s dividend has grown steadily during the period and today LTC pays out $2.16 on an annual basis or 4.7%. Readers should note that the 2016 annual dividend is estimated based on 1Q 2016.
During that same time, LTC has added to and upgraded its real estate holdings ensuring that growth in income, earnings, FFO, and dividend payments will continue. The chart below shows the real estate investments that LTC has made over the last 6 years and the first quarter of 2016.
Source: LTC Properties, Inc.
I believe there is also a very compelling driver for LTC’s continued strong performance going forward. We baby boomers are getting older and there are a lot of us. On average, roughly 10,000 boomers enter retirement every day. The leading edge of the boomer generation is just getting into their 70’s. The wave of boomers will last for the next 35 years.
As we age, we are going to demand more medical services, more skilled nursing care, and more senior housing. This is exactly what LTC is positioned to deliver. To read in more detail about how health care equity REITs will benefit from the wave of retiring boomers, see my previous articles “These REITs Will Profit” and “Riding The Wave of Age Demographics“. I strongly believe LTC as well as other health care equity REITs will benefit from the wave of boomer retirements for many years to come.
LTC Properties Current Valuation
I already have a small investment in LTC and I want to accumulate more. Thanks to the Federal Reserve’s Open Market Committee (FOMC) minutes and the recent comments made by some of the members, the opportunity to accumulate more share of LTC may present itself shortly. The two charts below show LTC’s Price/FFO and current dividend yield compared to its peers.
Today, the yield of LTC is a little low and the Price/FFO is a little high. LTC has been performing well and it shows in the metrics above. The dividend yield of LTC is about 4.7%. I’d like to see LTC reach a yield of 5.5% and the price/FFO drop to about 14 versus its current 16.4 in order to pick up a few blocks of additional shares.
That is about a 15% drop in LTC’s current valuation to $40. It is a tall order but the stock has dropped over 4% in the last 5 trading days. With the FMOC helping, we could see a brief dip to near $40 in the next couple of weeks. LTC is a great stock to own but the valuation is a bit high at this time.
One last point to make is on LTC’s balance sheet. LTC is a small cap REIT and does not yet have a credit rating from one of the major credit rating agencies. That said, LTC is one of the safest REIT investments out there today. LTC is run very conservatively by the experienced management team at the helm. The chart below shows LTC’s Total Debt to Total Capitalization ratio compared to many of its peers.
As you can see by the data, LTC has the lowest Debt/Capitalization ratio of any of its health care REIT peers. The low debt load that LTC carries is likely another reason it also carries a premium valuation compared to its peers.
What Are The Risks Of An Investment in LTC Properties?
The primary risk is the potential for interest rates to rise significantly. LTC is primarily an income investment with medium growth and a significant dividend yield. It therefore falls into the category of bond surrogate and will likely see its share price fall if interest rates begin to rise. Because LTC is able and expected to grow along with the economy, a fall in LTC’s valuation due to rising interest rates would likely be temporary.
The second impact of a rising rate environment would be an increase in LTC’s borrowing costs to continue to grow its real estate footprint. LTC’s cost of growth capital would go up in a rising rate environment. All that said, I don’t expect the US Federal Reserve will make any significant move to raise interest rates. It is an election year, the US economy is soft, the employment metrics have turned down over the last couple of months, and the rest of the world is still trying to juice their economies via loose monetary policy. If there is to be an increase in the Federal Funds Rate in June, I expect it will be a small one.