Will National Health Investors Become A Consolidator?
We all know that repealing health care is an essential part of President Trump’s broader agenda, especially now that the Better Care Reconciliation Act of 2017 is on center stage.
The purpose for my article today is not to get into a political debate over the pros and cons of the Better Care Reconciliation Act of 2017, I intend to provide a deeper dive in the upcoming edition of The Forbes Real Estate Investor.
I think it’s important to weigh in on the property sectors that could help or hurt the passage of the bill and I will be doing so in the newsletter.
Politics aside, there is no debate over the demographics that are driving demand for health care real estate, as I explained in a recent article:
“When you consider the supply (demographics) and demand with the Health Care sector, it’s clear that the senior population has immense sending power and wealth. Health Care spending is projected to grow 5.8% annually (2-14-2024).”
While the market perceives the operator risks that are weighing on shares in most Health Care REITs, there is little argument that the demographics provide compelling clarity that the growth in the senior population is enormous and the winning consolidators will emerge.
Today I am focusing on one such consolidator that is well-positioned to benefit from the strongest catalyst in health care: an aging population. This REIT has all of the ingredients to become a top performer and possibly a SWAN in a due time. (SWAN stands for “sleep well at night” and this is a term I use often in my newsletter).
National Health Investors
National Health Investors, Inc. (NHI) was founded in 1991, and for most of the last 26 years, the Tennessee-based REIT has maintained a small asset base. However, in 2013, the company closed on $752 million in deals, followed by $571 million in 2014 and $447 million in 2016.
NHI is considered a diversified healthcare REIT, based upon the following sub-sector breakdown: Skilled Nursing (29%), Hospital/MOB (3%), Entrance-Fee (20%), Independent Living (16%), Assisted Living (24%), Senior Living Campus (6%), and Other (2%).
One important footnote to the company's past is its dividend cut in 2000.
As you can see below, NHI was forced to cut its dividend around 17 years ago as a result of a technical default. At the time, NHI had a large loan with a Japanese bank, and when one of the company's tenants filed for bankruptcy, the bank called the loan. At that point, NHI did not enjoy the same financial flexibility and it had no tenant diversification.
As a result of the adversity (back in 2000), NHI's Board has gained valuable experience, and that is the reason that the company has become a more disciplined enterprise.
One of the lessons learned was to maintain sound geographic and tenant-based diversification. As you can see below, NHI has a well-balanced platform consisting of 215 properties in 32 states.
The company also has a well-balanced platform that consists of 34 operating partners. Here's a snapshot of NHI's partners.
As you can see 42% of the operators are publicly-traded and 39% are regional partners.
National HealthCare (NHC) accounts for 16% of cash revenue and has a corporate fixed charge coverage of 3.64x. Holiday Retirement represents 15% of cash revenue and has an EBITDA and coverage (as of Q1-17) of 1.19x.
Holiday has been working on transitioning their community management model to a traditional management team. The transition is ongoing, and NHI has been in regular communication with Holiday about its transition, as well as its plan to move its corporate offices to Florida.More on Holiday at the end of this article.
Bickford Senior Living accounts for 14% of cash revenue and has an EBITDA and coverage ratio of 1.21x (for the trailing 12 months ending December 31st). Last year NHI unwound its RIDEA joint venture with Bickford Senior Living and converted Bickford’s participation to a NNN (triple net) tenancy with assumption of existing leases and terms. NHI now has revenue from 40 Bickford facilities plus 4 in construction phrases.
As you can see below, Senior Living Communities, NHC, Holiday Retirement, Bickford, and Ensign (ENSG) represent 70% of NHI’s portfolio (based on revenue):
A few days ago I wrote on CareTrust (CTRE), a health care REIT with 50% exposure to ENSG. As I explain,
“The Better Care Reconciliation Act of 2017(Senate’s version of ACA Repeal and Replace) that was announced last week is positive for skilled nursing operators like Ensign. Skilled nursing facilities are major low-cost providers of rehab services (without overhead of an acute care hospital) and Ensign is a top provider.
The changing reimbursement strategies favor a larger role for well-managed skilled nursing properties as they derive a growing percentage of income from shorter stay and rehab care.”
The Balance Sheet
NHI’s strategy is to deploy a careful mix of debt and new equity to maintain a low leverage profile.As of Q1-17 NHI’s debt capital metrics were net debt to annualized EBITDA of 4.5x, weighted average debt maturity at 5.8 years, weighted average cost of debt at 3.62% and fixed charge coverage ratio at 5.7x.
At the end of Q1-17 NHI had $187 million outstanding on the revolver with an available capacity of $363 million.
Earlier in 2017 NHI sold roughly 1.12 million shares of common stock through its ATM program and the shares were sold at an average price of $72.31 per share, resulting in net proceeds after commissions of $80 million.
Net proceeds were used to fund a portion of the acquisitions, the ongoing development pipeline and loan commitments, and to maintain low leverage metrics.
In Q1-17 NHI sold the remaining 250,000 shares in LTC common stock resulting in net proceeds of $11.7 million. As we move through 2017, NHI sources of capital will continue to be cash flow from operations, cash flows from loan receivable or repayments, revolver proceeds, term debt proceeds and equity issuances from the ongoing ATM program.
Although NHI has no investment grade rating, I consider the debt "unofficially" rated as BBB. I like the fact that NHI maintains frugal practices like not forking out over $400,000 annually to a rating agency or supporting its corporate offices in an owned office building outside of Nashville.
Note: NHI has just 15 full-time employees and continues to outsource functions such as legal, internal audit, tax, compliance, IT and payroll to other professional firms. This business model is very efficient.
The Latest Results
For Q1-17 NHI’s normalized FFO increased to $1.25 per diluted share compared to $1.16 for the same period one year ago and normalized AFFO increased to $1.13 per diluted share compared to $1.04 one year ago.
NHI’s total revenues for the first quarter showed strong growth of 12.5% over the same quarter in 2016. This growth has been primarily fueled by new investments with the Ensign Group, Bickford Senior Living, Senior Living Communities and East Lake Capital Management.
In February NHI announced the purchase of two assisted living and memory care facilities totaling 86 units in Hendersonville, North Carolina to Ravn Senior Solutions which is led by Steve Morton and Ted Turner.
The neighboring facilities now known Carolina Reserve have a lease term of 15 years at initial lease rate of 7.35% plus annual fixed escalators. With this purchase, NHI was granted a purchase option of third building in the Raleigh/Durham market.
In early March, NHI announced the acquisition of a 126 beds skilled nursing facility in New Braunfels, Texas for an investment of $13.9 million. The facility was leased to an affiliate of the Ensign Group. The acquisition is the first of four that NHI had previously committed to and will be added to the existing lease at initial rate of 8.35% plus annual lease escalators, based on inflation.
During first quarter, NHI also announced the purchase of 102 unit assisted and memory care facility in Portland, Oregon for $26.2 million that was leased back to Prestige Senior Living. This facility was added to the existing Prestige master lease that is comprised of three skilled nursing facilities and one assisted living facility and has a remaining term of 12 years. The new investment has an initial cash yield of 7% plus annual fixed escalators.
Towards the end of the first quarter, NHI announced the purchase of five memory care facilities totaling 223 units. The facilities located in Texas and Illinois were purchased for $61.8 million and leased back to the LaSalle Group who operates its facilities under the Autumn Leaves. The LaSalle Group is a family owned company who develops, owns and operates 46 memory care communities across the US. The lease term is 15 years at an initial cash yield of 7% with annual fixed escalators.
NHI’s guidance ranges have remained unchanged. The normalized FFO guidance range is $5.06 to $5.12 per share and the normalized AFFO range is $4.61 to $4.65 per share. NHI does not include an estimate of investment volume in the guidance range.
Can NHI Move the Needle?
In terms of FFO/share growth, Physicians Realty (DOC), CareTrust, and Community Healthcare (CHCT) offer the best growth prospects; however, NHI compares favorable, as illustrated below:
As mentioned earlier, NHI has around 15% exposure to Holiday Retirement and it seems logical that NHI would have an interest in New Senior (SNR). As I explain in a recent article,
“Although SNR is less vulnerable to government pay risks, the company does have outsized risks related to its concentration with Holiday…the REIT derives around 75% of its revenue from Holiday and around 12% of revenue from Blue Harbor.”
What are the catalysts for M&A? Here’s what I said,
“What makes this REIT (SNR) particularly compelling is that is suffering from what I call the "triple whammy". This simply means it has (1) external management, (2) high leverage, and (3) little tenant diversification.”
The high leverage ($2.2 billion of total debtand $3.3 billion in assets) makes it difficult for NHI to acquire SNR, but withstanding the capital constraints, this deal makes some sense. On the recent earnings call Eric Mendelsohn, NHI’s CEO responded to an analyst question regarding the CCP/SBRA merger,
“…in the meantime, as we wait for the right mega deal to come along, we just continue with our twos and threes which on any given year could add up to between $300 million and $500 million, which is not a bad way to grow.”
He added,
“…being a REIT, our hands are constrained by our leverage metrics. And unless we’re willing to make some assumptions on future performance and lever up a deal beyond our comfort zone, we’re not going to be able to be competitive with private equity.”
A proposed New Senior deal would be transformational for NHI, but the transaction would catapult the company to a $5 billion+ REIT, a move that would certainly move the needle for the “sleepy” southern REIT hoping to carve out a slice of the highly fragmented health care REIT pie.
I’m a shareholder in SNR and I don’t see the company internalizing anytime soon. The recent lawsuit against New Senior could spark interest in a planned sale of the externally-managed REIT.
How Does NHI Compare?
I have been “in and out” of NHI and currently I’m on the sidelines. Let’s look at NHI based on the dividend yield:
The dividend appears “soundly valued”. In the first quarter, NHI reported a 5.5% increase in the quarterly dividend to $0.95 per share or $3.80 on an annual basis. NHI estimates that total dividends for 2017 will result in a normalized FFO payout ratio in the low 70% range and a normalized AFFO payout ratio in the low 80% range. Now let’s compare the P/FFO multiple:
As I said, I do not own NHI now, I prefer to own Ventas, Inc. (VTR), LTC Properties (LTC) as my “diversified “health care REIT holdings (in addition to “pure plays” DOC, HTA, SNR, CCP, OHI, and CHCT).
I don’t see anything wrong with NHI, I just believe that VTR is a better vehicle for me, and I like to own REITs with the lowest overall cost of capital. However, given the recent SBRA/CCP deal (proposed) I believe that NHI is well-positioned to become a consolidator.
Yet, M&A is not a catalyst, and I believe that NHI is “soundly valued”. This simply means that I would recommend “nibbling” but remaining a bit cautious until the Better Care Reconciliation Act is passed. I am upgrading NHI from a HOLD to a BUY with a Target entry price of $76.00 per share (equates to a dividend yield of 5%).