Community Healthcare Trust Inc

NYSE:CHCT

Earnings Call Analysis

Earnings Call Transcript 2024-Q2

[Operator]

Welcome to the Community Healthcare Trust 2024 Second Quarter Earnings Release Conference Call. On the call today, the company will discuss its 2024 second quarter financial results. It will also discuss progress made in various aspects of its business. Following the remarks, the phone lines will be opened for a question-and-answer session. The company's earnings release was distributed last evening and has also been posted on its website www.chct.reit.

The company wants to emphasize that some of the information that may be discussed on this call will be based on information as of today, July 31, 2024, and may contain forward-looking statements that involve risk and uncertainty. Actual results may differ materially from those set forth in such statements. For a discussion of these risks and uncertainties, you should review the company's disclosures regarding forward-looking statements in its earnings release as well as its Risk Factors and MD&A in its SEC filings. The company undertakes no obligation to update forward-looking statements whether as a result of new information, future developments or otherwise, except as may be required by law.

During this call, the company will discuss GAAP and non-GAAP financial measures. A reconciliation between the two is available in its earnings release, which is posted on its website. All participants are advised that this conference call is being recorded for playback purposes. An archive of the call will be made available on the company's Investor Relations website for approximately 30 days and is the property of the company. This call may not be recorded or otherwise reproduced or distributed without the company's prior written permission.

Now I would like to turn the call over to Dave Dupuy, CEO of Community Healthcare Trust.

[David Dupuy, executive]

Great, and good morning. Thank you for joining us today for our 2024 second quarter conference call. On the call with me today is Bill Monroe, our Chief Financial Officer; Leigh Ann Stach, our Chief Accounting Officer; and Tim Meyer, our EVP of Asset Management.

Our earnings announcement and supplemental data report were released last night and furnished on Form 8-K, along with our quarterly report on Form 10-Q. In addition, an updated investor presentation was posted to our website last night. As disclosed in our filings, we determined that certain lease and interest payments from geriatric inpatient psychiatric hospital tenant were not reasonably assured of collection. CHCT has six leases with the tenant, and it is the sole tenant in five of our properties with one lease and a multi-tenanted property, representing a total of approximately 79,000 square feet.

As a geriatric psychiatric hospital operator, COVID had a significant impact on the tenant's business through 2022. And during this time, the tenant was in process of expanding locations, which led to a more pronounced impact. In 2023, the company improved census installed the new revenue cycle management system and made other operational improvements resulting in improved performance. Unfortunately, recent management changes resulted in a decline in census, staff turnover and ultimately impacted the tenant's ability to consistently pay rent and interest. The tenant has hired a consulting team with significant behavioral operating experience to implement a turnaround plan and to stabilize the business.

CHCT has previous experience with this consulting team, and we have confidence in their ability to make the necessary changes to improve operations. We are working closely with the tenant and the consultants to monitor and evaluate progress with the turnaround. Bill will discuss in more detail the financial impacts from this tenant but let me review what we believe to be the unique features of this tenant relationship compared to the rest of our portfolio. Most importantly, this tenant is the only top 10 tenant where we are also a lender.

To improve transparency of our top tenants, we are now including in our supplemental data report and investor presentation, not just those tenants with greater than 4% of annualized rent, but a listing of all top 10 tenants. Another aspect of this tenant relationship that I mentioned earlier was the COVID significantly impacted this tenant given its geriatric patient base. During timing, we had also recently -- when it had also recently expanded locations. And because this tenant is a private founder and business, CHCT helped finance the tenant's expansion leading to CHCT's $22.7 million in notes receivable across the term loan and revolving credit facility.

This $22.7 million is by far our largest lending relationship with our only other notes receivable currently outstanding, consisting of a $4.5 million term loan to a long-term acute care and inpatient rehab hospital tenant and a $2.2 million revolving credit facility to a subsequent use and eating disorder mental health provider tenant. To conclude, we believe we can work closely with this tenant over the coming quarters to enhance returns on this unique investment within the portfolio.

As for other components of the business, our occupancy increased slightly from 92.3% to 92.6% during the quarter, and we continue to see good leasing activity in the portfolio. In addition, we have five properties or significant portions of those properties that are undergoing redevelopment or significant renovations with long-term tenants in place when the renovations or redevelopment is completed. Also, our weighted average main lease term increased from 6.9 years to 7.1 years. During the second quarter, we acquired an inpatient rehabilitation facility for a purchase price of $23.5 million. We entered into a new lease with a lease expiration in 2039 and anticipated annual return of approximately 9.1%. Subsequent to June 30, we acquired one medical office building for a purchase price of approximately $6.2 million and expected returns of approximately 9.3%. The property is 100% leased with a lease expiration in 2027.

Also, the company has signed definitive purchase and sale agreements for seven properties to be acquired after completion and occupancy for an aggregate expected investment of $169.5 million. The expected return on these investments should range from 9.1% to 9.75%. We expect to close on one of these properties in the fourth quarter of 2024, with the remaining six properties closing throughout '25, '26 and '27. And we continue to have many properties under review with term sheets out on properties with indicative returns of 9% to 10%.

With our modest leverage levels, we anticipate having enough availability on our credit facilities and through our banking relationships to fund our acquisitions and we expect to opportunistically utilize the ATM to strategically access the equity markets at favorable share prices. These traditional capital sources, combined with proceeds from selected asset sales will provide sufficient capital for continued growth at attractive yields.

To wrap up, we declared our dividend for the second quarter and raised it to $0.4625 per common share. This equates to an annualized dividend of $1.85 per share. We are proud to have raised our dividend every quarter since the IPO.

That takes care of the items I wanted to cover. So I will hand things off to Bill to discuss the numbers.

[William Monroe, executive]

Thank you, Dave. I will now provide more details on our second quarter financial performance. Let me start by detailing the impacts to our second quarter financials related to the geriatric inpatient behavioral hospital tenant that Dave described earlier.

Rental income in the second quarter was negatively impacted by the reversal of $1.9 million of rent, which includes approximately $900,000 of noncash straight-line rents. Also, other operating interest in the second quarter was negatively impacted by the reversal of $1.4 million of interest. Combined, these items reduced total revenue in the second quarter by approximately $3.2 million to $27.5 million. Compared to the second quarter of 2023, total revenue declined by $294,000 and compared to the first quarter of 2024, total revenue declined by $1.8 million. It is important to note that of the $3.2 million impact to second quarter total revenue I just described, only approximately $1.5 million as a result of rental income and interest we expected to receive in the second quarter of 2024 from the geriatric inpatient behavioral hospital tenant.

With the remaining amount resulting from onetime out-of-period adjustments to prior period amounts outstanding, net of payments and security deposits. In addition to the reversals of rent and interest, we recorded an $11 million credit loss reserve on the $22.7 million notes receivable from the tenant. This credit loss reserve reduced net income and is based on an estimated value of the underlying collateral which we will continue to monitor. But any future credit loss reserve, reversals or increases will not impact FFO or AFFO.

Moving to expenses. Property operating expenses decreased by $219,000 quarter-over-quarter to $5.6 million since the first quarter had higher seasonal expenses at several properties. General and administrative expenses increased by $206,000 quarter-over-quarter to $4.8 million as a result of increased professional fees and interest expense increased by $924,000 quarter-over-quarter to $6 million because of increased borrowings under our revolving credit facility to fund the $23.5 million of acquisitions during the second quarter of 2024 as well as the $27.7 million of acquisitions during the final week of the first quarter of 2024.

Moving to funds from operations. FFO was $11.6 million in the second quarter of 2024. On a quarter-over-quarter basis, FFO decreased from $14 million in the first quarter of 2024 and on a per diluted common share basis over these periods, FFO declined from $0.53 to $0.43 per share. These decreases are primarily the result of the $3.2 million of reversals of rent and interest described earlier. Adjusted funds from operations, or AFFO, which adjusts for straight-line rent and stock-based compensation, totaled $14.3 million in the second quarter of 2024.

On a quarter-over-quarter basis, AFFO decreased from $15.7 million in the first quarter of 2024 and on a per diluted common share basis over these periods, AFFO declined from $0.59 to $0.53 per share. These decreases are also primarily the result of the $3.2 million of reversals of rent and interest described earlier, net of approximately $900,000 of straight-line rent, which was added back and that is why you see a smaller impact to AFFO quarter-over-quarter than FFO. I'll note that even at $0.53, our dividend remains well covered with the current payout ratio of 87%.

That concludes our prepared remarks. Darwin, we are now ready to begin the question-and-answer session.

[Operator]

[Operator Instructions] The first question comes from the line of Rob Stevenson with Janney.

[Robert Stevenson, analyst]

Could you talk a little bit about how many facilities in total this tenant has? And what percentage you represent of them? And sort of what -- how these properties are performing versus maybe some of their others in case they were to file bankruptcy and look to give up some leases.

[David Dupuy, executive]

We are -- this tenant has a total of six hospitals and so the buildings that they have with us is really the entire -- makes up the entire complexion of their business. So obviously, the reduction in census has been the catalyst for some of the issues that they've been having in paying rent and interest. But anyway, what -- did that answer your question?

[Robert Stevenson, analyst]

Yes. I mean I guess the follow-up to that would wind up being how much revenue would be at risk here if they were in bankruptcy from where we've adjusted to thus far? And are any of the acquisitions in the pipeline with this tenant?

[David Dupuy, executive]

There are no acquisitions in the pipeline with this tenant. The run rate amount of rent and interest associated with this tenant is approximately $1.5 million a quarter. So that gives you a sense. And look, like I said, we've got consultants in there that we've worked with before that's familiar with this tenant and our intention and our thought is that, that consultant will be able to help affect the turnaround that should allow them to start paying us rent at some point. It's difficult when you're in the middle of the turnaround to identify exactly when that is, but we are on top of this on a weekly basis, monitoring progress.

[Robert Stevenson, analyst]

And I guess, how long were these guys on the watch list? I mean was this a sort of slow process to get to here? Or was it basically a couple of weeks and it was like flipping a switch. Just trying to get a sense as to these days how quickly these problem assets are appearing on the radar screen, whether or not it's something that there's a little bit more warning for basically, you've come in one day and find out that they're having much more difficulties than you imagined?

[David Dupuy, executive]

Well, one of the things I mentioned in the prepared remarks, because this has been a relationship for the firm for a while. So for the last for 2020 to 2022 during COVID, they were very much on the watch list just given the nature of the business and the geriatric patient base and the challenges they were having ramping up the two new hospitals that we have financed. And so they were on the watch list then they had fallen off the watch list in 2023, and the business is performing very, very well. Then with these management changes late in the fourth quarter of 2023, we started seeing some late rents and some concerns with regard to census and performance. And so they came back on the watch list in the first quarter. They made partial payments in the first quarter and second quarter, but ultimately, it wasn't enough to make us comfortable that although the rent was going to be collectible. And so that's why we moved them to cash basis.

[Robert Stevenson, analyst]

And speaking of the watch list, how significant is that overall today? And anybody else, any other of the top tenants on that list today?

[David Dupuy, executive]

None of the other top tenants are currently on our watch list. The watch list is similar today in terms of numbers than it was before. But obviously, very disappointing to us, it's such a large tenant on the heels of what we had to get through the Genesis Care last year is having this issue and these problems. But again, we feel good about the top 10 list currently. We're very well diversified beyond these other tenants. And so we feel good about the portfolio overall.

[Robert Stevenson, analyst]

And then just one last one for me. Bill, how should we be thinking about the $0.53 of AFFO per share going forward? I know that, that didn't get adjusted as much as the FFO but is that -- is there other stuff that either has to come out of that or be added back to that in future quarters? Or is that still a ballpark run rate for where the company is today given the reductions with this one tenant.

[William Monroe, executive]

I think until we see improvement from this tenant, we're kind of in the right ballpark. I mean the short answer is of the charges we took in the second quarter that were out of period charges you'd say approximately $750,000, $800,000 of AFFO should kind of be added back on a run rate basis compared to where our second quarter AFFO was. Obviously, as we move forward, we don't provide guidance, but interest expense, G&A, other things, it will also be taken into account as far as what AFFO will be. But clearly, the biggest impetus to an increase quarter-over-quarter on an AFFO basis will be improved performance and the payment of rent and interest from this tenant.

[Operator]

The next question comes from Alexander Goldfarb with Piper Sandler.

[Alexander Goldfarb, analyst]

Dave, I mean I don't -- as you have this tenant, and obviously, as you said, it's on the heels of Genesis, clearly something you guys didn't need. But one, these were all deals that were done before you guys took over, not casting blame, but clearly, these were deals done years ago, not recently. So as you look at the portfolio and at your underwriting, what are some of the lessons learned from Genesis and now here that as you look at your acquisition pipeline and existing tenants, you go, hey, maybe we want to kick these deals out or hey, you know what, we have other tenants that look like Genesis or this tenant in terms of payment history or coming up a little light in their envelope when they pay the monthly rent. What are some of the things that you've seen and reassessments of existing tenants and acquisition pipeline?

[David Dupuy, executive]

I will say, in the wake of Genesis Care in this latest situation, we have tightened our underwriting standards. The bar is higher I will also tell you, you won't see us land at these levels to a single tenant, again, that just won't happen. So obviously, COVID was a unique situation. And everyone who went through it, we all went through it, especially the geriatric population, a very unique situation. It was -- but it drove significant borrowings from this tenant. And at the end of the day, any slip in census had an impact on their ability to pay rent and interest. And so from our perspective, we're just going to be more rigorous with our underwriting, and you're just not going to see the same levels of loans to a single tenant going forward because honestly, that is not in sync with our diversification strategy as a firm. So -- and that's very important to us. So that is a core lesson here for sure.

[Alexander Goldfarb, analyst]

But as far as -- it's not just the loan that went bad, it was the tenant as well, and certainly it happened with Genesis. So does this mean that you want to shy away from doing portfolio deals and stick to single asset deals or -- like how is this changing? And then also why even lend anything to a tenant? Why not just keep it at purely a rental relationship?

[David Dupuy, executive]

Well, every situation is unique. And so sometimes there are competitive reasons. Sometimes there are very good reasons for us wanting to lend as part of an overall relationship. And what I would say, Alex, relative to portfolio deals, historically, we have been reluctant to do portfolio deals in a meaningful way. But going back to Genesis Care, look, that was a portfolio deal. Ultimately, it wasn't a fun process, and you're disappointed that the holdco had -- was overleveraged and didn't perform. But ultimately, the performance at our facilities largely worked out. And it wasn't a fun process, but at the end of the day, it's important that we underwrite each individual market and each individual property because that is what is ultimately going to drive rent and interest payment to us, whether from that tenant or a new tenant. So I'm not going to say we won't do a portfolio deal because there could be opportunities for us to do portfolio deals but our underwriting standards are going to be more rigorous.

[Alexander Goldfarb, analyst]

Just final question is, obviously, the stock has taken a bit of a hit. Do you reconsider the committed acquisition pipeline? Or how does where the stock is now trading change the goal of getting the pipeline back up to sort of that $130 million, $150 million a year?

[David Dupuy, executive]

Listen, we're very focused on looking at all sources of capital. We continue to have a modestly leveraged balance sheet. We don't think that this is going to impact in any way what we've committed to do in our pipeline. And actually, we recognize as a small REIT even though we are definitely going to be judicious with our capital, growth is what's going to drive our performance from a share price perspective, it's all about driving AFFO and FFO. And so we're just going to be very strategic in how we do that, and we've got other levers than just the stock. We can do some capital recycling in the portfolio. We can borrow just given our leverage levels and the support from our banks. And so overall, we feel very positive in our ability to access the various markets to be able to continue to fund our growth.

[Operator]

The next question comes from Michael Lewis with Truist.

[Michael Lewis, analyst]

So Alex just asked one of the questions that I think has one of the more important questions, right? So the stock over the last 12 months was already down 18% or 20%. And I think investors were asking at what point is the cost of equity no longer acceptable to issue shares to fund new investments at 9 handle cap rates. It's obviously this morning, it's taken another leg down. I know it's a tough question to answer. You don't want to put yourself in a box. But when does the cost of equity become prohibitive because I think there's a danger here if you lose access to kind of that capital or that spread over your investment yield, so I don't know what more you could say on that. Maybe you already answered it.

[David Dupuy, executive]

Well, it is a tough one to answer. But what I would tell you is we're looking to make accretive acquisitions. And those acquisitions need to drive overall revenue and AFFO growth for the company. And so we're highly sensitive as shareholders in the company about doing a dilutive equity raise and doing that in the ATM. And so we're going to be very mindful of that in terms of -- and as I just mentioned earlier, with the prior question, Michael, I mean, we've got opportunities within the portfolio to do some capital recycling to fund some growth. And so we do have other tools in our toolbox that will allow us to continue to grow without putting pressure on the stock. We recognize that, that's not good for us. And ultimately, it's not good for driving AFFO growth.

Bill, I don't know if you want to comment there.

[William Monroe, executive]

No, I agree.

[Michael Lewis, analyst]

And then you talked about your expectations to hopefully, the consultant helps and the tenant gets paying again. Worst-case scenario, where the tenant doesn't recover, are these properties -- do you think they're relatively easy to re-tenant or sell or what kind of the plan would be. I don't mean to jump right for the worst case, but I think it's important to kind of judge what that might look like.

[David Dupuy, executive]

So Michael, one of the benefits from having been in the health care services sector myself and Bill for a number of years is we know a lot of operators in this space. And obviously, we have some tenants that are operators that would be interested in these assets. The short answer without jumping to that scenario is there are many potential buyers that we think or operators, that we think will be interested in these site hospitals. And there is a little bit of scarcity value to these businesses. And so again, the business in these individual hospitals, I think, would be attractive to an individual potential buyer.

[William Monroe, executive]

And Michael, it's Bill. I'll add that we have not seen and we do not believe there's been a change in the competitive landscape in these local markets where this tenant operates, such that it is more of an execution issue. And so I think that helps preserve what is the value of these properties as we think about it.

[Michael Lewis, analyst]

Because for whatever it's worth, I mean, we do see REITs and other health care sectors lose significant tenants and the stocks don't take it like this, I think it has to do with being able to reposition assets. My last question, just on the acquisition pipeline. I think the deal that you closed in the first quarter, you had already mentioned on the -- or I'm sorry, closed in the second quarter, you had already mentioned on the first quarter call. So has there not been any new activity over the last few months? And does the pipeline still seem full? Do you think you're still on target for your acquisition goals for the year?

[David Dupuy, executive]

We have continued to be active seeing a number of deals. We've got term sheets outstanding, as I mentioned in the prepared remarks, sometimes we've seen in the past where closings are a little bit slower in the third quarter, just the reality of -- some are in vacation schedules, et cetera. But we do think that hitting our acquisition target is certainly still achievable in the balance of the year. And like I said, I think we're still seeing good activity from an acquisition standpoint, which doesn't always translate into closed deals, but it's certainly better than not seeing the activity. So yes, we still feel like that that's achievable.

[William Monroe, executive]

And Michael, I'll note, we did include that we closed a $6.2 million property early in the third quarter here. So it didn't show up in the second quarter closed numbers, but we did mention it in our investor presentation that we did close an additional property early this quarter, just this month.

[Operator]

[Operator Instructions] Next question comes from Wes Golladay with RBC Capital Markets.

[Wesley Golladay, analyst]

It's actually Baird Capital. When you look at the lease expiration schedule, you have $107 million of rent annually. Does that include the tenant that is having issues right now? And is that a cash number?

[David Dupuy, executive]

I have to look. So I would think that it would include those leases in the number, but those leases that we have with the tenant on -- yes, that's expired in the near term. The lease maturities of the tenant we've been discussing is between 2030 and 2036. So no upcoming maturities with that tenant.

[Wesley Golladay, analyst]

I just want to make sure the $107 million incorporates that. And then when you look at what they're paying on cash accounting now, would that -- did they pay anything in the second quarter?

[David Dupuy, executive]

Just a little bit, not much. Just some small payments. And we're not necessarily expecting to get meaningful payments in the third quarter either. I mean, they're in the middle of this turnaround.

[Wesley Golladay, analyst]

And then when you look at the line of credit, the utilization is getting higher, but then you could probably issue another term loan. How are you looking at that?

[David Dupuy, executive]

We had $41 million available under our revolver at the end of the quarter. The next maturity is not until March of 2026. But typically, what we do is when we get within a year or so of those maturities look to term out those revolver borrowings and so we'd anticipate taking a look at that, and again, have had success with our bank group doing that historically. And so we continue to evaluate that.

[Operator]

The next question comes from James Kammert with Evercore.

[James Kammert, analyst]

Do you have the ability under the lease with this tenant in question to replace them, meaning they're in default. I presume they're not paying the rent. Obviously, why wait in other words, and if these are desirable assets, try to parallel path and look for a replacement tenant or a new owner? I mean, [ priority ] to new operator?

[David Dupuy, executive]

Yes, we absolutely do have the ability to replace them. They're obviously in default of our list and we are taking multiple paths. We're not just kind of wed to the consultants, and we're looking at other options. But given the fact that this tenant has outstanding loans to us, and we think if you go back in 2023 and see how this tenant was able to perform and pay their rent and interest, certainly, from our perspective, we want to try to preserve options with this tenant. But I will say that they're on a short leash. And like I said, we've got a number of folks that we think could operate these facilities. And so we're -- obviously, we're aligned. We want to make sure that we get a paying tenant in there. Hopefully, it's this tenant. But if it's not, we'll evaluate others.

[James Kammert, analyst]

Because I'm just trying to reconcile that with the prior comments, that's very helpful. You've taken basically a 50% reserve against the loan balance and if these are just basically the business entire network of hospitals keep you salable, just trying to understand why such a [indiscernible] hit then on the receivable. If there's any additional color you can provide there, it seems sort of inconsistent with the premise that these are salable marketable assets. Maybe just going through cycle sell it?

[David Dupuy, executive]

Yes. No. Listen, I hear you. It's just one of those processes you have to go through that CECL requires you to go through, and it's a pretty structured accounting process that we have to take. And so that's what we went through. And look, at the end of the day, you're trying to come up with a value for the business and be conservative given the current environment. And so that's kind of what you're seeing there in terms of the reserve. But there's no question. We think that there is value in the operations here. And we're trying to stabilize the business and make sure we can drive as much value from those operations as we can.

[James Kammert, analyst]

So you worked it with your accountants and so CECL really did drive that determination. It was not a sort of in-house?

[David Dupuy, executive]

Yes.

[Operator]

Ladies and gentlemen, this concludes our question-and-answer session. I would like to turn the conference back over to Dave Dupuy for any closing remarks.

[David Dupuy, executive]

Listen, thank you, operator, and thank you, everyone, for joining us this morning. We hope everyone has a good day, and look forward to talking to you next quarter.

[James Kammert, analyst]

The conference has now concluded. Thank you for attending today's presentation. You may now disconnect.