CareTrust REIT Inc

NYSE:CTRE

Earnings Call Transcript 2024-Q1

[Operator]

Thank you for standing by. My name is Mark, and I will be your conference operator today. At this time, I would like to welcome everyone to CareTrust REIT First Quarter 2024 Operating Results. [Operator Instructions] I would now like to turn the call over to Lauren Beale, Senior Vice President and Controller. Please go ahead.

[Lauren Beale, executive]

Thanks, Mark, and welcome to CareTrust REIT's First Quarter 2024 Earnings Call. Participants should be aware that this call is being recorded, and listeners are advised that any forward-looking statements made on today's call are based on management's current expectations, assumptions and beliefs about CareTrust's business and the environment in which it operates. These statements may include projections regarding future financial performance, dividends, acquisitions, investments, returns, financings and other matters and may or may not reference other matters affecting the company's business or the businesses of its tenants, including factors that are beyond their control, such as natural disasters, pandemics such as COVID-19 and governmental actions.

The company's statements today and its business generally are subject to risks and uncertainties that could cause actual results to materially differ from those expressed or implied herein. Listeners should not place undue reliance on forward-looking statements and are encouraged to review CareTrust's SEC filings for a more complete discussion of factors that could impact results as well as any financial or other statistical information required by SEC Regulation G. Except as required by law, CareTrust REIT and its affiliates do not undertake to publicly update or revise any forward-looking statements or changes arise as a result of new information, future events, changing circumstances or for any other reason.

During the call, the company will reference non-GAAP metrics such as EBITDA, FFO and FAD or FAD, and normalized EBITDA, FFO and FAD. When viewed together with GAAP results, the company believes these measures can provide a more complete understanding of its business, but cautions that they should not be relied upon to the exclusion of GAAP reports. In addition, certain operator coverage and financial information that we discuss is based on data provided by our operators that has not been independently verified by CareTrust. Yesterday, CareTrust filed its Form 10-Q and accompanying press release and its quarterly financial supplement, each of which can be accessed on the Investor Relations section of CareTrust's website at www.caretrustreit.com. A replay of this call will also be available on the website for a limited period.

On the call this morning are Dave Sedgwick, President and Chief Executive Officer; and Bill Wagner, Chief Financial Officer. Our Chief Investment Officer, James Callister, is unable to attend the call today. I'll now turn the call over to Dave Sedgwick, CareTrust REIT's President and CEO. Dave?

[David Sedgwick, executive]

Well, hello, everybody, and thank you for joining us. Let me kick things off today by first excusing our Chief Investment Officer, James Callister, from the call. Given how busy we have been with acquisitions, you would be justified and guessing that he's just too busy for you. But this morning, he has a family matter that trumps his participation with us. So while we're on the subject of investments, I'd like to start by talking about our current robust phase of growth. The sharp increase to interest rates has resulted in a unique situation in our nearly 10 years of business.

On the one hand, like everyone, our borrowing costs have increased significantly. But on the other hand, because we conservatively established a fortress balance sheet for times like this and because of strategic relationships we've formed and because our cost of equity is remarkably a touch lower than our cost of debt today, we are better positioned to invest and grow than any time in our company's history.

It's extraordinary to be able to say that we view interest rates staying higher for longer as a net positive for CareTrust insofar as it should continue to drive investment opportunities in our direction. Those of you who know us best, know a couple of important guiding principles we follow when it comes to capital allocation. First, we do not grow for growth's sake. Health care real estate, skilled nursing, in particular, requires a high level of discipline. Every acquisition should immediately or quickly be accretive and must be matched with the right operator.

Second, we are building a company to outlast all of us. We are not nearly as sensitive as the algorithms are to quarter-to-quarter numbers. We run the business for long-term value creation and will at times when the pipeline justifies it, take some short-term dilution to lock in permanent financing and accretion and thereby set the table for future growth. We started this year with about $300 million of cash on the balance sheet because we saw the potential for 2024 to be a record year of investments. I want to congratulate the team for such a strong start. They are the best pound-for-pound investment team I know and are tireless when it comes to sourcing and closing deals.

With the investment on May 1, we've already closed approximately $205 million in new investments, approximately $154 million of that has been either acquisitions or loans with purchase options at an average yield of 9.4%. The other $52 million of deals closed our mezzanine loans at an average yield of 13.6%. Last quarter, I elaborated on our strategic approach to lending. You may recall that we are not agnostic between acquisitions and lending. Lending results in lumpiness to earnings and does not by itself result in long-term growth. However, we do enthusiastically lend the strategic borrowers and operators who we believe will result in real estate acquisitions in the future.

Let me put a finer point on that. As of today, we attribute about $260 million of real estate acquisitions in the last 12 months alone and another $200 million of acquisitions in our current pipeline that came from this strategic approach to lending in recent years. If we don't have at least a handshake deal with the borrower or operator for acquisition opportunities in the future, chances are pretty low that we will lend.

The deal we closed on Wednesday is a perfect example of this philosophy in action. In case you missed it, on Wednesday, we closed on a mortgage loan of $26.7 million at an annual interest rate of 9.1% in connection with the borrowers acquisition of a 2-property skilled nursing portfolio in Tennessee with Ensign as a long-term triple-net master lease tenant. The relationship with this borrower goes back many years. They understand our strong preference to own the real estate, and they provided us a purchase option beginning in the fourth year of the loan.

After yesterday's Tennessee deal, our pipeline today sits at approximately $260 million and is roughly 50% acquisitions and 50% loans. It includes one larger deal we have been pursuing for some time that we now feel confident enough to include in our quoted pipe. Furthermore, the pipe today is almost entirely skilled nursing properties. In addition to today's quoted pipe, we are also interested in some other large deals that at this point are not tracking at a high enough probability to include in that number.

So with our line of sight on a reloaded pipeline, we have continued to position the balance sheet to capitalize on this window of opportunity while it remains wide open. We are pleased to report a net debt-to-EBITDA of 0.6x. High level, if we don't use any more equity we can now deploy the $345 million of cash on hand, plus the undrawn $600 million line of credit, and still only arrive at 3.6x net debt to EBITDA.

In other words, we are locked and loaded to grow in a meaningful way for the next few years. Remember how we quote our pipe, we only quote deals that are at least under LOI that we believe have a strong likelihood of closing and should close within the next 12 months.

Now turning to the portfolio. You will see in the supplemental, lease coverage continues to show a tremendous strength in security overall. Property level EBITDAR with a 5% management fee and EBITDARM coverage was reported at 2.18x and 2.78x, respectively.

You may have noted in the supplemental both Priority Management Group and WLC reported declining coverage from Q3 to Q4. This was due to large onetime reserve accruals for workers' comp and/or bad debt have the reserves been better accounted for during 2023, you would not have seen the type of decline they reported. They had occupancy and labor headwinds in the quarter as well. However, both have favorable state Medicaid rate increases this year that should, among other things, drive coverage higher by year-end.

We are not worried about either of them or anyone in our top 10. The transition of 2 Eduro, Colorado facilities to Ensign took place on March 1 as expected. Ensign stepped in at a lower rent, and Eduro is covering the difference across the remaining 7 CareTrust properties in the master lease. Therefore, we do expect to see fairly tight lease coverage for Eduro this year, but we also expect that coverage to increase going into next year.

Also, we are still under contract to sell the portfolio of 11 skilled nursing assets with negative EBITDAR in the Midwest. Understandably, financing has been challenging, but the buyer continues to make good faith efforts that lead us to believe a deal will get done. On the regulatory front, a couple of items. First, CMS announced a 4.1% Medicare rate increase for fiscal year 2025 effective this October. And second, as we expected, CMS issued their final rule on the minimum staffing mandate.

We remain disappointed with the rule that is impossible to implement given the widely publicized staffing shortage in skilled nursing and throughout health care today. Furthermore, an unfunded mandate of more staff will not magically make those employees appear. We remain hopeful that reasonable heads will prevail in D.C. to modify or reverse course altogether before the mandate takes effect.

Now before I hand it over to Bill, let me conclude like this. First, the investment environment is very healthy. Second, we have a balance sheet that provides enormous flexibility and historic capacity for both the near term and midterm. Third, we have an interest rate environment that has opened wide a window of opportunity as long as borrowing costs remain higher for longer. And fourth, we are at the start of demographic tailwinds that should last for decades to come. Bill will now provide you with color on the numbers we reported yesterday.

[William Wagner, executive]

Thanks, Dave. For the quarter, normalized FFO increased 32.9% over the prior year quarter to $46.5 million. Normalized FAD increased 33.1% to $48.7 million. On a per share basis, normalized FFO was flat at $0.35 per share, and normalized FAD was also planned at $0.37 per share. Because of our replenishing robust pipeline, we continue to take advantage of our ATM and issued $273 million of equity under the ATM during the first quarter, resulting in us having $451 million of cash on the balance sheet at quarter end, substantially up from year-end when the balance was $294 million.

Since quarter end, we have used a chunk of that for investments and our dividend, leaving us with approximately $345 million as we sit here today. In yesterday's press release, we updated guidance for 2024 with a range for normalized FFO per share of $1.42 to $1.44 and normalized FAD per share of $1.46 to $1.48. This guidance includes all investments made to date, a diluted weighted average share count of 140 million shares and also relies on the following assumptions: one, no additional investments nor any further debt or equity issuances this year; two, CPI rent escalations of 2.5%. Our total cash rental revenues for the year are projected to be approximately $210 million to $211 million.

We have lowered the reserve of 2% to 3% last quarter to 1.5% to 2%. Not included in this number is the amortization of a below-market lease intangible that will total about $2.3 million, but this will be in the rental revenue number as required by GAAP; three, interest income of approximately $44 million. The $44 million is made up of $27 million from our loan portfolio and $17 million is from cash invested in money market funds; four, interest expense of approximately $33 million.

In our calculations, we have assumed an interest rate of 6.9% for the term loan. Interest expense also includes roughly $2.4 million of amortization of deferred financing fees; and five, G&A expense of approximately $23 million to $24 million and includes about $5.9 million of deferred stock comp.

Our liquidity continues to strengthen as we march to a record-setting year for investments. We have approximately $345 million in cash today, and our entire $600 million is available under the revolver. Leverage hit an all-time low with a net debt to normalized EBITDA ratio of 0.6x. Our net debt to enterprise value was 4.1% as of quarter end, and we achieved a fixed charge coverage ratio of 7.5x. I said last quarter that I wouldn't be surprised to see leverage tick further downward as we continue to fund our pipeline with equity, which it did and then some. I also said I would expect that leverage would begin to pick up as we deploy the cash into accretive investments. I still believe that this will occur. But given the price of our equity relative to the current cost of long-term debt issuance we believe that it makes much better sense to continue to lock in accretion using equity on a robust and replenishing investment pipeline.

Our net debt to EBITDA range of 4 to 5x is still our range. It just may take some time and a lot of investments to get back there, which we plan on doing. And with that, I will turn it back to Dave.

[David Sedgwick, executive]

Great. Well, we hope our report has been helpful and happy to take your questions now.

Mark, are you there to conduct the questions. We are waiting for our host to conduct the Q&A portion.

[David Sedgwick, executive]

In the meantime, for our analysts who are in the queue, if you want to e-mail or text us your questions, I suppose we can adapt that way to our missing host. Please standby as we wait for the host and/or your questions to come in. We'll try to manage this from our end. Jonathan, we're going to unmute you on our screen and see if that works. Unfortunately, it doesn't look like we have that capability after all.

So again, if you have any questions -- okay, we got a question in from Jonathan here. He says, I think it's fair to say expectations are very high for continued acquisition activity, given the cash on hand and leverage profile. And with that comes pressure to get deals done.

I know James isn't on, but Dave, I was hoping you could talk about how you managed to balance those expectations for continued investment activity while maintaining underwriting discipline. And how much investment capacity can your current team handle before needing to meaningfully increase headcount?

All right. Let me touch on those. It always makes James a little bit nervous when I answer questions on investments in pipeline because I tend to not manage those expectations as well as he does. Look, it is -- in my prepared remarks and what you've seen from us so far this year, we certainly feel and see a flow of deals coming our way, and we've been able to execute on those now for a good 18 months in an accelerated pace. We expect that to continue going forward. And so we just want to like Bill and I talked about lock in that accretion, be prepared to take advantage of that regardless of what happens at a macro level. The discipline though has got to be there. It's always been part of our story, and we haven't changed. We're not going to grow for growth sake.

In terms of capacity, the current team can handle certainly the pace of growth that we're looking at today We have added head count in the last 18 months or so. And we can always evaluate that, but I think we're positioned really well to take advantage of the window of opportunity that we're in.

And then last 1 from Jonathan here. Bill can take that. It's about our preference to settle equity proceeds now versus raising on a forward basis.

[William Wagner, executive]

Yes, Jonathan, the reason we are settling our ATM issuances right now, instead of putting them on a forward is, we have some better visibility as to the closing dates, as Dave said in his remarks, of less than 12 months that we expect to close on the investment pipeline. So that's really -- and the minimal dilution that is about taking the cash now as opposed to putting it on a forward.

Mark, are you back?

[Operator]

Yes, I'm sorry for what happened. I just had a system error on my end, but we're ready to go to the Q&A session again.

[William Wagner, executive]

Great. If you want to take the first question in the queue.

[Operator]

Our first question comes from the line of Jonathan Hughes from Raymond James.

[David Sedgwick, executive]

We just had -- we just handled Jonathan's questions. So Jonathan, unless you have anything else, we can move on to the next one.

[Jonathan Hughes, analyst]

Nothing for me. Thanks for taking my e-mail.

[Operator]

Your next question comes from the line of Juan Sanabria from BMO Capital Markets.

[Juan Sanabria, analyst]

I guess a question for Bill. I mean given your strong cash balance and the fact that you probably you said wouldn't run through that in quite some time. Absent the pipeline growing from here, which it seems to be continually being replenished, should we expect you to continue to issue equity via the ATM to further drive up cash and leverage down? Or from here, do you think you just kind of fund it with cash on hand, absent again, the acquisition pipeline being replenished or growing?

[William Wagner, executive]

It goes to what Dave said earlier, which is, hey, when we quote our pipeline, it's under this definition, and that's pretty solid, and we expect to close on that within 12 months. But there's also deals that are coming in every day. And if we think those are actionable and we'll get eventually into our pipeline, we're continuing to raise equity against that number if we like the equity price and taking into consideration those deals and the yields that they will produce.

[Juan Sanabria, analyst]

Yes. Second question just on portfolios out there. Can you comment on how many are you kind of in play for? How does that compare to history? And the likelihood that you land one from here, it sounded like one is in the [ 260 ], but anything above and beyond that? Any commentary would be helpful.

[David Sedgwick, executive]

Yes. We're reluctant to give too much color on those bigger deals just because there's lower probability. And it changes from month to month, stuff gets -- stuff falls out and stuff comes in. But it's primarily skilled nursing portfolios that we're looking at. And I'd say we're chasing more larger deals than we have historically, but fairly consistent with the last 12 months.

[Operator]

Your next question comes from the line of Michael Carroll from RBC Capital Markets.

[Michael Carroll, analyst]

I guess, Dave, kind of following off of that last question related to the larger portfolios, I mean, has the competitive landscape for those deals have that changed versus pre-COVID or even a few years ago? I mean, who are you typically competing against for those assets right now?

[David Sedgwick, executive]

Yes. The competition for the deal sort of depends on the deal itself. In other words, if it's a nice stabilized cash flowing deal, there's going to be quite a bit of competition for that. If it requires more of a turn, there's still competition, but there's just less players going after it.

[Michael Carroll, analyst]

Okay. And then going to your press release, it indicated that you collected 98% of your rents. Can you kind of highlight the 2% rents that weren't collected in the quarter? And if that something that's going to recover here shortly?

[David Sedgwick, executive]

Yes. We think there's a few operators, primarily seniors housing and are not top 10 list that aren't quite performing like we would like. We think that there are worst performances behind them. We see them making some improvements now. And so we would expect those underpayments to improve going forward.

[Operator]

Your next question comes from the line of Tayo Okusanya from Deutsche Bank.

[Omotayo Okusanya, analyst]

So I'm sure if you guys noticed consensus estimates are much higher versus your guidance. And I think a part of it has to do with just, again, overall assumptions about capital structure and leverage. Again, I don't think I've ever seen a net debt to EBITDA of 0.6 in my 25 years of doing this. So just kind of curious, again, like, why does that makes sense for you guys even on a near-term basis, just kind of given all the prefunding does have a negative at least near-term earnings impact?

[David Sedgwick, executive]

Well, I'll answer that and have Bill clean up after me. I think that the -- really, the big difference in consensus with our guidance is that we do not include investments -- future investments in our guidance. And of course, you and everybody that is -- that folds in a consensus to. And so I think as you look at what our run rate is for guidance and you fold in the assumptions for investments, then I think that comparison is the more meaningful one.

[Omotayo Okusanya, analyst]

I would push back on that because I think when everyone normalizes for the amount of acquisitions you've done year-to-date, we're still much higher than your current guidance. And I think, again, a part of it just has to do with assumptions around capital structure. So I guess, my main question is you guys have -- you're very disciplined about how you do acquisitions.

So if you kind of are out there not finding what you want, in the meantime, you're kind of overequitized, if I may use that word, on impacting earnings growth. So if you end up not doing deals just because they don't pencil or whatever, I think there's a fair amount of earnings growth that you're kind of giving up in the pursuit of deals that you ended up not doing. So how do you kind of...

[David Sedgwick, executive]

Yes, that's true. If we don't actually execute on the pipe that we have and the pipe doesn't continue to build as we anticipate, then you're right. We would have a lag to our earnings growth. We positioned the balance sheet based on our confidence level in our ability to continue to do what we have been doing over the last 12 months.

We have a high level of confidence in the quoted pipeline number that we have and we have a funnel of deals making their way to that level of confidence still coming, which is all why we would position the balance sheet to lock in that permanent financing, lock in that accretion because we believe that we will easily deploy that cash on the balance sheet in the near term.

[Operator]

Your next question comes from the line of Alec Feygin from Baird.

[Alec Feygin, analyst]

Kind of to piggyback on that, what is the timing to deploy the capital? Should we expect a similar rate for the rest of 2024 as we have seen year-to-date?

[David Sedgwick, executive]

Well, the -- when we quote our pipe, like I said in my prepared remarks, that typically means we have a high level of confidence in closing on that quoted number within 12 months. But that could be as early as next month to 11, 12 months from now. In skilled nursing, one of the nuances of closing on deals is that there is always a requirement for skilled nursing acquisitions to have state licensure approval, and different states have different requirements there. And so that's one of the reasons why we give ourselves a little bit of latitude in terms of quoting the timing. But 12 months -- inside of 12 months, we think is a conservative way to read our quoted pipeline of deployed capital.

[Alec Feygin, analyst]

Okay. And second question for me is on the 11 asset portfolio that's held for sale. Does CareTrust have any sort of nonrefundable deposits from that potential buyer? And what is holding that buyer back from actually closing?

[David Sedgwick, executive]

Yes, we do. We have about $1 million of money that's gone hard and it's nonrefundable. And we're staying close with those guys, and they're making progress. And what they're telling us is they think it can get closed here in the next month or 2.

[Operator]

Your next question comes from the line of Juan Sanabria again from BMO Capital Markets.

[Juan Sanabria, analyst]

Just curious, given your strong cost of capital, if you have any interest in looking at seniors housing operating assets? Is that something that potentially you could add to the fold? And is the kind of dovetail to that? Would you have any interest in LTACs by any chance?

[David Sedgwick, executive]

Well, I'll go in reverse order. We probably don't have the interest in LTACs today. I would never say never, but it's not something that we're currently interested in or pursuing. With regards to SHARP, seniors housing, I would say that we are certainly open to that. We're not exactly built for it today. We're really built to scale in a triple net way. But if we were to go into a SHARP investment, we would not -- we would have to solve both the economics of the deal, but also the back-end support structure for it. And that's something that we would be open to looking at.

[Juan Sanabria, analyst]

And one last question for me. Given how low the leverage is, is there any chance you could recut any of your loans to get some benefit for how conservative your balance sheet is positioned or any discussions with lenders to that out?

[David Sedgwick, executive]

No.

[Operator]

Your next question come from the line of Austin Wurschmidt from KeyBanc Capital Markets.

[Austin Wurschmidt, analyst]

Just a question about some of these larger deals as well. So I'm just curious with each kind of incremental decrease in leverage and just a more attractive cost of equity. Is that what's really improved the probability of doing these larger deals? Or has something else changed either just the benefit of time and underwriting, given the size of the transaction that's gotten you comfortable to get under LOI, again for specific maybe to the one that's in the pipeline today?

[David Sedgwick, executive]

Well, I think we're seeing an increase in larger deals because of how attractive we've become as a transaction partner in today's environment where borrowing costs are so high. And another reason for it is it's the fruit of some relationship building that we've done over recent years and strategic lending that we've done over recent years where as we've expanded these relationships and done some things that have been a little bit outside of the norm, these folks continue to stay active and they come to us because we've had a really good experience transacting together. So I think it's kind of a combination of a lot of those.

[Austin Wurschmidt, analyst]

Got it. So I mean just given sort of your calculated measured commentary when it comes to talking about the pipe, is it fair to say that the newer larger deals then that aren't in the pipe is simply because of that they're newer deals and really are too soon to have under LOI, and you've got enough to chew on with what's in front of you and what you have capacity to acquire today? Or are there other factors that kind of have you on the sidelines with some of the newer stuff that you've seen?

[David Sedgwick, executive]

Yes. I'd say the thing that keeps us from including more is really just about stage of progression of the deals. As things get -- the bigger the deal, we're just going to wait until things are really baked and ready to go before we start including those in a quoted pipe. We've just seen larger deals for a number of reasons fall through after we thought we had a good chance at it. That's just learning from chasing bigger deals over many years.

[Operator]

Your next question comes from the line of Joe Dickstein from Jefferies.

[Joseph Dickstein, analyst]

Just have a quick one here. WLC Management coverage has come down quite a bit the last couple of quarters at 1.72x EBITDARM, I guess kind of what's the story there? And where do you guys see this settling?

[David Sedgwick, executive]

Well, I think, Joe, I think I'd just add a little bit to my prepared remarks about WLC. They are a great operator for us in Southern Illinois. They've been doing it a long time for us and have been operating this portfolio a very long time. They did have kind of an end of year large adjustment. And also, as I talked about, I think I talked about them last quarter, I could be mistaken. They had a drop in skilled mix quite a bit.

And so as you -- as they recover on the skilled mix side, as the new rates kick in Illinois on April 1, then we would expect that coverage to improve. We're not concerned about them.

[Operator]

That concludes our Q&A session. I will now turn the conference back over to Dave Sedgwick for closing remarks. Please go ahead.

[David Sedgwick, executive]

All right. Well, thanks, everybody. Really appreciate your time. And of course, we always stand by for follow-up questions, you know where to find us. Have a great weekend.

[Operator]

Ladies and gentlemen, that concludes today's call. Thank you all for joining. You may now disconnect.