CareTrust REIT Inc

NYSE:CTRE

Earnings Call Transcript 2018-Q2

[Operator]

Welcome to CareTrust REIT's Q2 2018 Earnings Call. Please note that this call is being recorded.

Before we begin, please be advised that any forward-looking statements made on today's call are based on management's current expectations, assumptions and beliefs about CareTrust REIT's business and the environment in which it does operate. These statements may include projections regarding future financial performance, dividends, acquisitions, investments, returns, financing and other matters, all of which are subject to risk 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. During the call, the company will reference non-GAAP metrics such as EBITDA, FFO and FAD and normalized EBITDA, FFO and FAD. When viewed together with its 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 except as required by law. CareTrust REIT and its affiliates do not undertake to publicly update or revise any forward-looking statements where changes arise as a result of new information, future events, changing circumstances or for any other reason. Listeners are also advised that CareTrust yesterday 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 time period. Management on the call this morning includes Bill Wagner, Chief Financial Officer; Dave Sedgwick, Chief Operating Officer; Mark Lamb, Chief Investment Officer; and Eric Gillis, Director of Asset Management.

I will now turn the call over to Greg Stapley, CareTrust REIT's Chairman and CEO.

[Gregory Stapley, executive]

Thanks, Sherry. Good Morning, and welcome, everyone. Although it was an uncharacteristically quiet quarter for us on the acquisition front, Q2 was one of our best quarters ever in terms of meaningful long-term accomplishments. With a couple of difficult re-tenantings behind us and solid operating reports started to come out of those operations, we've been able to pivot and settle back into the business of growing CareTrust. Not that we ever took our eye off that ball, but with deal flow light for the past few quarters and a lot of behind-the-scenes work to do on the asset management side, it's been refreshing to focus once again on new transactions. I'd note for the record that while we remain firmly committed to our core discipline of deploying capital, solid returns and reasonable prices, sitting on the sidelines is not our favorite place to be. But we'll go there when necessary and hold out for good assets, fair pricing and especially, the right operators. Today, I'm pleased to report that the pipeline is on the upswing. We have new assets and new operators slated to join our growing portfolio, and our current operators are performing as expected. In addition, we've been carefully using our ATM to raise new equity, pay down debt and improve liquidity, so we're poised to grow again as the right opportunities materialize. Bill will give the details in a moment, but for my part, I'll just say that the market's response and the availability of our equity has been gratifying, to say the least. I'm also pleased to congratulate 2 individuals, both of whom most of you know well, on their recent promotions. This past week, our Board of Directors appointed Dave Sedgwick, who has served as our Vice President of Operations since 2014 and was a key member of the Ensign team prior to the spinoff, as CareTrust's Chief Operating Officer. In addition, the board appointed Mark Lamb, CareTrust's Director of Investments since 2014, as Chief Investment Officer. In addition to their sterling operational credentials as long-time nursing home administrators and health care industry leaders, both have worked hard to become well-respected and highly capable real estate professionals. Mark and Dave have been key contributors to CareTrust's growth and success since our inception, and on a personal note, they've been great friends and partners in this endeavor. Speaking for all of us here at CareTrust, we couldn't be more pleased to see them receive this recognition.

And with that, I'd like to turn some time over to them. So I'll just conclude by saying that we still look forward to a bright 2018 and beyond, and we pledge to continue making solid investments with topflight operators at superior returns. Dave?

[David Sedgwick, executive]

Yes. Thanks, Greg, and good morning. So much of our efforts in Q2 centered around ongoing asset management work related to the transition of the Ohio properties to Trillium, Trio and Hillstone. I'm pleased to report that things are going well. Now 7 months in, Trillium seems to have worked through most of the normal transition challenges, such as obtaining Medicaid certifications and receiving Medicare tie-in notices that allow them to take those patients and build those programs, contracting with managed care payers, negotiating more favorable vendor contracts and myriad other things that an operator must do in transitioning a facility. As expected, their overall census declined during the early months when they were not yet permitted to admit new Medicaid or HMO patients. We're pleased to report that as of this week, their overall census has recovered and, in fact, finally surpassed what they walked into back in December. We expect steady improvement through the end of the year from Trillium. With regards to Trio and Hillstone, it's still too early after only a couple of months to draw any definitive conclusions about their performance. That said, we're very encouraged by their reported results thus far. Despite the fact, they're still very nice in that early post-transition stage when they are still getting some of the pieces of their operating puzzle in place. They too are enthused about the buildings and believe that they'll be able to hit their own targets for performance in year 1. While investment activity was quiet in the quarter, we have used the opportunity to find some new operator prospects and further strengthen existing operator relationships, all of which are key to our continued growth and success. And even though our tenants are now generally performing as expected, we take nothing for granted. We're working to focus more closely than ever on their operations and results. We continue to enhance our asset management systems so that we can see early and help our tenants stay ahead of challenges that might erode their lease coverages as well as opportunities that might enhance those coverages. In addition, we've continued to refine our underwriting processes to be sure that we are only partnering with the current and future best-in-class regional operators. As our overall lease coverages demonstrate this focus is producing promising results. Finally, looking at the broader skilled nursing industry, the landscape remains stable with no major changes from last quarter. We continue to believe, as the last 19 years have taught us, that very good operators of all shapes and sizes can and do adapt to the constantly shifting ground. CMS is 2.4% increased to the Medicare rates for this October, and PDPM, the Patient Driven Payment Model, that was approved on Tuesday to replace RUGs IV starting in October of 2019, have actually brought a welcome tailwind to the skilled nursing sector.

And with that, I'll hand it over to Mark to talk about the pipeline. Mark?

[Mark Lamb, executive]

Thanks, Dave, and hello, everyone. Q2 was relatively quiet on the transactional front, but it wasn't without effort as we continued to underwrite new opportunities and press on the deals we have in the pipeline and those that we've recently added. Since quarter end, we did close on a very nice 99-bed skilled nursing facility in Aberdeen, South Dakota, with Eduro Healthcare. We bought the building from QCP in ManorCare, as part of their disposition plan, and their early signs indicate the transition is going extremely well. This is the third near seamless transition Eduro has executed with us this year and brings our total investments year-to-date to approximately $57 million. On the new deal front, we have begun to see actionable deal flow pick up again with the bid-to-ask spread tightening over the past few months. Sellers are appearing again and seem to have become more realistic, even as a solid Medicare rate increase and the proposed shift from RUGs IV to PDPM appear on the horizon. Whatever they're thinking, we believe the logjam of the past 9 months is finally showing signs of breaking. With our increased liquidity and reputation for speed and certainty of close, we believe we're well-positioned to take advantage of the market as sellers come off the sideline and prices rationalize. We continue to hear that more opportunities are coming to the market, so we believe that the momentum of the past few months will take us into the end of the year with what we hope will be a solid finish to 2018. Our pipeline, which as we've told you has felt very thin for the past 2 to 3 quarters, has rebounded today to the $125 million to $150 million range, which is where we've accustomed to being. In addition to the fully stabilized sale-leaseback assets that we've been buying, we also continue to look for the stable but under-managed opportunities to which our operators can bring their superior sophistication, culture and care delivery models that the current pipeline includes both on and off-market skilled nursing and senior housing deals with almost all of the current pipeline made up of skilled nursing and post-acute facilities. Many of the opportunities we are currently pursuing would allow us to bolster our lease coverages with existing tenants over time, while also filling out our operator bench with new operators we believe will provide us with another layer of depth in some key growth states to ensure that we have enough operational horsepower to continue our growth into 2019 and beyond. Please remember that when we quote our pipe, we only quote deals that we are actively pursuing, which meet the yield and coverage underwriting standards we have in place from time to time and then only if we have a reasonable level of confidence that we can lock them up and close them.

And now I'll turn it over to Bill to discuss the financials.

[William Wagner, executive]

Thanks, Mark. For the quarter, we are pleased to report that normalized FFO grew by 19% over the prior year quarter to $24.5 million, and normalized FAD grew by 18% to $25.6 million. Normalized FFO per share grew by 14% over the prior year quarter to $0.32, and normalized FAD per share grew by 10% to $0.33. Given our most recent dividend of $0.205 per share, this equates to a payout ratio of 64% on FFO and 62% on FAD, which again represents one of the best covered dividends in the health care REIT sector. As a result of our pipeline increasing as Greg and Mark have talked about, during the quarter, we turned on our ATM. Through today, we have issued 4.9 million shares at an average price of $16.50 resulting in $79.2 million of net proceeds. These proceeds were used to fund the investment we recently announced and the remainder paid down our line of credit to $130 million. In yesterday's press release, we updated our 2018 annual guidance range for normalized FFO per share of $1.26 to $1.28 and for normalized FAD per share of $1.32 to $1.34. This guidance includes all investments made to-date, a diluted weighted average share count of 78.4 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%. Our total rental revenues for the year, again including only acquisitions made to date, are projected at approximately $139 million and includes approximately $1.7 million of straight-line rent. Three, our 3 independent living facilities are projected to do about $400,000 in NOI this year. Four, interest income of approximately $1.5 million. Five, interest expense of approximately $28.2 million. In our calculations, we have assumed a LIBOR rate of 2.15%. That, plus the current grid-based LIBOR margin rates of 185 bps on the revolver and 205 bps on the 7-year term loan, make up the floating rates on our revolver and term loan. Interest expense also includes roughly $2 million of amortization of deferred financing fees. And six, we're projecting G&A of approximately $12.4 million to $13.3 million. Our G&A projection also includes roughly $3.9 million of amortization of stock comp. As for out credit stats calculated on a run-rate basis as of today, our net debt to EBITDA is approximately 3.9x, leverage is about 28% of enterprise value and our fixed charge coverage ratio is approximately 5.2x. We also have $14 million of cash on hand today.

And with that, I'll turn it back to Greg.

[Gregory Stapley, executive]

Thanks, Bill. To sum up, we're optimistic about our future and the future of the skilled nursing and senior housing industries. And we look forward to continuing to grow CareTrust in an intelligent and measured way. We hope this discussion has been helpful. We thank you again for your continued support.

And with that, we'll be happy to answer questions. Sherry?

[Operator]

[Operator Instructions] Our first question comes from Jordan Sadler with KeyBanc Capital Market.

[Jordan Sadler, analyst]

Wanted to just dig into the pipeline a little bit. Can you, Mark, maybe give us a little bit of color on the mix? And what you're seeing on pricing?

[Mark Lamb, executive]

Yes. I would say, the mix is -- as I stated in the prepared remarks, is very SNF-heavy and there's a couple small AL deals mixed in there, but for the most part, it's all SNFs. From a pricing perspective, I would say, in the market, it's still somewhat of a mixed bag. I think, the -- certainly on the SNF side, you're seeing stabilized portfolios that are straight in that, kind of, historical cap rates what we've seen over the last couple of years, some relatively aggressive pricing on our price-per-bed basis. And then, we're also seeing non-stabilized, non-core, nonstrategic assets that are being spun off that have virtually no NOI that are trading at price-per-bed numbers that fluctuate typically by state.

[Jordan Sadler, analyst]

Okay. You touched on the South Dakota one and the seller there. Any expectation, I mean, of additional assets to shake out from that portfolio that might be on your radar?

[Mark Lamb, executive]

Yes, I think it -- my understanding is they haven't completely disposed of the full 75 that they had talked about disposing of. So I think there are more out there, and we're continuing to pursue those as best we can.

[Jordan Sadler, analyst]

Okay. And then maybe one for Dave. The coverage overall throughout the -- looked pretty strong sequentially. There was a little bit of softness on the SNF side away from Ensign, the transition portfolios. Any insights there? Or is it just the overall prevailing conditions?

[David Sedgwick, executive]

No, there was nothing major as is the case with skilled nursing. There can be cyclical issues, there can be survey-related issues that hit an operator or a facility or 2 from time to time. And so we would expect a little bit of choppiness just from that, but no, there's nothing seismic happening in the portfolio.

[Gregory Stapley, executive]

Jordan, it's Greg. Just to add to Dave's comments. Everything you said was right. I would just also note that the Kindred assets that we took last fall and placed in the hands of a couple of different operators are still ramping and also undergoing -- or preparing to undergo some renovations and things. So that's always going to depress our census just a little bit. And layering those in has impacted the overall number just a tad, I think that's the most of what you're seeing.

[Jordan Sadler, analyst]

Okay. And is there -- maybe any update you can offer on the transitioned facilities? Everything going as planned?

[Eric Gillis, executive]

Jordan, this is Eric. We're seeing some great stuff from our operators that have these transitioned buildings. As Dave mentioned, Trillium censuses have surpassed what they had come into. A lot of those contracts have -- are in place now, Medicaid waiver is in place, so we're seeing a lot of the assisted livings filling up quick and we're seeing some great things from Trillium. Again Trio and Hillstone, it's a little early, but all signs are pointing into the up-and-up with them as well. We stay close with all 3 of these operators. We speak on a weekly basis, and we're seeing some really good and positive signs from those portfolios. So we're excited and continue to stay close to make sure that the transition runs smoothly. But again, we're seeing some great stuff out of it.

[Operator]

Our next question comes from Michael Carroll with RBC Capital Markets.

[Michael Carroll, analyst]

Mark, I want to talk a little bit about your comments regarding the investment market. I know that you [Audio Gap] it's true that the market has been a little bit competitive the past [Audio Gap] quarters, but you expect it to improve going forward. What really drove this shift that you expect in the second half of the year? Are buyers not getting as aggressive with pricing? Or is there just more sellers coming to the market with product?

[Mark Lamb, executive]

Well, I think, we've stated on past calls that the overall, call it, inventory has been light from a volume perspective. And so, I think, the good stabilized assets in key states such as Florida, Maryland, Virginia, California, those have continued to remain competitive over, I would say, the past 2 years. In some of the, call it, Midwest markets, we've had money that's come into the Midwest markets in states like Ohio, Illinois, to an extent Indiana. And so, we're just seeing, kind of, players that previously hadn't come into the Midwest markets, that we were able to do some investments over the past couple of years, have just increased the competitive landscape there. So -- but like I said in my call -- or in my prepared remarks, I think, the shift from RUGs IV to PDPM is a little bit of a game changer for mom-and-pops and not knowing how to navigate that. A lot of the feedback that we're getting from the brokerage community is that a lot of them don't want to go through another transition and so they're choosing to sell at this point.

[Michael Carroll, analyst]

Have you seen any buyers or competition that you guys were competing against the past few years? Have they have they stepped back at all given some of these changes? Or have you seen that pick up just given where pricing is?

[Mark Lamb, executive]

No. I would say, we've actually seen 1 or 2 non-traded REITs that have come into the market recently to probably chase yield, to step away from the MOB space and to come back into the SNF space. And then consistently, we've seen private buyers and, to an extent, well-capitalized regional and superregional operators. So I don't think -- I think most operators and people that have invested in the space and have good relationships with their tenants and have studied it out realize that PDPM is actually a good thing from the space. And so, we would probably expect to see the -- kind of, the same players as we've seen over the past 12 months.

[Gregory Stapley, executive]

Mike, I would just add there, this is Greg. I think that during the past few quarters, we've seen these rather rich pricing out of a lot of the sellers and brokerage community and a lot of it going to the kind of buyers that Mark talked about, some of the private equity and regional -- well-capitalized regional operators. I think, what they have discovered is that while they've had this flirtation with big prices, surety of close and reputable counterparties are valuable, valuable components of any transaction. And I think that explains part of why the market is flowing back in our direction a bit. Not to call out anybody, but I do think that we are getting a lot of brokers coming back and saying, we're really looking for somebody that can actually close this deal. And we are picking up the pieces on some busted deals out there.

[Michael Carroll, analyst]

Okay, great. And then Greg, how do you guys think about [Audio Gap] in rural markets, kind of like the Dakota [Audio Gap] more urban markets. What are some of the gives and takes [Audio Gap] in your underwriting on those types of transactions?

[Gregory Stapley, executive]

Look, it's all about the operator, Mike. You can't -- you just cannot overstate the importance and value of the right operator. And we -- the considerations that we look at are, can the operator -- if they're not in the market, can they get to that market readily? And if they're not in that market, will they be a good cultural fit for that market? And the South Dakota acquisition is a perfect example of a transaction that works. You have, in Eduro, an operator that has, kind of, culture that is going to adapt very, very well to that community. They spent a lot of time looking at that community, interfacing with the health care community there. We did our due diligence as well. And really, it felt like that asset was -- it was doing fairly well, I mean ManorCare lofted off as an outlier, not as an underperformer. And so, it was an easy transition for Eduro to just step in and keep the machine running, and then start injecting their own culture and philosophy in there, which, by all accounts, has been well, well received. So you're right to ask this question. It's one that we ask constantly, and we got to get the right answers before we do something like that. But the secondary markets, I mean, they're great for us. We can get assets at better prices and the -- often times, the profit equation is much friendlier than it is in some of the large urban and suburban markets out there.

[Mark Lamb, executive]

Mike, I'll just add, this is Mark. There's a pretty significant amount of not-for-profit skilled nursing operators up in that Aberdeen market, and so it's great because their philosophy is not necessarily to chase the short-term skilled patients. And their mission is more so to take care of the long-term patients. So we look for markets and look for attributes like this building that performed well, but has just additional upside because maybe it wasn't well supported on a -- from a regional structure perspective.

[Operator]

[Operator Instructions] Our next question comes from Jonathan Hughes with Raymond James.

[Jonathan Hughes, analyst]

A bit of an extension of Mike's last question. But obviously, the large Ohio deal from 2015 didn't work out exactly as planned, but with the credit facility sitting today with a lot of capacity, would you do another large deal if it penciled, had the right operator and, of course, the benefit of hindsight and lessons you've learnt from that experience?

[Gregory Stapley, executive]

Yes, of -- this is Greg, Mike -- or Jonathan. Yes, of course, we would. We've got the capacity, that's what we're here to do. As long as we have the right operator and the right price in markets we felt they could win at, we'd do that all day long. So if you know of any, send them our way.

[Jonathan Hughes, analyst]

I guess [Audio Gap] lead me to question to Mark then. Are there any big portfolio deals in that $125 million to $150 million pipeline that you cited earlier?

[Mark Lamb, executive]

Not at this point. We're -- there's somewhat of a summer slump, but just in discussions with the brokerage community, we're expecting to see some deals come towards the end of this month. So that could change over the next couple of months, but not at this time, we're not seeing those types of deals, certainly on the SNF side. On the Class A, AL side, those are out there, but not anything that -- it's not -- deals that we're not currently chasing.

[Jonathan Hughes, analyst]

Okay. And is there -- I don't know if you've quoted this in the past, I don't think you have, but I mean like a shadow pipeline? And if there is, what would the size of that be?

[Mark Lamb, executive]

No, there's not a shadow pipeline, I mean, the pipeline evolves almost on a daily basis, as we bid on transactions and transactions fall out. So this is a pipeline that we feel good about our chances of executing on.

[Gregory Stapley, executive]

Jonathan, this is Greg. I like that question. I would just tell you that no shadow pipeline, it's either real or it's not. We have a phenomenal underwriting team here that turns deals so fast, it's amazing. And we can give brokers and sellers a sort of thumbs-up or thumbs-down on what they send us relatively quickly, really quickly actually. So we don't -- which is a service to them, because if we're not going to be interested, they don't waste time with us. So we really don't put anything on the board as pipeline deal that we are not serious about.

[Jonathan Hughes, analyst]

Okay. Got it. And then I don't want to leave Bill out here. So you guys hit the ATM to pay down debt in the quarter since there were no deals. But how do you think about raising equity proceeds with no immediate opportunities to deploy capital? And can we expect that trend to continue keeping your credit facility with this big capacity?

[William Wagner, executive]

Jonathan. Yes, I'm not -- in Mark's remarks, he said that the pipeline is pretty firm. So when we look at our share price and the premium to now, we felt taking some risk off the table to pre-fund these acquisitions that we feel very confident was the right call. It's short-term dilution, not -- it's not a long-term issue. So as we go forward, as the pipe continues to evolve and deals become more certain, you'll see us probably issue more equity as well as use the line to fund these acquisitions that are coming. We've stated that our leverage ratio, we want to keep it between 4 and 5x, and we're currently just outside the low end of the range, so...

[Jonathan Hughes, analyst]

Okay. Yes, no, the question I wasn't disagreeing with the strategy, I just wanted to hear your thoughts on it. And congrats to Dave and Mark on the new titles.

[Operator]

And we do have a question from Jordan Sadler with KeyBanc Capital Markets.

[Jordan Sadler, analyst]

Maybe just one more for Dave and/or Mark. You guys have thoughts or have contemplated the underwriting of facilities pro forma for PDPM? Is there a capital investment number that operators should be anticipating as a result of PDPM? Or that you think that needs to be baked into underwriting?

[David Sedgwick, executive]

So yes, we're not -- we have not updated our model -- our underwriting model for PDPM yet. Eric, our Director of Asset Management, and I will actually be at a conference to really get into the weeds on the algorithm next week on PDPM and tools will be forthcoming to help us map RUGs to PDPM scores. And as we get -- we'll get more sophisticated on that as the months advance here this year and prepare to deal with that by the turn of the year as we start 2019. So it is a challenge. Now that, that's been finalized to be able to say, okay, here is the Medicare rate under RUGs, what does that Medicare rate look like in 2019 and beyond? And we will fuel -- equip ourselves accordingly. But we're not quite there quite yet.

[Operator]

Thank you, speakers. I'm showing no further questions at this time. I'll turn the call back over to you for any closing remarks.

[Gregory Stapley, executive]

That's it. Thanks, Sherry, and thanks, everybody, for being on the call today. We look forward to seeing you when we're out on the road this fall.

[Operator]

Ladies and gentleman, thank you for participating in today's conference. This does conclude the program. You may all disconnect, and have a wonderful day.