CareTrust REIT Inc

NYSE:CTRE

Earnings Call Transcript 2018-Q3

[Operator]

Good day ladies and gentlemen, and welcome to CareTrust REIT Third Quarter 2018 Earnings Conference Call. [Operator Instructions] As a reminder today's conference is being recorded.

At this time, I would now like to turn the call over to Lauren Beale, CareTrust Controller.

[Lauren Beale, Controller]

Thank you and welcome to CareTrust REIT's Q3 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 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, all of which 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.

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 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 would now turn the call over to Greg Staple, CareTrust REIT's Chairman and CEO.

[Greg Stapley, Chairman and CEO]

Thank you, Lauren and welcome everyone and good morning. We know that most of you already had a busy morning today, so we plan to keep our comments brief.

Our third quarter went about as smoothly as any in our history. We closed on a couple of nice deals, we saw robust demand for equity under our ATM program and we continue to watch closely and actively our tenant operations. We're pleased to report the facilities are doing well, including the ones that transition's new operators over the past year.

The level of engagement we're seeing from both our continuing tenants and our replacement tenants across the portfolio is exciting. In fact several of transition operations are running ahead of pro forma and although we were careful to pause and let those tenants digest the new operations following the initial transitions, several are doing well enough that we're again actively seeking additional opportunities to grow together.

We also added two new operators to the portfolio, since the last time we spoke to bring our total to 20 tenants across our 192 asset triple-net portfolio. In addition to strengthening our operator pool, we've also been fortifying our balance sheet.

As I mentioned, in yesterday's press release on a net debt to EBITDA basis, our leverage is at an all-time low, earnings are at an all-time high, and our pipeline is in the best shape we've seen in over a year.

The 2018 slow start we don't expect to replicate the last two years plus or minus $300 million acquisition pays, but year-to-date, we've successfully deployed over $88 million at a blended 8.9% yield a little less, we expect that the 2018 number will grow before we're done. More importantly from there we project that our current pipe should position as well to resume our historical pace in 2019.

In short, despite what started out as a challenging year in a lot of ways, both CareTrust and our operators are finishing 2018 very well and we see an outstanding 2019 on the horizon.

So, with that, I'd like to turn sometime over the team to fill you in on the details. Dave will start by talking a little bit about our current assets and operators, then Mark will discuss recent acquisitions in the pipeline and Bill will wrap up with the financials. Dave?

[Dave Sedgwick, COO]

Thanks Greg, and good morning.

I'm pleased to report that things are going well in Ohio. Trillium which took seven of the 16 Ohio assets last December appears to be hitting their stride. Likewise Trio which took seven more of the assets on May 1 is working through many of the same transition challenges that Trillium initially experienced and is poised to finish the year right on track.

Trio has now obtained their Medicaid certifications and received their Medicare Tie-in notices and occupancy is back on the upswing. They've also contracts with managed care payers and negotiated more favorable vendor contracts.

And Hillstone which took the remaining two and arguably most challenging of the Ohio assets has admittedly surprised us a bit, significantly exceeding performance and least coverage expectations well ahead of schedule in their two facilities.

Speaking of exceeding coverage expectations, we've had several operators improve their coverage over the course of the year. For example, our largest tenant, The Ensign Group had another stellar quarter. Remember, they started at 1.85 times coverage when we launched CareTrust with Ensign as our sole tenant in 2014.

In just four years, which have been a challenging four years for the industry as a whole, Ensign's coverage has climbed to 2.3 times as of the end of Q3. As Greg mentioned, we've also added new operators this quarter and since.

One of them, California-based Kalesta Healthcare is made up of great operators we personally know and admire from our own operating days. Knowing them personally and the outstanding companies they come from not only helps us understand their approach to the business, but it also gives us extra confidence in their abilities. This group has what we look for in local or regional providers. They’re nimble, smart and sophisticated, and committed to people and quality care.

In the quarter, our asset management team continued to develop deeper relationships with our tenants and more advanced analytical tools to see into the health of our operators and their individual facilities. We talk to them regularly and brainstorm question and share ways to improve and prepare for coming changes to the business. We see the fruits of our operation-centric asset management approach almost weekly as we dig into their challenges with them in a spirit of partnership.

Finally, looking at the broader skilled nursing industry, the landscape remains stable with no major changes from last quarter. Our operating experience, our operators, the stable reimbursement environment, and the coming new PDPM reimbursement model combined to inform our positive outlook on the sector even as near-term labor pressures continue to challenge operators nationwide.

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

[Mark Lamb, CIO]

Thanks Dave, and hello everyone.

Since the start of Q3 we've closed just under $42 million in investments including a 99-bed SNF in Aberdeen, South Dakota, and a 110-bed SNF in Fargo, North Dakota with our existing tenant and operating partner Eduro Healthcare. The transaction closed in two steps due to the slower licensure process in North Dakota.

In September we acquired The Villas at Saratoga, an 85-bed SNF, and 37-unit ALF Campus in Saratoga, California with collapsed to Kalesta Healthcare. As Dave referenced, we have known Kalesta’s principles for some time and look forward to watching them expand their model into new facilities in the coming years.

Lastly, this past week we closed on a SNF/ALF Campus with our new tenant Providence Health Group. Providence has been running the building since 2015. The sale leaseback allowed them to recapitalize the business and buyout their former partner.

Taking the investments highlighted about the new accounts our total investments year-to-date is approximately is $88 million. Today our pipeline sits in the $125 million to $150 million range, and is almost exclusively made up of skilled nursing assets, and includes tack-ons with existing operators and deals where we compare with new operators versus those we had over the past year or so.

Although we are excited about the acquisitions in the pipe and how early 2019 targets are taking shape, we are hopeful assuming everything goes as planned that we are not finished adding accretive investments in 2018. As for the broader market unlike earlier this year, we are currently seeing what we would characterize as a normal flow of both one-off and smaller portfolio opportunities.

In addition, there are few larger portfolio deals out there that are interesting but as we have always said the bigger portfolios offer much lower probability from a pricing and execution standpoint.

But overall we are encouraged that the volume of deals in the market today that we think are deliverable at the underwriting standards and economics you are accustomed to seeing from us.

Please remember that when we quote our pipe we only quote deal that we are actively pursuing which meets the yield coverage and other 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.

[Bill Wagner, CFO]

Thanks Mark.

For the quarter, we are pleased to report that normalized FFO grew by 23% over the prior quarter to $25.8 million, the normalized FAD grew by 20% to $26.6 million, normalized FFO per share grew by 14% over the prior quarter to $0.32 and normalized FAD per share also grew by 14% 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 healthcare REIT sector.

Given the increase in the pipeline as Greg and Mark have mentioned, during the quarter we continued issuing equity under the ATM. For the quarter and through today we have issued 4.8 million shares at an average price of $17.62 resulting in $83 million of net proceeds. These proceeds were used to fund investments and the remainder paid down the outstanding balance on our revolver to $95 million. Year-to-date we have issued 7.8 million shares resulting in a $130.6 million of net proceeds.

In yesterday's press release we revised our 2018 annual guidance range for normalized FFO per share of a$1.27 to $1.28 and for normalized FAD per share of $1.32 to $1.33. This guidance includes all investments made today a diluted weighted average share count of 79.4 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 at $140 million and includes approximately $2.3 million of straight line rent. Three, our three 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 $27.9 million.

In our calculations we have assumed a LIBOR rate of 2.35%. That plus the current grid based LIBOR margin rates of 185 bps on the revolver and 205 bps on the seven-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 $12.2 million to $12.8 million. Our G&A projection also includes roughly $3.8 million of amortization of stock comp. As for our credit stats, calculated on a run rate basis as of today, our net debt to EBITDA is approximately 3.5 times, leverage is about 24% of enterprise value and our fixed charge coverage ratio is approximately 5.5 times. We also have $12 million of cash on hand today.

Before I turn it back to Greg, I’d like to correct a couple of numbers in occupancy for the total portfolio excluding Ensign and transition portfolio on Page 6 of our supplemental. SNF occupancy is 78.1% instead of the 75.3% and seniors housing is 88.9% instead of 69.5% resulting in a total occupancy of 80.2%.

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

[Greg Stapley, Chairman and CEO]

Thanks Bill.

To sum up, as we speak today, our tenants and their operations appear to be in good shape overall. We've not stopped working on 2018 acquisitions and our prospects for 2019 look very encouraging. We hope this discussion has been helpful. We thank you again for your continued support and with that we will be happy to answer questions.

And just a note, Eric who will be available for questions is out in Cincinnati today, touring buildings with Trillium. Dave is in Baltimore but he's also headed out to meet the prospective tenants today. Mark as likewise here but headed out to Texas today to tours and buildings to meet with prospective tenants, and Bill and I drew the short straw and will be headed to San Francisco for NAREIT this afternoon.

So we hope to see some of you up there. But I want to reassure you that even though things are going well this year we are - we have not stopped and they're not resting on any of the laws. So that's it. Let's take some questions.

[Operator]

[Operator Instructions] And our first question comes from the line of Daniel Bernstein of Capital One. Your line is now open.

[Daniel Bernstein, Capital One]

Yes, I guess really the one question I have just on the pipeline, it seems like it’s building some, how are you thinking about underwriting the PDPM into the lease coverages into rent bumps, so just trying to get a sense of how you think about the - what the opportunities and risks are there when you underwrite?

[Dave Sedgwick, COO]

At this point, it’s a little bit early to talk about, how we're going to do that. As you get into the weeds of PDPM there is not an easy way to map a rug score under the current revenue formula to a PDPM rate without patient specific information. There are several consulting firms who could help with that process, it's certainly something that we are going to have eyes wide open to as we go in to look at deals in the new year but there is not really an easy way to map it yet, we're going to have to dig into more information than we have in the past.

[Greg Stapley, Chairman and CEO]

I’ll remind you that when we talked about our optimism about PDPM there is a conceptual optimism nobody that we know has yet built a reliable cross-walk. As Dave says between rugs and PDPM, but we know that there - those out there that are feverously working on that, we just - we see the opportunity for cost savings, we see the opportunity to - that comes from having, a more clinically focused reimbursement system and we believe that both not only our operating profits going to improve but quality care is likely to improve.

So, we bought VPM initiative in our aims to do that, but we're not building anything special into our underwriting right now. We actually try not to value assets based on any kind of pro-forma, but rather on their trailing numbers. But what we probably will have to start doing that dual analysis a little more carefully in the coming year.

[Daniel Bernstein, Capital One]

That was really the question whether you're pro forma - thinking about pro forma numbers versus trailing. So, I think the other question I had is it seems like the skilled nursing space has stabilized somewhat, but wages are picking up probably with low unemployment nationally. How are you thinking about the risk to margins going in the 2019 for the skilled space and senior housing perhaps?

[Dave Sedgwick, COO]

Yes. So, this is David again. We look at - we have because our asset management team is so in touch regularly with our operators, we know where in our portfolio that felt most acutely and it varies state by state and operator to operator. As you look historically, the numbers of the labor expense in our portfolio is at - right now is basically tracks with how it has historically, so overall those labor pressures aren’t impacting margins like we might expect, but if you drill down and look at specific operators that's where you’ll see some of that manifest itself.

We expect that to continue to be the case going forward. And it’s something that our operators have to be able to differentiate themselves as the employer of choice in order to reduce their turnover rate, reduce the amount of agency that they use. And even with the thinner talent pool, better operators are able to control that labor cost by being that better employer in their market.

[Daniel Bernstein, Capital One]

One last question if I can. I mean you're at really the lowest leverage, not the lowest leverage you've ever been at. Is this a place you want to stay given where you see the current acquisition environment risk out there are opportunities or do you think you'll at some point as you invest in 2019 the leverage will come back up.

[Bill Wagner, CFO]

No I would expect the leverage to come up over time as we try and get that range to our stated range of 4 to 5 times on a net debt to EBITDA basis. So yes we're a little below it right now but we've been below it, below the stated range, last year. So I would expect it to come back up like it has in the past.

[Operator]

And our next question comes from the line of Jordan Sadler of KeyBanc. Your line is now open.

[Jordan Sadler, KeyBanc]

So I wanted to follow up a little bit on Dan's questions regarding the leverage but also I'm curious about what you're seeing in terms of the pipeline if you could elaborate a little bit, are you seeing it, do you see it more optimistic, or are you seeing a an abundance of one-offs or are you seeing more platform level type deals.

[Mark Lamb, CIO]

I would say it’s both one-offs and call it two buildings, three buildings you know small portfolios, you know it's anywhere from operators trimming their portfolio where maybe geographically they need to dial it back. They have somehow outliers still seem landlords looking to divest we're actually seeing private landlords divesting.

So it's really kind of across the spectrum and then and then we're still seeing albeit not as frequently but opportunities to do sale lease backs with the operators that own - currently own assets, so it's completely a mixed bag, but more so I would say what’s driving the divestiture would be just - it's not most of the time are not strategic and that's where we see the one-off, two buildings, three buildings portfolio.

[Jordan Sadler, KeyBanc]

And I think you've characterized the pipeline optimistically but very similar in terms of magnitude as to what you've seen over time. Can you maybe describe or characterize the shadow pipeline with maybe not imminent but what the underwriting looks like a little bit more elaborately is there more out there today and then what might be driving it and how you're seeing pricing.

[Mark Lamb, CIO]

Well I can't really speak to the shadow pipeline because we don't have one but I think pricing is - pricing is interesting, it’s really on a market-by-market basis I mean there are there are markets in California, Virginia, Maryland, Florida that we've alluded to in the past, where you're still seeing facilities trade at north of $100,000 a bed, while other states and other places we are seeing - we're seeing buildings trade at $50,000 a bed.

So it's really it's really a complete mixed bag all the way across, I mean there are - we're looking for good strategic assets that fit with our operators and you know most of the time, there's a - there is upside in terms of kind of switching the mix from Medicaid to more of a short stay and so as we look at those opportunities that oftentimes there's a little bit of cash - cash flow going in, a little bit of coverage going and we're able to kind of leverage off that - dial back expenses and really kind of make some day one changes that, that we get we get coverage almost immediately from.

So from that perspective, I mean it really it's a wide spectrum of - we're seeing stuff at $25,000 a bed, to the north of $100,000 a bed and sometimes, in certain states north of $100,000 a bed makes sense to us, if it is a strategic fit for our operator.

[Jordan Sadler, KeyBanc]

But it sounds like you feel like the balance between buyers and sellers seems somewhat similarly balanced, how it has been in the past with the exception of maybe what you saw earlier this year lighter pipeline, not to put words in your mouth but that’s what it kind of sounds like, and I guess, I’m curious as Dan was that I guess sellers aren’t really taking much here in one way or the other as it relates to B2B. Is that fair?

[Greg Stapley, Chairman and CEO]

I think that probably is fair, and I think the other part of your statement is correct too that the sellers, that the balance between seller and buyers is coming back from where it was, you don’t quite feel like it’s all the way back, maybe that’s just our perspective, we'll never feel like it's an even level playing field. But with respect to the smaller deals and one-off deals that Mark referenced, we think that playing field is getting pretty darn close to level and we're seeing some good deals there. Larger portfolios continue to be sort of higher premium, lower probability short for us.

And you ask about the shadow pipeline, we do look at other things outside of the $125 million to $150 million that Mark carefully quoted and described how we chaff that, and you know deals that are likely, or at least have a better chance than not of us closing.

And so there are some larger deals out there, but we're still seeing significant competition on those from private equity and a few cases other REITs, and the underwriting on those just if we ever got them would have to be a little more aggressive.

[Operator]

And our next question comes from the line of Michael Carroll of RBC Capital Markets. Your line is now open.

[Jason Idoine, RBC Capital Markets]

This is Jason on for Mike. Dave, you mentioned the active role that your team has taken with some of the operators. I was wondering if you could offer a little more color on some of the analytical tools that you’re using in coordination with your operators. Also what type of insights this new analysis is offering that you might not have had before.

[Greg Stapley, Chairman and CEO]

Eric will handle that question for you. That’s okay

[Eric Gillis, Director, Asset Management]

Yes, over the course of this last year like most recently, we have a database that brings in all of the financials of our operators but we're really focused on this last year putting together a dashboard that really analyzes all of the key performance indicators that we have set out from our - from the history we've had as operators, what those what we view as the key performance indicators are for each operator as well as breaking it down to the building level and really diving down into those on a monthly basis and really trying to understand not just the financial metrics but also what goes into the operations of each facility.

We use those numbers and those analytics alongside of our operators, for example I'm here in Cincinnati right now with our operator Trillium being able to continue to track the progress that they're having in the Cincinnati portfolio. And so when we can come in and see those trends, and analysis and work alongside with our operator and being able to point out that but also reinforce what they’re seeing, it really kind of comes in unison to see a lot of these - while these operators continue to progress.

As I have been so excited today to see the progress that our operator here in Cincinnati has had and not just from a numbers perspective, but we also look at the culture of a building, the culture of a regional team that’s operating it and really understanding and getting to another leadership, that’s what also helps this as well.

We continue to invest in those tools and also continue to invest in tools not just from a financial perspective but also looking at it from a clinical perspective as well.

[Jason Idoine, RBC Capital Markets]

And then next I was wondering if you guys could give some color on how the underwriting is different when you're working with new operators versus those that you have - might have an existing partnership with?

[Mark Lamb, CIO]

With new operators obviously, we want to make sure that we have sound coverage going in and that we're careful to make sure that that as we look at their budgets and the performance for the assets going in the door that that they've really kind of taken into consideration every line item, every cost.

So that from an underwriting perspective, we have a team here of guys who's been here for a number of years that have seen hundreds of deals and have come through multiple financials and so we take a deep dive specifically with the operator and go through on the nursing side specifically PPDs, we take a look at what's nursing labor on a PPD basis and we dive down into the details alongside the operators to make sure that everything is accounted for so that there are any surprises once they get in and that any added expenses might erode coverage.

So, it's going in the door, it's much more of a call it a hand-holding process with our new operator just to make sure that they've accounted for everything, and then that helps us to get comfortable that they have their arms around the cost structure and in the business.

[Operator]

And our next question comes from the line of Seth Canetto of Stifel. Your line is now open.

[Seth Canetto, Stifel]

This is Sean on for Chad. Just a question on the pipeline. I know you guys have said that it consists mostly of SNF assets and that stands out compared to the other publicly traded healthcare REITs, is there a reason why it's almost all SNFs and really no senior housing is that a function of your underwriting cap rates, geographic footprint or any color you could add there?

[Greg Stapley, Chairman and CEO]

This is Greg, Seth it's kind of all of the above. We feel like you know - if you look at just one statistic I saw recently which is that for the past 10 quarters the number of new senior housing units coming on line has exceeded absorption. We feel like there's a lot of markets out there where senior housing is overbuilt, overpriced and we are not ready to step into those.

That doesn't mean that we can't still find the hidden gems out in the sort of B-plus type secondary market assets that we like to find and put in the portfolio when it comes to seniors housing.

But it’s just, I think it's just a coincidence, partly and partly the fact that things do seem overpriced and under occupied out there that makes us - that has put us where we are today - where most of what we're looking at is it skilled nursing.

The skilled nursing side, we're really comfortable in that space as you know. We see - we get much better yields on our investments in that space and from our perspective we don't have - we don't right now don't perceive it as being really any more risky than a lot of the seniors housing assets that are on the market out there and so we're happy to take the risk premium if the market will give us when we acquire those and not feel like we're assuming any real risk when we do so. Does that make sense?

[Seth Canetto, Stifel]

And then, you guys have mentioned how well the transitions have played out this year. And you mentioned Hillstone in Ohio exceeding expectations. Can you just sort of talk about what expectations you had and maybe how they've done what they've done and is there room to grow with that operator?

[Eric Gillis, Director, Asset Management]

Specifically with Hillstone, Hillstone has been an operator here in the state of Ohio for quite some time and really has some great experience in here. And I think really the difference is - Hillstone came in and really understood the facilities that they were taking over and understood the things that they needed to put in place immediately to really bring some good growth to these two facilities.

For example, Toledo, one of the buildings that they took over had struggled with an identity with the past operator and Hillstone came in and embraced it and knew how to - what contracts that they needed to put in place. And because of their presence in Ohio, really had some great contracts that they could put in place that lowered some costs. They understood the labor market very well and have been able to really come in and exceed those expectations from a coverage perspective.

In regards to the rest of the portfolio in the state of Ohio, we're seeing the trends in occupancy is definitely coming along and we're even seeing it increase over the model that we had going into the transition. We're also seeing some really good labor management and really focusing on cost and being able to focus on cost but really giving great quality care as well.

Having toured these buildings now, meeting with the directors of nurses and meeting with their staff, it's really incredible the delivery of service that they're giving from a clinical perspective. So, we're seeing a lot of great progress in the state of Ohio, and we're really excited about where it's going to continue to go.

[Operator]

[Operator Instructions] And our next question comes from the line of Jordan Sadler of KeyBanc. Your line is now open.

[Jordan Sadler, KeyBanc]

I just had one more regarding inflation. I think Bill you assumed 2% in the guide. Can you maybe elaborate a little bit in terms of what the actual realized escalators have been to date and if there are any meaningful escalators to set in 4Q?

[Bill Wagner, CFO]

For the year, I'd say most of the CPI bumps have been around 2% or slightly over. For the remainder of this year - for those that have not always been calced and included in our guidance, I think there's only one more lease that has a renewal - that has a bump on December 1 and it’s not material.

[Operator]

And I’m not showing any further questions at this time. I would like to turn the call over to Greg Stapley for closing remarks.

[Greg Stapley, Chairman and CEO]

Thanks Mark. Thanks everybody for being on the call and we hope to see some of you at NAREIT this week and for the rest of you. If you have any other questions, please don't hesitate to give Bill, me or anybody on the team a call. Thanks.

[Operator]

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