(NYSE: VTR), pending signs of clear improvement in the senior housing industry. The company’s Senior Living properties were hit hard when coronavirus cases and deaths spiked in 2Q and 3Q. Residents fled senior living communities, and occupancy declined. Same-property occupancy averaged 76.6% in 3Q20, versus 86.4% in 3Q19. Making matters worse, margin compression has historically been an issue in VTR’s Senior Housing Operating Portfolio (SHOP). The SHOP NOI margin was 33.2% in FY15, but declined to 29.6% in FY19. Segment NOI also fell 42.2%. Even with vaccines in distribution, we expect continued challenges for the senior housing segment.
VTR shares have benefited from recent investments in life science properties, as discussed below. But with the shares up in the triple digits from their March lows, VTR is no longer positioned to outperform the overall market, and a near-term HOLD rating appears appropriate.
They have risen 134% from their near-term low on March 18. The beta on VTR is 1.26.
Ventas recently reported results that exceeded analysts’ expectations. On November 6, Ventas reported 3Q20 revenue of $919 million, down 7% from 3Q19, reflecting lower triple-net leased and office segment revenues, partially offset by flat revenue from resident fees and services. Consolidated NOI came to $423 million or 46% of revenue, down from $520 million or 53% of revenue in the prior-year period. Normalized FFO fell 22% to $283 million or $0.75 per share, driven by lower revenue and higher expenses.
Along with 3Q20 earnings, Ventas announced that it had entered into a $930 million joint venture with GIC. The JV will own four in-progress life science developments. Two developments will be in Philadelphia at Drexel University, one will be at the University of Pittsburgh, and one will be at Arizona State University. In another recent announcement, Ventas acquired a life science portfolio in South San Francisco for $1.0 billion. The cap rate on this transaction was approximately 5%.
On July 27, Ventas announced that it was restructuring its agreement with Brookdale Senior Living to address the impact of COVID-19. The agreement revised the master lease between Brookdale and Ventas, with Ventas granting Brookdale rent leniency. Under the terms of the agreement, Ventas will receive $235 million, comprised of cash, a note payable, and stock warrants for up to 8% of Brookdale’s stock at $3 per share. In exchange, Brookdale will receive a rent reduction on 121 senior living communities, lowering Brookdale’s annualized rent paid to Ventas to $100 million from $182 million. This will decrease revenue in Ventas triple-net segment.
Management withdrew its earnings guidance for FY20 in May. It has not reinstated earnings or revenue guidance, but did offer capital expenditure guidance for 2020. It projects capex of $500 million, down from a pre-COVID expectation of $800 million.
EARNINGS & GROWTH ANALYSIS
Third-quarter operating performance and management’s full-year forecasts by business segment are summarized below.
– In the Triple-Net segment, third-quarter same-store cash NOI fell 8.7% from the prior-year period, driven by write-offs of rental income and lower rent due to the above-mentioned Brookdale lease modification. Triple-Net leases require tenants to pay for property taxes, insurance, and maintenance, so the NOI margin runs considerably higher than other segments at roughly 97%. Historically, two of the largest revenue streams have been Brookdale and Holiday Retirement. However, Brookdale renegotiated its master lease at a lower run rate, and Holiday Retirement’s properties have shifted to the SHOP segment. Given the challenges facing two large operators in this industry, smaller property owners are likely to require rent leniency as well. The Triple-Net segment posted same-store NOI growth of 2.2% in 2019 and 3.6% in 2018. The segment accounted for 37% of portfolio income in 2019.
– In SHOP, same-store cash NOI declined 42.2% from the prior-year period. Sequentially, it decreased a more modest 0.6%. Average occupancy declined to 79.6% in September, down from 80.9% in June. Prior to COVID, the SHOP NOI margin had faced pressure from a tight labor market and general oversupply in the senior housing space. The SHOP NOI margin was 33.2% in FY15, but slid to 29.6% in FY19. In 3Q20, the SHOP NOI margin was 28.2%.
– In the Office segment, which includes medical offices and life science buildings, same-property cash NOI came to $125 million, down 2.2% from 3Q19. The decrease was primarily driven by assets sold (intersegment) to Ventas’s Healthcare Fund, a lease termination, write-offs of previously accrued straight-line rental income, and reduced parking revenues. These negatives were partially offset by strong leasing activity and contractual rent increases. Same-store occupancy rose 50 basis points year-over-year to 91.1%. In 2019, NOI was flat at $1.8 billion after rising 1.7% in 2018. The Office segment accounted for 28% of 2019 portfolio income.
We are raising our 2020 normalized FFO estimate to $3.20 per share from $2.92 to reflect strength in certain areas of VTR’s portfolio, such as Triple Net Leased and Office.
FINANCIAL STRENGTH & DIVIDEND
The company has investment-grade credit ratings of Baa2 from Moody’s and BBB+ from S&P and Fitch.
Cash and cash equivalents increased to $588 million from $106 million. The company borrowed $41 million from the $3.0 billion available on its credit facility.
On June 19, 2020, Ventas cut its quarterly dividend by 43% to $0.45 per share. Our 2020 dividend estimate is $1.80 (reduced from $2.14) and our 2021 estimate is $1.88 (lowered from $1.90).
MANAGEMENT & RISKS
Debra Cafaro has been the CEO of the company since 1999. Prior to joining Ventas, she served as president of Ambassador Apartments, a REIT.
The COVID-19 pandemic presents specific risks to companies engaged in the senior living industry, as high numbers of deaths have been associated with nursing homes. While ‘nursing homes’ and ‘senior living’ are not synonymous, demand for senior living facilities could suffer from the public perception that communities with high proportions of senior citizens have greater mortality risk.
Ventas faces risks associated with volatile income in its senior living portfolio, and with its lack of sole decision-making authority in joint venture operations. It also faces risks from healthcare regulation, including changes in reimbursement rates for care at senior living facilities.
REITs face interest rate risk, which may be exacerbated if acquisitions are funded with floating-rate debt, or if existing debt matures and credit conditions are tight. Moreover, healthcare REITs are the most sensitive to interest rate changes of all REIT subsectors.
The company acquires, develops, leases, and manages about 1,200 senior housing and medical office properties. The company was founded in 1998 as a spinoff of Vencor, a healthcare services company. Since 2004, Ventas has completed nine major acquisitions for about $19 billion.
On price/AFFO, the shares trade at 15.2-times. Considering the recent dividend cut and the company’s exposure to senior housing, we believe that the stock is appropriately valued at current levels and are reiterating our HOLD rating.
On December 22, HOLD-rated VTR closed at $49.27, up $0.44.