CareTrust REIT: Long-Term Outlook Favorable But Currently Fairly Valued - CareTrust REIT, Inc. (NASDAQ:CTRE)

CareTrust (CTRE) has a portfolio of senior housing and healthcare properties in 28 states. The REIT should benefit from an aging U.S. population and the trend towards more outpatient services. CareTrust has a strong balance sheet that should allow it to pursue opportunistic acquisitions to grow its portfolio. The REIT currently pays a growing dividend with a dividend yield of 3.6%. However, its shares are currently fairly valued. We believe investors may want to wait for a pullback.

In Q1 2019, CareTrust reported that its normalized funds from operations increased by 16% year over year to $27.9 million. Similarly, its funds available for distribution also grew by 16% to $29 million. Despite its double-digit growth in normalized FFO, its FFO per share remained flat in Q1 2019 due to temporary dilution from equity issuance. CareTrust also had an eventful quarter as the company reported approximately $290 million in new investments.

CareTrust has a geographically diversified portfolio of 211 facilities in 28 states. It has a large exposure to some of the populous states such as California and Texas.

As can be seen from the table below, nearly 73% of its rental revenue in Q1 2019 came from skilled nursing facilities. The rest of revenue came from multi-service campus (14.1%) and seniors housing properties (13.3%).

There is an ongoing migration of medical services from hospitals to other less urgent services such as skilled nursing services. As the chart below illustrates, distribution of outpatient revenues has increased from only 28% in 1994 to 48% in 2016. On the other hand, distribution of inpatient revenues has declined from 72% in 1994 to 52% in 2016. We believe CareTrust's exposure to skilled nursing facilities is well-positioned to benefit from this trend.

According to a 2014 report by U.S. Census Bureau (see first chart below), Population over 85 years old is expected to double in 20 years. It is estimated that seniors between 65 to 84 years old spend on average 2.2 times than an average person in the United States (see second chart below). This significant growth in senior population has resulted in higher total capital expenditure nationally. According to Centers for Medicare & Medicaid Services, national spending on healthcare is projected to grow 5.5% annually between 2018 and 2027. This means that the total healthcare expenditure will reach nearly $6 trillion by 2027. We believe there will be significant growth in demand for skilled nursing services and other healthcare related services. This will in turn result in strong demand for healthcare properties. We believe CareTrust is well-positioned to take advantage of this trend and grow its revenue.

Most of CareTrust’s leases are triple net leases. This means that its tenants who rent these properties are responsible for paying property taxes, maintenances of the building, and insurances. Therefore, the maintenance expenses are low for CareTrust. In addition, the company’s leases are well-protected by inflation-based rent escalations. Management expects that its average rent increase this year is about 1.5%.

CareTrust has a conservative balance sheet with no significant debt maturities before 2025. This means that management does not need to worry about refinancing its debt in the next 4 years.

Its net debt to EBITDA ratio of 3.3x is quite low. In fact, it is also much lower than its target of 4.0x ~ 5.0x range. Management has indicated in its past few conference calls that they do not expect this ratio to stay this low. In other words, management expects to lever its balance towards future growth if they can find good investment opportunities to grow its portfolio. Therefore, we expect any announcement of quality acquisitions will be positive to its share prices.

Share price of CareTrust has appreciated by nearly 70% in the past 3 years. The company expects to generate an adjusted funds from operations between $1.35 and $1.37 per share in 2019. Using the midpoint of its guidance, its price to 2019 AFFO ratio is about 17.8x. This is slightly higher than Physician Realty’s (DOC) 16.6x but comparable to HCP REIT’s (HCP) 17.8x.

CareTrust pays a quarterly dividend of $0.225 per share. This is equivalent to a dividend yield of about 3.6%. The company has raised its dividend 3 times in the past 3 years. Its current dividend yield is towards the low end of its 3-yield range. CareTrust’s dividend is secure with a payout ratio of about 70% in Q1 2019.

Reduction of healthcare reimbursement from government programs and private insurance payors

Sources of revenue for CareTrust’s tenants typically include the U.S. federal Medicare program, state Medicaid programs, private insurance payors and health maintenance organizations. However, its tenants continue to face increased government and private payor pressure to control or reduce healthcare costs and significant reductions in healthcare reimbursement. These trends will continue to pressure its tenants’ profitability and may hinder their ability to renew their leases at higher rates.

We like CareTrust and its portfolio of healthcare properties. The company also has a growing 3.6%-yielding dividend. However, its shares are currently fairly valued. We think the risk/reward is not particularly compelling at this moment. We think investors may want to wait for a pullback or seek opportunities elsewhere.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Additional disclosure: This is not financial advice and that all financial investments carry risks. Investors are expected to seek financial advice from professionals before making any investment.

Source: Seekingalpha.com

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