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HCP, Inc. (HCP 1.00%) reported its second quarter earnings, and slightly beat expectations for funds from operations (FFO). Additionally, the company raised its full-year adjusted FFO and funds available for distribution (FAD) guidance. While the earnings report was pretty solid, it's the upcoming spinoff that is creating uncertainty among investors, and here's what we learned.
Solid earnings and increased guidance
HCP's earnings report looked pretty solid all around. The company reported FFO of $0.71 per share which slightly beat analysts' expectations by a penny. Adjusted FFO, perhaps the most accurate indicator of REIT earnings came in at $0.74 per share.
At first glance, it may appear that this was worse than the $0.79 per share AFFO of the same quarter last year, but last year's number included $0.08 from the company's HCR ManorCare assets and this year's figures did not include that income source. Also, the company reported FAD of $0.72 per share, more than enough to cover HCP's $0.575 quarterly dividend.
During the quarter, HCP actually disposed of more assets than it acquired -- $282 million in all. From the three largest disposition transactions, the company recognized a total of $135 million in gains. In all, the company expects to dispose of about $1.25 billion in assets this year, not counting the upcoming spinoff.
As far as the full-year outlook is concerned, the results were pretty promising. While FFO guidance was lowered a bit, adjusted FFO guidance was raised from a range of $2.77-$2.83 to $2.83-$2.89, and FAD guidance increased from $2.65-$2.71 to $2.68-$2.74. Since these are the best two metrics for assessing REIT profitability and the ability to pay dividends, it's fair to call this "increased guidance" for 2016.
Update on the spinoff: Hello QCP
Many HCP investors, myself included, were eager to get an update on the pending spinoff of the HCR ManorCare portfolio into a newly created REIT, and we got one.
We now know that the new REIT will be known as Quality Care Properties, or QCP for short. The company announced that it filed QCP's registration statement with the SEC this month, and that the spinoff is expected to be completed during the fourth quarter of 2016. We don't know, however, how many shares of QCP shareholders will receive for each share of HC, or what QCP's stock symbol will be. I assume it will simply be QCP since there isn't currently a stock with that symbol, but we don't know for sure.
QCP will initially own 336 post-acute/skilled nursing properties, a surgical hospital, and one medical office building. The vast majority of the properties are HCR ManorCare, but the rest of HCP's post-acute/skilled nursing portfolio is included in the spinoff as well.
The transaction will not qualify as a tax-free spinoff, but HCP's letter to shareholders states that "for stockholders with sufficient tax basis in their HCP common stock and that hold their HCP common stock for the entire taxable year of HCP in which the spin-off occurs, the net effect of the spin-off is that the distribution is expected to be treated as a return of capital not subject to tax."
What will happen to HCP's dividend?
One area of concern for shareholders is the dividend policies of both post-spinoff REITs. The company has said that both REITs will set their own dividend policies, and while both have to pay out at least 90% of their new income, we don't know for sure what that means -- as most REITs pay out more than their net income (which is why we use FFO and FAD to determine earnings, not net income). In fact, HCP's net income for 2015 was just $1.21 per share, far short of the company's $2.30 annual dividend rate. However, adjusted FFO of $3.16 was more than enough to cover the payout.
While I'm fairly certain that the post-spinoff HCP will continue its policy of high, growing dividends, QCP is more of a mystery. In the company's registration statement, QCP said that it anticipates a "conservative distribution policy" initially in order to maximize liquidity and flexibility. While this makes perfect sense, given the objective to maximize the value of a troubled portfolio of assets, a dividend policy that's too conservative could leave shareholders unhappy.
The bottom line on HCP
I love HCP as both an income investment and a long-term growth play. In fact, I own shares of HCP in my own retirement account. Having said that, if you decide to buy HCP, it's important to be aware that the upcoming spinoff creates some uncertainty, which could lead to volatility as both companies adjust to operating independently and shareholders swallow any changes to the dividend policies of both companies. Over the long term, however, HCP has a winning business model, and a solid strategy to maximize shareholder value.
