Healthcare, especially when it involves taking care of senior citizens, has the potential to be a rapidly growing industry for decades to come. As the baby boomer generation continues to retire, and Americans on average live longer lives, the senior population in the U.S. is expected to roughly double over the next 40 years.
HCP, Inc. (DOC 2.51%) and Senior Housing Properties Trust (DHC 2.10%) are real estate investment trusts that invest heavily in senior housing and medical offices. With similar objectives, these companies make for a logical comparison, and one that I've discussed before. However, since I last looked at these two REITs side by side, their share prices have dropped considerably -- HCP's by 15% and Senior Housing Properties Trust's by 8% -- and another set of quarterly earnings reports have been revealed. So let's see which is the better buy now.
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Similar business models
As I mentioned, the basic business models of these companies are quite similar. Both have substantial investments in senior housing and medical office properties in the U.S., and are well-positioned to take advantage of the expected growth in the senior housing market.
HCP is the larger of the two, with a market capitalization nearly three times that of Senior Housing Properties Trust. As of the latest available data, HCP owns 799 properties, and by rental income, 44% are senior housing, 23% are medical offices, 23% are life science facilities, and 10% are other property types.
Senior Housing Properties Trust's portfolio of 434 properties consists almost entirely of senior housing (53%) and medical office buildings (41%). The other 6% is made up of skilled nursing facilities and wellness centers.
Why have these stocks dropped recently?
REIT stocks have been weak in general, thanks to rising interest rates, which are generally a big negative catalyst to high-yield stocks. In addition, there have been several analyst downgrades recently in the healthcare REIT space, citing factors like oversupply fears in the senior housing industry, and in HCP's specific case, potential for declines in its funds from operations (FFO) after proposed asset sales take place.
To be clear, these stocks are down for a reason. And they could have further to fall over the near term, especially if more downgrades happen or if interest rates end up rising even faster than expected.
However, all of the factors that have driven the stocks lower should be temporary issues. While these healthcare REITs could be volatile in the short term, this could be an excellent opportunity to get into a long-tailed growth opportunity at a discount.
A big difference in dividends
One major difference between the two stocks is in their dividend yields. HCP pays a very strong 5.5% annual yield, while Senior Housing Properties Trust pays a staggering 8.1%.
There are a few things of note here. For starters, HCP's dividend represents a lower percentage of its FFO. The current dividend rate of $1.48 per year is about 73% of the company's 2016 adjusted FFO (backing out the contribution of spinoff Quality Care Properties), and about 77% of HCP's expected 2017 adjusted FFO. Note that HCP's FFO is expected to decline a bit in 2017 -- as I noted earlier, the company has sold some assets, a move that reduces its earning power. On the other hand, Senior Housing Properties Trust pays out 83% of its 2016 normalized FFO. This leaves HCP with relatively more money to reinvest and grow the business, and also gives it more of a cushion to sustain its dividend if FFO falls.
Also, Senior Housing Properties Trust uses significantly higher leverage to generate income, which adds another element of risk. The company's debt-to-total-capitalization ratio is 44% as of this writing, significantly higher than HCP's 36%. This risk difference is reflected in HCP's higher credit rating (Baa2/BBB, versus Baa3/BBB- for Senior Housing Properties Trust).
Which is the better buy?
From a valuation standpoint, Senior Housing Properties Trust looks like a far better value, the same result as last time I looked at these two. The stock trades at a P/FFO multiple of 10.4, significantly higher than HCP's multiple of 13.2 based on last year's earnings.
However, there's the question of how much HCP's lower-risk business is worth. HCP has lower debt, better credit, and a better dividend payout ratio. It is also the larger company, and until the 2016 spinoff of QCP, it had a 25-plus-year track record of dividend increases. I also consider HCP's more diverse portfolio to be a positive factor, as its large life science portfolio could help to offset any oversupply effects in senior housing.
The bottom line in this comparison is, if you want a high dividend and a cheap stock, with room for long-term growth, choose Senior Housing Properties Trust. On the other hand, if you want a strong dividend and excellent growth potential without excessive risk, HCP is the stock for you. I'm more of a fan of HCP and own it in my personal portfolio, but having said that, I don't think investors will go wrong with either stock.
