Healthcare real estate investment trust HCP (HCP 1.47%) reported strong third-quarter earnings and increased its full-year 2017 guidance. In addition, the company announced several transactions designed to further reduce its concentration to its largest tenant and strengthen the balance sheet. Here's a rundown of the news and what it means for investors.
The third quarter was strong
For the third quarter of 2017, HCP reported adjusted funds from operations (FFO) of $0.48 per share, which is down by $0.02 from last year (excluding HCP's spun-off assets). However, this isn't bad news. HCP has taken steps to get rid of certain assets in order to pay down debt and strengthen its balance sheet, so its FFO is coming from a narrower pool of assets and, more importantly, is more stable and secure than it was a year ago.
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On a same-property basis, net operating income grew by 2.5% year over year. And the company's FFO is far greater than the $0.37 per share it pays out in dividends. In fact, this translates to a 77% payout ratio, which is actually quite low for a REIT.
Adding to the good news is HCP's increased full-year guidance. The company has increased its adjusted FFO guidance range to $1.92-$1.96 per share, which is two cents higher than the previous guidance, at the midpoint.
In fact, HCP's stock price was up by more than 4% after the earnings announcement (as of 10:30 a.m. EDT on Nov. 2), indicating that investors are more than satisfied with the results.
Newly announced transactions should pay off in the long run
Along with its third-quarter earnings, HCP also announced several transactions designed to reduce its concentration to its largest tenant, Brookdale Senior Living, and strengthen the company's financial condition. Specifically, the company plans to:
- Sell six of its properties to Brookdale for $275 million.
- Purchase Brookdale's 10% interest in two joint ventures for $99 million.
- Terminate management agreements with Brookdale on a total of 68 senior housing properties. HCP plans to either transition these properties to other operators or sell them.
- Retain the right to terminate management agreements on its 20 remaining SHOP (senior housing operating properties) managed by Brookdale.
Overall, these transactions are expected generate about $500 million in proceeds initially, and future transactions on the former Brookdale properties are expected to generate an additional $600 million to $900 million.
To be clear, these transactions are likely to have a negative impact on HCP's bottom line in the near term. According to estimates by the company, the announced transactions should reduce FFO by $0.07 to $0.10 per share.
However, the long-term benefit should certainly outweigh any short-term weakness. Reducing the Brookdale concentration from 27% of cash net operating income to 15.7% adds diversification to the portfolio and will allow HCP to pay down debt and strengthen its balance sheet.
Not quite there yet, but on the right track
The Brookdale transactions are part of a plan that has been in progress since early 2016 to transform HCP into a well-diversified REIT with an extremely solid asset portfolio. The first phase of the plan -- removing HCP's skilled nursing facilities from the portfolio -- was completed in October 2016 by spinning them off into the newly created REIT Quality Care Properties, or QCP.
The other part of the plan involved reducing HCP's concentration to its largest tenants, paying down debt, and ultimately earning an upgrade to the company's credit rating. After the Brookdale transactions are completed, HCP estimates that its concentration to its top three tenants will fall to 29%, sharply lower than 54% in the third quarter of 2016, and that its net debt will fall below 6.0 times adjusted EBITDA, down from 6.5 times before the QCP spinoff.
While the transformation isn't quite finished yet, HCP has stuck to its plan, and the results so far have been rather encouraging. In a nutshell, this was a solid quarter that shows HCP's efforts are paying off -- earnings are more predictable than they used to be, and the company is well-positioned to grow responsibly and take advantage of the growth in healthcare real estate that is expected to take place over the next several decades.
