The U.S. population is getting older on average, which means a rising number of Americans will need an increasing amount of care. Several real estate investment trusts have sprung up over the years to address this need, and one of the most prominent is HCP (PEAK -0.33%), which specializes in senior housing and related facilities.
Prominence doesn't mean popularity, however. HCP's stock didn't have a great 2017: It slumped by over 12% during the year. Let's explore whether that decline has pushed it into "bargain buy" territory.
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Slimming and diversifying
REITs are required to pay out at least 90% of their net profits in the form of shareholder dividends, which makes them ideal for income investors. As a group, these investors are fairly conservative, and they like consistency and stability.
HCP has been neither consistent nor stable lately, and on top of that, it sliced its dividend last year. But these were actually positive developments. Let me explain.
The REIT has been divesting numerous assets over the past few years. The idea is to raise money so the company can retire debt and become more streamlined in general. It's also reducing its dependence on its top tenant, Brookdale Senior Living (BKD 0.93%), the top owner and operator of senior living and retirement communities in the U.S. Last year, arrangements with Brookdale accounted for 27% of HCP's cash net operating income.
Last November, concurrent with the release of its third-quarter results, HCP announced that it was putting more distance between itself and Brookdale through a set of transactions. These included the outright sale of six properties to Brookdale, the buyout of Brookdale's stake in a pair of joint ventures, and either the termination or the right to terminate the management agreements on nearly 90 senior living facilities. According to HCP, these moves should reduce that 27% share of CNOI to less than 16%.
This announcement came just over a year after HCP completed another big move: spinning off its skilled-nursing and assisted-living facilities. The resulting company, Quality Care Properties (QCP), is now an independent, publicly traded entity.
Transitions aren't easy, and they often exact a high price. Such was the case in the third quarter for HCP, which, on the back of the Brookdale deals, booked a drop in adjusted funds from operations. AFFO slipped by 3% on a year-over-year basis if we account for the Quality Care Properties divestment -- or 32% if we include that unit's results in the year-over-year comparison -- to just under $228 million.
Revenue, unsurprisingly, also slipped -- by 14% to $454 million.
Yet if we look at the balance sheet, HCP's moves are having the desired effect. All of the company's debt items -- term loans, bank lines of credit, senior notes, and especially mortgage debt -- were down from the year-ago quarter. Those four items alone decreased by almost 20% altogether to land at $7.4 billion.
Meanwhile, the REIT's all-important dividend has been stable since the company slashed it in late 2016. The current $0.37 per share is at least sustainable, as it's only 77% of the company's AFFO, which is modest for a REIT. Considering that, we shouldn't be surprised if the company starts raising its payout again, as was its habit in the years before the cut. It's hefty at the current stock price: At a quarterly payout of $1.48, it yields 6.24%.
Senior population explosion
Zooming out a bit, providing senior care facilities is, and will remain, a very good business. From the 2012 level of 43 million, America's senior citizen population is expected to nearly double to nearly 84 million in 2050, providing a massive opportunity for companies that cater to that demographic.
HCP is one of those companies. It's a solid operator in the facilities segment and is taking concrete steps to better position itself to profit nicely from that growth. The REIT didn't deserve the market's shunning of its stock this year, and it's a bargain as a result. To me, it is certainly a buy at its current price.
