An aging baby boomer population is set to boost results at HCP, Inc. (NYSE:HCP) and Universal Health Services, Inc. (NYSE:UHS) for years to come. But is it better to own physical assets, like real estate investment trust HCP, or run them, like health facility operator Universal? In the end, these two companies are very similar but also differ in many ways. Here's what you need to know to pick the one that's right for you.
I love a big dividend
I am a big fan of high-yield dividend stocks, so my preference here is for HCP and its 6% dividend yield over Universal Health's paltry 0.3%. But there are details that complicate what would otherwise be an easy decision: Not too long ago, HCP found itself saddled with an underperforming nursing home portfolio, as its lessees struggled to adjust to increasingly stringent government reimbursement rules in a sector that's heavily reliant on Medicare and Medicaid. Getting out from under those assets required a spin-off in late 2016 and, more worrisome, a dividend cut.
Interestingly, healthcare REIT peer Ventas also spun off its nursing home business, but before it became a trouble spot. HCP was clearly late to adjust to changing industry dynamics. But HCP has been doing more than just spinning off troubled nursing homes. It has also refocused its portfolio around medical offices and research facilities, an increasingly important part of the $1.1 trillion healthcare property market (of which REITs overall still have a less than 25% share).
These two business segments make up roughly half of its portfolio today. The rest is largely composed of senior housing assets, a fairly stable business with notable long-term growth potential as the baby boom generation continues to transition into retirement. A high level of building, however, has left senior housing in a temporary funk as demand has to catch up to supply. But medical office and research facilities are still in high demand, and HCP is working to take advantage of the opportunity -- by spending around $600 million on development (with expected returns of 6% to 8%) and redevelopment projects (with expected returns of as much as 12%) in these two segments.
Well-located medical office buildings should benefit as more medical services are provided on an outpatient basis to save money. Medical research assets, meanwhile, support the primary research in areas like pharmaceuticals and medical devices that helps keep people alive longer (a good thing) and are often associated with well-known and financially strong companies and universities (an even better thing). HCP has an impressive list of partners in both divisions. Well-known names like Merck, Duke University, Google, and Amgen reside close by on the research side and HCP has around 80% of its medical office buildings physically located on hospital campuses, run by companies like HCA, on the office side. Meanwhile, both medical office buildings and research facilities tend to have high, sustainable occupancy levels, most recently above 90%.
At this point, HCP looks like it has positioned itself well for the future. Investors looking for a high yield should take a close look -- but also keep in mind that the dividend hasn't been increased since the cut. However, as HCP works through its backlog of construction projects, it's reasonable to expect dividend growth to resume over time. That said, HCP isn't a slam dunk win over hospital and mental health facility operator Universal Health Services.
A good price for a strong performer
Universal Health's business is split roughly evenly between acute care facilities and mental health facilities. It operates in 37 U.S. states, Puerto Rico, the Virgin Islands, and the United Kingdom. The company is set to benefit from the same demographic trends favoring HCP, as well as the increasing prevalence of mental health issues in society, notably including addiction.
Both of Universal's businesses have seen same-store admission growth each year over the past five years. That said, revenue per admission increased annually on the mental health side of the business for the last five years, but dipped slightly into the red in 2017 on the acute care side. That was the culmination of a multiyear downtrend that appears to have reversed course in the first quarter of 2018. The weakness in this division, however, is a notable issue to watch.
A large percentage of Universal Health's top line comes from third-party payments. That includes Medicare and Medicaid, government programs that are under pressure to keep costs low. Insurance companies are another major piece of the puzzle, a group that's also perennially looking to reduce costs. Swift increases in medical costs in recent years coupled with the increasing number of baby boomers passing into their retirement years (those age 65 and older spend four times as much on medical care as those younger than 65) has made cost containment a key focus for these third-party payers. And such cost constraints are likely to remain a key focus for years to come since the wave of baby boomers passing age 65 has yet to crest. But this isn't really a new factor.
In fact, Universal Health has managed to grow its business despite the payment issues it faces. Between 2012 and 2017, the company spent $2.6 billion on capital projects and $2.1 billion on acquisitions. It's top line more than doubled in past the decade, with earnings in 2017 nearly four times higher then they were in 2008. The company is clearly doing something right. To keep growth going, it plans to add beds on both sides of its business, with the expectation of pushing 2018 revenues up by as much as 6% and earnings higher by as much as 25%, using the top end of management's guidance.
What's most enticing about the stock, however, is its valuation. The company's price to earnings, price to sales, and price to book value are all currently below their five-year averages. One thing I like almost as much as dividends is a bargain. Especially at a company that has proven it can manage through difficult times -- something that HCP didn't do so well when it came to the nursing home issue it faced. In other words, there are definitely some things to like at Universal Health Services.
Current income gets the edge
Although I think Universal Health Services has executed better than HCP over the last few years, I'm going to give the nod to HCP and its 6% yield. That's largely because the pain of the REIT's strategic repositioning is behind it. Investors today are buying a very different, and better positioned, company.
While Universal Health's relatively cheap price today is enticing, it's not cheap enough to make up for the minuscule dividend yield, in my book. That's especially important since the business is pretty much always going to face pricing headwinds from key payers. However, I plan to keep an eye on the stock -- if valuations fall further it might be worth a second look.