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Is CareTrust REIT a Buy?

By Jason Hall - Jun 22, 2019 at 12:01PM

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By most metrics, CareTrust looks expensive. But there's a very good reason why investors should consider buying anyway.

It's been a pretty good year for healthcare-focused REITs -- real estate investment trusts. Between fears of economic weakness and the 20% market drop to close 2018, many of the best-known healthcare REITs have seen their stock prices gain more than 30% over the past 12 months.

CareTrust REIT (CTRE -0.85%) is at the top of the list, with its share price up 49% since last June. If we add in dividends paid, total returns are 56% over the past year. That's pretty nice if you've owned it over that period.

There's a catch: Its stock price has gone up much faster than cash flows, resulting in a heady valuation that can easily be called expensive. On the other hand, there's also an argument that based on its balance sheet and cash flows -- the product of a very talented management team's actions -- it's still buy-worthy.

Man standing at a fork in the road, scratching his head.

Image source: Getty Images.

So which is it: buy or not? In short, a deeper look says CareTrust is the rare company that's worth paying a little bit of a premium for. The combination of its existing assets, a big tailwind from a huge demographic shift, and one of the best-executing management teams in the healthcare REIT space could make it one of the best stocks to own over the next two decades.

CareTrust is expensive

Over the past year, CareTrust's stock price has shot up company guidance for funds from operations -- or FFO, a better proxy for profits than earnings for REITs -- for the full year of $1.35 to $1.37 per share, a small improvement from last year's $1.28 per share. That works out to 18 times 2019 FFO at recent prices, not cheap for a REIT at all.

That's particularly true when considering CareTrust's dividend. After the run-up, investors who buy at recent prices would earn a 3.4% yield. Here's how that compares to some of its well-known peers:

CTRE Dividend Yield (TTM) Chart

CTRE Dividend Yield (TTM) data by YCharts.

As you can see, there's a substantial difference between what CareTrust yields -- for more context, it's nearly the lowest-yielding REIT in its category -- and what investors could earn from some of its bigger peers.

Here's why it may be worth a premium

Sure, investors could capture a higher yield by investing in any of the three REITs above. Moreover, I think there's a solid case to be made that HCP Inc. (PEAK -0.84%) and Welltower (WELL 0.35%), both of which also own senior-focused housing and healthcare properties, should also do well as America's Baby Boomer population ages, creating the biggest population of seniors in history.

But CareTrust stands out in the strength of its balance sheet and cash flows:

CTRE Financial Debt to EBITDA (TTM) Chart

CTRE Financial Debt to EBITDA (TTM) data by YCharts.

The table above tells us that CareTrust's balance sheet is less leveraged with debt, and it spent a much smaller portion of cash flows on dividends. These two things mean the company has more breathing room to meet its financial obligations and should also prove to have more flexibility to access capital to fund growth initiatives.

Moreover, CareTrust is still a relatively small fish in the huge ocean that is senior housing and healthcare real estate. It owns fewer than 250 total properties, compared to more than 700 for HCP and almost 1,700 for Welltower.

Lastly, CareTrust isn't the only healthcare REIT that's seen its valuation surge over the past year. HCP management called for $1.73 per share at the midpoint in adjusted FFO for 2019 on the Q1 earnings call, putting its valuation at nearly 19 times 2019 FFO. Welltower management called for $4.17 in normalized FFO at the midpoint this year; at recent prices, it trades for just under 20 times 2019 FFO.

Put it all together, and CareTrust doesn't look quite so expensive, at least compared to its peers, when we consider multiple factors that are material to its ability to both maintain the dividend and -- more importantly -- raise it over time.

A perfect "buy now, buy more on the dip" stock

I'm not going to try to predict what CareTrust stock -- or its peers -- will do over the short term. There are too many factors that simply cannot be predicted, despite its relatively rich valuation, to say whether it will fall in value or gain over the next year or so.

But I have absolutely no problem predicting that CareTrust will deliver solid long-term returns for investors who pay even today's near-record price for the company. It is as well run as it gets, owns an excellent collection of cash-generating properties with great operators under long-term contracts, and has a massive demographic trend in its favor to support multiple decades of growth.

From where I sit, that makes it worth potentially overpaying for today and being prepared to act opportunistically to buy more if the stock price were to fall in the near term on a market "correction" of its valuation or that of its peers. Sure, that might create a little short-term pain if your initial investment falls into the red, but patient investors should be rewarded with tremendous long-term gains.

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Stocks Mentioned

CareTrust REIT, Inc. Stock Quote
CareTrust REIT, Inc.
$17.49 (-0.85%) $0.15
HCP, Inc. Stock Quote
HCP, Inc.
$30.63 (-0.84%) $0.26
Welltower Inc. Stock Quote
Welltower Inc.
$89.97 (0.35%) $0.31

*Average returns of all recommendations since inception. Cost basis and return based on previous market day close.

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