Please ensure Javascript is enabled for purposes of website accessibility
Free Article Join Over 1 Million Premium Members And Get More In-Depth Stock Guidance and Research

Why This Dividend Stock Is Still Worth Owning Despite an Earnings Miss

By Reuben Gregg Brewer - Nov 17, 2019 at 1:36PM

You’re reading a free article with opinions that may differ from The Motley Fool’s Premium Investing Services. Become a Motley Fool member today to get instant access to our top analyst recommendations, in-depth research, investing resources, and more. Learn More

After Ventas reported that a key segment won't be growing as fast as predicted, investors punished the REIT's shares. Here's why it's worth giving management more time.

There's no doubt about it, Ventas ( VTR -2.62% ) let its shareholders down with its third-quarter earnings report. The healthcare-focused real estate investment trust's (REIT) actual earnings results weren't bad, but management had made a big promise about 2020 from which it had to backtrack. Understandably, that upset investors.

However, it's important to look at this specific promise and compare the situation at Ventas to "broken promises" made by other companies. After you step back and do this analysis, you'll see that Ventas looks like it's still worth owning... and you'll also get a feeling for what shareholder-friendly companies do and don't do.

News that hurts

Before getting into the situation at Ventas, consider the dividend history of Kinder Morgan ( KMI -1.23% ). In 2016, the midstream oil and natural gas giant cut its dividend by 75%. Management intended to put the freed-up cash toward their capital investment plans -- and they picked that tactic because the company was highly leveraged relative to its peers and selling stock at that point in time wasn't a great option.

It was, in the end, the right move for Kinder Morgan as a company. And, at this point, the dividend is back in growth mode (though the quarterly payment is still just about half of what it was prior to the cut).

Two hands holding blocks spelling out the words RISK and REWARD

Image source: Getty Images

The real problem, though, traces back to the period prior to that dividend deflation.

On Oct. 21, 2015, Kinder Morgan announced that it was on track to increase the dividend by as much as 10% in 2016. By Dec. 4, however, management was throwing off hints that the dividend might not be as secure as those earlier statements had indicated. And then,  on Dec. 8, investors were hit with the news of a 75% dividend reduction. That was a massive change in less than two months. Given this history, it's easy to see why dividend investors might still have serious trust issues with Kinder Morgan.

It would be fair to argue that midstream companies are very different from healthcare REITs. Given that, let's consider an interesting comparison point that's a closer peer to Ventas. HealthPeak Properties, formerly known as HCP, reduced its dividend in late 2016. The move was made in conjunction with the spinoff of the company's struggling nursing home business. The dividend from the newly independent Quality Care Properties was expected to make up the difference, with investors who held both stocks essentially getting the same total dividend as before.   

That was a nice plan, but it didn't work out that way. The struggling nursing home operation, perhaps predictably, couldn't support its dividend, and eventually cut it. So HealthPeak investors basically suffered a dividend cut, even though the original REIT can say that it didn't reduce its payout. QCP itself was later acquired, but for investors, the results were painfully similar to those experienced by Kinder shareholders: Dividend investors were left with a bitter taste in their mouths.  

What makes HealthPeak all the more interesting as a comparison is that Ventas also spun off its nursing home operation. Only it did so before the business started to struggle and without a dividend reduction. Which is where Ventas' third-quarter misstep comes into play. 

Falling flat

Earlier in 2019, Ventas' management had been talking up a "pivot to growth" in 2020, when it believed that senior living facilities would start to see a material uptick in demand and pricing. But when the REIT reported third-quarter 2019 earnings, CEO Debra Cafaro had to tell investors that its forecast had been too optimistic: "Because we will end 2019 and enter 2020 off a lower base, we have also concluded that our enterprise growth will be deferred until after 2020."  

VTR Chart

VTR data by YCharts

The backstory here is that the Baby Boomers are in the midst of transitioning into retirement. That is expected to materially increase demand for senior housing. With that in mind, Ventas has positioned itself to benefit, with a little over half of its net operating income (NOI) dedicated to the space. But roughly 33% of Ventas' NOI is tied to its senior housing operating portfolio. Called "SHOP" in industry lingo, these are assets that Ventas owns and operates (it actually hires third-party businesses to do "operating" part), allowing it to see more revenue when times are good. Unfortunately, the SHOP arrangement also means that Ventas participates in the pain when times aren't so good.  

Everyone is aware of the demographic shift taking place, so other companies have been building senior housing assets, too. At this point, the market is oversupplied. Ventas expected a surge in demand to start sopping up that oversupply, but it only got worse in the third quarter. The REIT was, simply put, taken by surprise.

But the arc of this story hasn't changed -- only the timeline. In fact, Ventas highlighted that demand was strong in the quarter, it was just overshadowed by abundant supply. Further, after a long building spree in the space, construction of new facilities has fallen materially. Ventas may have gotten the timing wrong, but it still looks like it's on the correct course.  

And, notably, management did not cut the dividend after recognizing its misstep. In fact, given Ventas' payout ratio of just over 80% based on its 2019 adjusted funds from operations (AFFO) guidance, there's no particular reason to worry about the safety of the payout right now. If you extrapolate the run-rate based on the fourth quarter, which is expected to be relatively weak, the payout ratio jumps into the high 80% range. That's more troubling, but Ventas has growth plans in other areas (medical research facilities and office buildings, for example) that should help to offset the hit from its SHOP portfolio. So that worst-case scenario for AFFO seems unlikely, and even if it does come to pass, there's still no reason to expect a dividend cut. Ventas is far more likely to simply operate with tight coverage for a little while.  

Its leverage, meanwhile, isn't out of line with its closest peers, so there's no reason to believe it can't muddle through this setback. In other words, its problems look temporary and manageable. Investors definitely should watch the SHOP portfolio's progress. But at this point, there doesn't seem to be a reason to worry that management has done anything more than overhype a turnaround that will now take a little longer than predicted.  

Trust is key

At first blush, you can see why investors took a dim view of Ventas' revelation about its senior housing business and the impact that it will have on the company's near-term growth expectations. It dealt a blow to investor trust, to be sure. But the real impact seems much less material. And based on its past successes (the timely nursing home spin-off, for example), Ventas probably deserves the benefit of the doubt. 

The true moral of the story, however, is that investors should always take a closer look at the details before blindly following Wall Street's lead on a company. Sometimes, the "bad" news really is bad. Other times, the situation is more nuanced. Long-term investors need to take the time to do a bit more digging and figure out the difference. 

This article represents the opinion of the writer, who may disagree with the “official” recommendation position of a Motley Fool premium advisory service. We’re motley! Questioning an investing thesis – even one of our own – helps us all think critically about investing and make decisions that help us become smarter, happier, and richer.

Invest Smarter with The Motley Fool

Join Over 1 Million Premium Members Receiving…

  • New Stock Picks Each Month
  • Detailed Analysis of Companies
  • Model Portfolios
  • Live Streaming During Market Hours
  • And Much More
Get Started Now

Stocks Mentioned

Kinder Morgan, Inc. Stock Quote
Kinder Morgan, Inc.
KMI
$15.27 (-1.23%) $0.19
HCP, Inc. Stock Quote
HCP, Inc.
PEAK
$32.51 (-1.06%) $0.35
Ventas, Inc. Stock Quote
Ventas, Inc.
VTR
$45.69 (-2.62%) $-1.23

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

Related Articles

Motley Fool Returns

Motley Fool Stock Advisor

Market-beating stocks from our award-winning service.

Stock Advisor Returns
656%
 
S&P 500 Returns
144%

Calculated by average return of all stock recommendations since inception of the Stock Advisor service in February of 2002. Returns as of 12/02/2021.

Discounted offers are only available to new members. Stock Advisor list price is $199 per year.

Premium Investing Services

Invest better with the Motley Fool. Get stock recommendations, portfolio guidance, and more from the Motley Fool's premium services.