CareTrust REIT (NASDAQ:CTRE) largely owns nursing homes. As the baby boom generation enters their retirement years, they're providing a huge tailwind for such properties, which is a big selling point for healthcare real estate investment trusts (REITs) like CareTrust. So far CareTrust has done a pretty good job of capitalizing on the opportunity in its relatively short history. That said, there are some important negatives here to know about if you are considering investing in this REIT.
A relatively new REIT to market
CareTrust only came public in mid-2014, when it was spun off of the Ensign Group. The main goal of this move was to split the ownership of Ensign's physical assets from the actual day-to-day running of the assets. The problem is that CareTrust started its life with 94 properties and just one major tenant. From a diversification standpoint, that's a terrible position to be in for a REIT.
CareTrust quickly went to work buying new properties. Today it owns around 200 facilities spread across 22 different operators. Ensign still accounts for around a third of the REIT's rent roll, but that's a huge improvement over 100%. And the change here was achieved in just five and a half years or so. Management did a lot of heavy lifting...and didn't obliterate the balance sheet in the effort.
In fact, CareTrust's debt-to-equity ratio of 0.25 is notably below those of some of the largest players in the healthcare REIT space. Its debt-to-EBITDA ratio of 4.8 is also relatively strong. And its 2.75 times interest coverage is greater than two of the three largest and most diversified peers in the healthcare REIT sector. So CareTrust looks like it is on fairly solid financial ground.
Investors, however, haven't just benefited from increased diversification and strong finances -- they also received an increasing stream of dividends. CareTrust has upped its disbursement each year since it came public, taking the regular quarterly dividend from $0.125 in 2014 to the current level of $0.225. That's a whopping 80% increase in just five and a half years. Management is clearly keeping investors in mind as the REIT grows.
So what's the problem here?
There are a couple of issues that investors need to take into consideration before putting CareTrust on their buy list. The first is that it largely owns nursing homes (71% of assets, with another 10% a mixture of skilled nursing and assisted living). Nursing home bills are usually paid for by third parties, notably Medicare and Medicaid. Payments from third parties can change dramatically and, at times, become politicized. Many investors prefer healthcare REITs that get most of their income from private payers (the actual customers). For more conservative investors, this alone might be a reason to nix CareTrust from consideration.
The second big issue is valuation. While the 4.4% dividend yield (more than twice what you'd get from an S&P 500 index fund) backed by a swiftly expanding disbursement may seem enticing, it is relatively low for CareTrust. Looking at the valuation issue a different way, the stock is trading for roughly 15 times CareTrust's projected 2019 funds from operations (FFO is like earnings for an industrial company), a dear price historically speaking. Put simply, investors are aware of the REIT's successes and are paying up for it. This is not a value play, though you could argue that the dividend growth CareTrust has shown so far is worth a premium price tag.
Another issue to keep in mind is that CareTrust recently did some "spring cleaning." That's the term management used to describe its decision to sell some assets and shift properties to new operators. These and other moves resulted in a $16.7 million third-quarter impairment charge, the write-off of $12.1 million worth of rents, and a $1.1 million loan loss reserve. In some ways this is actually a good thing, as the "spring cleaning" addressed problems within the portfolio. However, investors should be asking why these problems existed in the first place.
Put simply, after roughly five years of rapid growth, CareTrust ended up with some properties and operators that were less desirable. That is bound to happen when a company is growing quickly. Since growth is the core story here, investors should be prepared to see this type of "cleaning" effort happen again. It is worth noting that shares are down roughly 17% since management started to talk about this process in its second-quarter earnings release. Since the stock still looks fully priced, even after the drop, investors should be prepared for more choppy price performance if CareTrust needs to do additional "cleaning" in the future.
A mixed showing for CareTrust
The management team at CareTrust has done a very good job of growing and diversifying its business while rewarding income investors with dividend growth. There's no particular reason to expect that to change. However, it is heavily focused on nursing homes, which can be a difficult niche to navigate. And the valuation here still seems to be pricing in lots of good news. While dividend growth investors may want to take a closer look, conservative investors and those who prefer bargains would probably be better off on the sidelines.