Sunrise Assisted Living (NYSE:SRZ) has been changing its business model to both improve the business and keep its bankers happy. Its earnings report, released Monday, seems to imply that Sunrise is nearing the end of its remodeling.
Historically, Sunrise's business involved building, owning, and managing senior-living residences. However, in 1999 a bad acquisition and a heavy debt load caused Sunrise's earnings to tank, while public-pay competitors such as Manor Care (NYSE:HCR) and Beverly Enterprises (NYSE:BEV) suffered from Medicare cutbacks. At that point, Sunrise decided to redefine recurring earnings to include real estate sales. Its explanation was that "normal operations" involved building residences and selling them to third parties. Consequently, Sunrise reasoned, income from property sales should not be considered one-time gains.
One problem (of several) with this reasoning was that Sunrise was realizing long-term portfolio appreciation in a single year. Suppose in 1995 I looked at various neighborhoods, prudently researched mortgages in the Motley Fool Home Center, and finally bought a house for $100,000. Suppose I turned around and sold it now for $200,000. Even if I build another house, my wife would be displeased if I quit my day job, claiming that my recurring income is $100,000. Nevertheless, these unconventional earnings numbers seemed to support the stock.
In late 2002, Sunrise decided to change into a management services company. Under this model, Sunrise wouldn't own any real estate but just manage buildings owned by third parties. This strategy seems more sustainable since management revenue is recurring.
With Monday's report, Sunrise is nearing the end of its transformation. It now has only 35 wholly owned communities, down from 109 in 2000. The change in the business model has greatly improved the balance sheet. Debt has fallen from $700 million in 1999 to $232 million, and the debt-to-equity ratio has dropped from 2.09 to 0.47. Sunrise's revenue from property sales has been used to acquire Marriott's (NYSE:MAR) senior-living subsidiary and to repurchase shares. The firm's shares outstanding have decreased almost 10% since 1999.
Furthermore, the future reduction in property sales income may not have the catastrophic effect on Sunrise's earnings that seemed possible a year ago. Sunrise was able to grow management service revenue by 70% year over year, which boosts confidence that Sunrise can achieve its aggressive 2004 management service earnings projections of $1.55 to $1.65. If it succeeds, Sunrise will be less dependent on property sales to sustain future earnings.
One negative of the new Sunrise is that the company will not participate in the future appreciation of its real estate. However, overall, things look good. Sunrise has survived several years of weaker operating earnings, grown revenues, bought back shares, sold much of its real estate when prices were high, and reduced leverage.
Fool contributor Richard Gibbons does not own any of the securities mentioned in this report.
