By Dane Bowler :
The healthcare sector touts impressive demographic data
suggesting a continued rise in the 80+ population. This extra
demand is bolstered by the government's continued support of
Medicare and Medicaid which survived sequestration unscathed. The
healthcare REIT sector is fundamentally desirable and investors
know it as evidenced by the average FFO trading multiple of 18.1.
This article will detail Brookdale Senior Living ( BKD ) as a
value-friendly alternative to gain exposure to a powerful industry.
We will begin with an overview of the sector's valuation over the
past year to demonstrate the importance of value when investing in
Historical healthcare valuation
Among healthcare REITs, there is a powerful correlation between
cheap valuation and subsequent performance. I would posit that it
is a causal relationship as well. Each healthcare company has
similar access to the industry's powerful fundamentals, so by
buying those with the lowest trading multiples, you get the most
bang for your buck. Let us examine this fundamentally driven trend
over the past year.
The entire sector has performed favorably, but the cheap REITs
have substantially outperformed. Four in particular have
exemplified the aforementioned correlation.
In June of 2012 Sabra Healthcare ( SBRA ) was the
cheapest before rising over 70% to its current multiple of 15.9.
Medical Properties Trust ( MPW ) was next in line
as the cheapest, and it too exploded to a healthy valuation. Such
movement left Omega Healthcare ( OHI ) as the value
champion which in turn rose from under $23 to over $32.
As the sector became overvalued, AVIV REIT ( AVIV ) went public at
$20 which made it the cheapest healthcare REIT. In just over a
month, it now trades above $25.
When seen as an aggregate, the correlation between value and
performance in the healthcare sector looks like this.
(click to enlarge)
Data from SNL Financial
While OHI, MPW and AVIV are arguably still decent values, they
lack the extremely cheap valuation that has brought their investors
so much success. There is, however, one healthcare company that has
remained cheap despite the industry's strength: Brookdale Senior
Overview of BKD
Brookdale is a REOC that offers a variety of senior housing
products. Its units can be broken into the 5 categories shown
(click to enlarge)
It has a market cap of $3.3B which places it in the middle of
the pack by size. A fair amount of leverage allows it to have over
$4.6B of assets despite only around $1B of equity. These assets are
distributed over the units listed above and across the entire
(click to enlarge)
Unlike the healthcare REITs which mostly lease out their
properties, BKD functions as an owner, operator, and manager.
BKD can be considered the premium package of senior housing as
its facilities have amenities that go above and beyond medical
needs. It caters to the wealthier portion of the 80+ population and
consequently gets much of its revenues from private pay.
This affluent consumer is the key to its first catalyst of
Outperformance catalyst #1: an increasingly wealthy
In addition to the rising number of 80+ seniors, a greater
percentage of them have substantial wealth. According to a March
2013 presentation , the number of 80+ seniors making
over $50,000 a year is projected to rise 34.6% by 2015. It just so
happens that the average annual rent charged by BKD is just over
$50,000, so the 34.6% increase translates directly into its
potential customer base.
One may view an investment in BKD as an interest rate hedge as
rising interest rates would tend to bolster the income of retirees,
further facilitating demand for its high-end senior living
Outperformance catalyst #2: a healthy acquisition
While the healthcare REITs seem to be able to make nice
acquisitions of their own, BKD has a unique angle from which to
acquire. Much of its leased portfolio comes with purchase options
at the end of the term. On Jan 15th, BKD announced the acquisition
of 12 communities for $162.1mm and each was acquired through
exercising a purchase option.
Since these leases were written back when the environment was
not as strong, the price was considerably cheaper than would be
charged today. Each was acquired at a cap rate greater than 9%.
In addition to external growth, BKD is well positioned for
increasing profits in its current portfolio.
Outperformance catalyst #3: organic growth
Its internal growth can come from two sources: leasing and
Brookdale has been quite successful with leasing in recent
quarters, but it has way to go.
(click to enlarge)
Both rates and occupancy have been steadily improving. I expect
the demand growth from demographics and affluence to afford
continued improvement. Such progress seems to be supported by
conservative new supply among senior housing.
(click to enlarge)
Beyond getting more residents and charging more rent to each,
BKD is further profiting by providing extra services. Brookdale
offers a variety of therapies aimed at improving quality of life.
As many of these are not medically necessary, government
reimbursement has been difficult to attain, but most are paid for
through private pay. With all services being performed in the
on-site clinics or in the patient's units, costs are minimal and
margins are strong. In 2012, ancillary services contributed $47.8mm
The Buy Thesis
Brookdale Senior Living is significantly cheaper than the
healthcare REITs as it trades at an FFO multiple of 11.07. In
contrast, healthcare REITs trade at an average multiple of 18.1,
with even the cheapest (( OHI )) trading at 13.3.
BKD has numerous fundamental catalysts which allow it to excel in
the present environment and take advantage of favorable industry
trends going forward. I believe BKD is an excellent play on the
healthcare sector, but we must also consider its risks.
Risks and Concerns
Healthcare is traditionally considered to be a defensive sector
as its demand remains strong even during recessions. This benefit
does not apply to BKD. Its quality of care goes well beyond the
medically necessary and there are cheaper sources of care. If the
economy does not support sufficient income streams, Brookdale could
lose occupancy and be forced to cut rates.
Healthcare also comes with political risk as cuts to Medicare or
Medicaid could damage income. While BKD has reduced exposure to
this risk due to its high private-pay component, it remains a
Additionally, healthcare investors need to be concerned about
regulation changes to standards of care. Such changes can raise the
cost of providing certain services. In my opinion, BKD has a
reduced risk here as its premium quality healthcare would likely
already exceed the new standard of care.
Since healthcare companies each have access to the favorable
industry fundamentals, valuation seems to be the driving factor of
outperformance. Its cheaply-valued peers have already outperformed,
leaving Brookdale next in line. I am very bullish on its economic
prospects, but less on its near-term stock performance. Until the
dividend craze winds down, I doubt the non-dividend paying BKD will
outperform. However, as it continues to grow earnings, it will
become an increasingly irresistible value. Investors could buy now
for a long-term investment, or wait for the dividend craze to end
for faster capital gains.
Disclosure: 2nd Market Capital and its affiliated accounts are
long OHI, MPW, SBRA and AVIV. I am personally long OHI and AVIV.
This article is for informational purposes only. It is not a
recommendation to buy or sell any security and is strictly the
opinion of the writer.
Disclosure: I am long [[OHI]], [[MPW]],
[[SBRA]], [[AVIV]]. I wrote this article myself, and it expresses
my own opinions. I am not receiving compensation for it (other than
from Seeking Alpha). I have no business relationship with any
company whose stock is mentioned in this article.
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