Sunday, July 26, 2015

Healthcare Property Investors, Inc (HCP) Dividend Stock Analysis

 Hello, this is Div4son,




As you know, I have been studying REITs recently to add to my portfolio. You can read about my evaluation process here.

http://div4son.blogspot.com/2015/05/evaluating-reits.html

After using my simple screen, three companies came up on the top of the list.
  • Yield over Avg Yield > 1.10
  • Yield > 4% (but less than 7%)
  • Chowder > 8%
  • Dividend growth > 5 years

These companies are: WPC, OHI and HCP.

This article summarizes my thought process for evaluating the REIT - Healthcare Property Investors, Inc (HCP).



About  Healthcare Property Investors, Inc (HCP)

Healthcare Property Investors, Inc. is a REIT that invests (via development, leases, mortgage and financing) in real estate serving the  healthcare industry. They focus on five healthcare segments: senior housing, life science, medical office, hospital, and skilled nursing.
 




Criteria List for HCP evaluation


The framework for my criteria is similar to my stock selection which is foundation is based on the SBI book:

Good quality + high yield + high growth (+ time & patience)

There are some differences but overall, I am looking at high quality companies that offers high yield and growth.


HCP May 2015AreaCriteriaCheckListComment

Quality Company
Dividend Growth>10 yearsYes29 years
Rising FFORising FFOYesSee Chart
Payout Ratio (FFO)<85%Yes~70% See Chart
Steady ROE (FFO)Steady FFO ROEYes Adjusted ROE with FFO
P/FFO<15Yes~13
M* & S&P
Credit Rating
> BBB+YesS&P BBB+
Debt to Capital (Bal Sheet)<50%Yes~Mid 40s
M* & S&P Stars> 3 Stars for bothYesM* 4 Stars
S&P CapIQ 3 Stars B Quality

Dividend Growth
& Yield
Dividend Yield>3%Yes5.7
Dividend Growth>5%No5Y CAGR 3.6
Chowder>12%No9.30%

Valuation
Yield/Avg Yield>1.1Yes1.16
Dividend Yield Theory Mid PointBelow Mid PointYesMid Point 41.15
Low Point 25.88
DDRM~10%YesSee Table - ~9.9
M* Estimate<M* estYesM* 51
S&P Estimate< S&P cap IQ estYesS&P Cap IQ 43
Data from M*, gurufocus, yahoo finance, S&P CapitalIQ, David Fish CCC list


One problem that I have is that there is no readily available FFO numbers - eg on M* etc (apart from HCP's IR page which is a pain to copy and paste). 

Therefore, I calculate my trend data & the FFO based on data from Morningstar raw data. (I currently only have access to their free 5 year data.) There is a slight difference (~4-5%) difference in the ratio numbers from the HCP reports - which is sufficient for me to determine the trends.

While I double checked the IR site, please follow your own due diligence process accordingly.

Dividend Growth

Based on David Fish's CCC list, HCP has grown its dividend for 29 years.
This provides a very good indication of HCP's management commitment to provide continued dividends.


Rising FFO & Payout Ratio

As you can see below, the FFO is rising for the last five years. The payout ratio is also currently within the 70% range - reduced from the high 90% in 2010.
The threshold is  85% - which is based on the Ultimate Dividends Playbook recommendation.



The Payout Ratio is based on the FFO. Once I calculate the FFO, I divide by the number of shares to get the FFO/share and I use this with the dividends to get the FFO payout ratio.  

From looking at the data on  HCP's investor relation page, the FFO per share is generally rising YoY for the last ten years. 

The payout ratio was actually quite high ten years ago (high 90s) which explains the slowing down of the dividend growth. 

However, the above data shows that the payout ratio is down to a more manageable level. 

The FAD (similar to FCF in regular stocks) reported by the IR page indicates that it follow covers the dividends in the near term.  

Steady ROE

For HCP, I use the FFO basis to calculate ROE. The equity is adjusted with the depreciation. The adjusted equity is used with the FFO to get the FFO ROE ratio. 






Here, I look for steady FFO ROE year over year for HCP. This is a real estate business, and I am looking for around 10% range. The ROE is quite low for a REIT in 2010/2011 but this during the tail end of the great recession. The current ROE is within range of the 10% threshold.


Price / FFO 

Here, I look for a price to FFO ratio from less than 15 -  The recommendation is from the SBI book to  seek a moderate multiplier of FFO. The book suggests, ten or eleven times current FFO being a reasonable price for an average REIT and twelve or thirteen times for a rapidly growing REIT

HCP's P/FFO is in the ~13 range which is reasonable for a REIT. 

Credit Rating

For stocks and REITs, I look for companies with BBB+ credit rating for the security of the company. Per the IR page, HCP's credit rating is BBB+.

Debt to Capital

The ultimate dividend playbook suggests avoiding a REIT if its debt/capital ratio is more than 60 to 65 percent on a market value basis or more than 80 percent on an FFO basis. 
SBI recommends 30% (I assume this is FFO or market basis) which is very conservative. 

HCP's debt to ratio is in the 40% range - which is not as low as the SBI's recommendation, but lower the the ~65% threshold from Ultimate Dividend Playbook.
Note: During the Great Recession, the Debt/Capital for HCP was much higher. 

M* & S&P Stars
 
I am noticing that the Morningstar and S&P Capital IQ recommendation stars are a good indication on when to buy. I am looking at 3+ stars from both. 

HCP has 3 stars from S&P Capital IQ and 4 stars from Morningstar - which is a good indication to buy.


Dividend Growth & Yield

Dividend Yields

The SBI book suggests a dividend yield in the mid range (not too high, not too low) in relationship to other REITs.

The HCP's dividend yield is 5.7% - which in my mind is reasonable when compared with the range of dividend yields from other REITs.

Dividend Growth

HCP dividend yield for 5 years CAGR is 3.6% which is below my 5% threshold. However, for an established REIT, I am okay for a lower growth rate.

Chowder

In the case of HCP, the low dividend growth means that it is below the 12% threshold (9.3%).
Per my previous article, I haven't established if Chowder of 12% is reasonable for REITs. However, getting close to ~10% chowder I think is reasonable.


Valuation

5 years Average Yield

HCP yield over 5 year average yield is 1.16 which means it is ~15% over the 5 years average yield. This means the stock is reasonably valued.


Dividend Yield Theory

The book from dividends don't lie describes the dividend yield theory. 

Please see my previous post for more information. 


 I estimate the high to be 8.90% and low to be 3.9%. 

Note: I could have picked a high yield line  that 'ignored' the years 2008-2010 to ignore the noise from the Great Recession.


This gives the following Mid and Low price lines:


Mid Price:41.71
Low Price:26.23

The current price is around $39 - which means it is slightly below the mid point. 

This also means that there is a potential for the price to drop lower. I need to consider the possibility of averaging down if the fundamentals are still in place.

DDRM - Dividend Drill return model

The DDRM is from the ultimate dividend play book. The difference with REITs is that the calculations are adjusted with FFO basis. 

There is also a 'fudge' Free Growth percentage per the book which I have also included as part of the calculation. 

DDRMEstimated
Dividend Rate ($)2.27
Divided by: share price39.82
Current yield (%)5.70
Core Growth Estimate (%)5.60
Divided by: ROE FFO (%)8
Multiplied by: EPS ($)3.04
Cost of Growth (%)2.13
Earnings per Share ($)3.04
Minus: Dividend2.27
Minus: Cost of Growth2.13
Funding Gap ($)-1.36
Divided by: Share Price ($)39.82
Share Change (%)-3.41
Free Growth Estimate2.00
Core Growth (%)5.60
Plus: Share Change (%)-3.41
Total Dividend Growth (%)4.19
Plus: Dividend Yield (%)5.70
Projected Total Return (%)9.89
 
Note1: the Core Growth is based on S&P Cap IQ Est. Growth
Note2: The ROE (FFO) is based on the average ROE above
Note3: The "fudge" 2.00% is based on the Ultimate Dividend Playbook. I think 2% is reasonable for an established REIT.
So, we are close to the 10% range per my criteria.
If I rearrange the numbers based on dividend growth:

Dividend Rate ($)2.27
Required Return (%)10.00
Growth (%)4.19
Price39.07

If I rearrange the numbers based on S&P Capital IQ growth estimate: 


Dividend Rate ($)2.27
Required Return (%)10.00
Growth (%)5.60
Price51.59

Basically, the fair value is in the mid $40s.

M* and S&P Capital IQ estimates

M* Fair Value is 51
S&P Capital IQ Fair Value is 43

The current price is around 39 - which gives HCP a margin of safety of approx. 10%.

Risks 

There are some negative news regarding HCR ManorCare which is HCP's largest tenant. 
Rising interest rates can negatively impact performance of REITs in general. 
HCP is highly leveraged. A downturn in the economy can make it difficult to refinance. 
Government regulations on healthcare building codes are imposing tougher requirements which can affect HCP's collection on rent. 

Conclusion

HCP is an excellent REIT with a long history of dividend payment and growth. Their growth slowed down in the last ten years due to a high payout ratio which they have reduced to a reasonable level in the last five years. I don't expect the dividend growth to improve  much in the near term. 
I think there are definitely risks with HCP especially with their largest tenant HCR which is being investigated by the justice department. 
My parents owned some real estate including a couple of commercial properties, and having bad tenants can a big problem. I believe HCP can work around the issues with HCR. 
29 years of dividends growth is difficult to achieve - especially for REITs. 

Recently, I have initiated a new position with 45 shares of HCP at ~$39.

This will increase my estimated forward dividends to $101.92. 

I will continue to monitor the situation with HCR ManorHouse. 

I think there is still a downside potential with HCP, so I will consider adding more shares if the price goes down further and the fundamentals are still in place. 

Lastly, there is tax implicitly with REITs so I plan to use tax deferred accounts for future additions. 


That's all for now! What do you think of HCP?

Div4son

Disclosure: Long HCP


6 comments:

  1. Nice analysis, Div4Son. I have been looking at a second healthcare REIT to add after my OHI holding. HCP is attractive right now, but it has its own problems, which Im sure they will work through.

    Thanks for sharing the writeup.
    R2R

    ReplyDelete
    Replies
    1. R2R, Thanks for your kind comments. Yes - HCP requires some monitoring but sometimes problems can become opportunities.
      D4S

      Delete
  2. Thanks for sharing this analysis of HCP. I just added the three big health REITs to my portfolio in the last couple of weeks. Picked up HCP, HCN and VTR. While I'm also interested in other REITs such as WPC, O, DLR, NHI, lTC and OHI I think I may just focus on the three I have for now.

    ReplyDelete
    Replies
    1. DivHut, your 3 REITs are excellent companies. I will just focus on a 3-4 REITs going forward. I will look at your list for further consideration.
      Thanks for visiting!
      D4S

      Delete
  3. Hi Div4son,
    I am looking to add my first REIT to my young portfolio. At some point I would like to have HCP, OHI, and O but if you had to choose one for the coming year which would you choose. I was leaning towards HCP but still researching.
    Thanks

    ReplyDelete
    Replies
    1. Particular Places,
      Thanks for visiting. These are all good REITs.
      For me (based on my strategy, risk outlook etc - see my disclaimer), I will continue my investment in HCP. I am looking add OHI, O, WPC. The longer the div history the better. I will slowly add the positions to smooth out the impacts of interest rate changes. Moreover, I will invest these REITs using my tax deferred or ROTH accounts and let them compound over time.
      Good luck with your decision!
      D4s

      Delete