HCP Spinoff Reduces Risk for Its Investors

chart01.pngSignificant changes are an understandable source of concern for investors. However, HCP’s decision to spin off both its skilled nursing facilities and its assisted living facilities should not be interpreted in a negative light. After all, it promises to boost its financial performance by reducing its risk for its investors, which is what its management should be seeking under the current circumstances.

In short, the U.S. government has become more and more concerned about rising healthcare costs in recent times, which in turn, has prompted more and more scrutiny of the healthcare sector. Unsurprisingly, this has resulted in the detection of more and more cases of wrongdoing, which has sent tremors running through investors with investments in healthcare REITs reliant on government reimbursements.

HCP has had its multiples brought below the healthcare REIT average by these incidents involving one of its most important tenants, HCP ManorCare. Last year, the U.S. Department of Justice accused HCP ManorCare of requesting government reimbursements to which it was not entitled. This February, HCP announced impairments due to the tenant’s poor performance.

While HCP might not be able to predict the repercussions of the U.S. Department of Justice claims, its status as a large cap REIT with an investment grade rating provides muscle power to contain it. Even after the spin-off, the REIT will remain large.

HCP’s new portfolio will be equivalent to 73 percent of the total revenues, coming from senior housing, life science, and medical offices, thus ensuring the stable revenues from private pay sources that are most attractive to investors who want to earn an income while also playing it safe. In contrast, the spun-off portfolio of both skilled nursing facilities and assisted living facilities will bear the higher risk, and potentially higher rates of return, thus ensuring its appeal to investors who are more willing to take a chance.

Summed up, HCP’s decision is a sensible one that will make its portfolio safer by divesting its sources of risk, thus putting it in an excellent position to reach parity with other healthcare REITs.

Source: HCP, Inc.(NYSE:HCP), Fast Graphs

Disclaimer: This newsletter is not engaged in rendering tax, accounting, or other professional advice through this publication. No statement in this issue is to be construed as a recommendation to buy or sell any security or other investment. Please do your own due diligence before making any investment decision. Some information presented in this publication has been obtained from third-party sources considered to be reliable. Sources are not required to make representations as to the accuracy of the information, however, and consequently the publisher cannot guarantee accuracy.

Disclosure: The author has no positions in any shares mentioned, and no plans to initiate any positions within the next 72 hours.

What Can We Learn From HCP?

chart01In 2015, HCP recorded a $1.3 billion impairment related to their HCR ManorCare investments. HCR ManorCare, their biggest tenant in the post-acute/skilled nursing segment, has experienced deteriorating operational performance due to changes in reimbursement rules. Also, the U.S. Department of Justice has sued HCR ManorCare on the grounds that they had filed claims to Medicare for services not needed by their patients.

Although the litigation is at an early stage, this is nonetheless a reminder to investors who invest in skilled nursing facilities (SNFs) through healthcare REITs that their investments tend to be reliant on Medicare and Medicaid reimbursement. As a result, changes in Medicare and Medicaid reimbursement can have enormous consequences for their investments, which can catch them by surprise.

How Can You Evaluate Healthcare REITs Investing in SNFs?

Before evaluating healthcare REITs that invest in SNFs, it is important to mention some of the background. In brief, Medicare and Medicaid reimbursement rates tend to increase over time, as shown by how average Medicare reimbursement rates rose from $408 per day in 2008 to $484 per day in 2014 while average Medicaid reimbursement rates rose from $164 per day to $186 per day across the same period of time according to Eljay LLC and CMS. This means that SNFs possess potential in the long run, though the same cannot be said in all periods of time.

If you are interested in investing in SNFs through healthcare REITs, there are some simple ways to evaluate your potential investments:

* The Centers for Medicare and Medicaid Services post updates such as the payment rates for 2016, meaning that it can be worthwhile for investors to monitor their website. While its updates can have a wide range of effects on SNFs, most may not prove pleasing to investors because it has an unsurprising interest in ensuring that the costs of Medicare and Medicaid are as low as possible.

* Some SNFs have slimmer margins than others, meaning that a negative occurrence can hurt them and thus their investors more than competitors. One way to avoid such SNFs is to examine their EBITDAR coverage ratio, which is their earnings before interest, taxes, depreciation, amortization, and rent divided by rent costs. A higher coverage ratio means that a SNF is more resilient in the face of negative occurrences because it has the earnings needed to tough them out.

* Occupancy is a useful figure for telling whether a SNF will be profitable or not because each occupied unit is a unit that is earning revenue for the SNF. There is a problem in that the occupancy at which a SNF becomes profitable is not the same from SNF to SNF. However, it is very much possible to compare occupancy from year to year for the same SNF, meaning that a rising occupancy is a positive sign for its profitability.

* Finally, check whether a healthcare REIT has all of its investments in the same state or has taken the proper precautions by spreading them out. You should avoid healthcare REITs that cannot be bothered with diversification because a statewide change for the worse can hammer their figures, which is particularly problematic because state governments can have significant influence over Medicaid spending.

Source: HCP, Inc.(NYSE:HCP), Ventas, Inc.(NYSE:VTR), CMS

Disclaimer: This newsletter is not engaged in rendering tax, accounting, or other professional advice through this publication. No statement in this issue is to be construed as a recommendation to buy or sell any security or other investment. Please do your own due diligence before making any investment decision. Some information presented in this publication has been obtained from third-party sources considered to be reliable. Sources are not required to make representations as to the accuracy of the information, however, and consequently the publisher cannot guarantee accuracy.

Disclosure: The author has no positions in any shares mentioned, and no plans to initiate any positions within the next 72 hours.

HCP needs a Hazard Control Plan

chart01Last week, the healthcare real estate investment trust (REIT), HCP, the only REIT in the S&P 500 Dividend Aristocrats index, scared the hell out of investors, when it dropped by 17%. Its fourth quarter results included an $817 million noncash impairment that led to a negative FFO per share of 0.99. In isolation, for a noncash impairment that represents less than 3% of its total capitalization value, it goes without saying the financial markets have overreacted. Yes, the market has been very unstable, but, in this case, investors may be showing signs that they are tired of the developments behind the impairment.

The cause of the impairment can be traced back to HCR ManorCare, a top tenant focused on post-acute/skilled nursing facilities (SNF) for those not requiring the more intensive treatment, has seen its operational performance deteriorate. In light of this situation, HCP decided to project reduced future lease payments, which decreased the fair value of the related direct financing leases (based on the present value of the future lease payments).

chart02  The fact that HCR ManorCare’s rental rates are under direct financing leases (DFL), rather than operating leases, is an important accounting aspect. Unlike DFLs, the reduction of future operating leases wouldn’t lead to impairments. Consequently, if HCR ManorCare had been operating leases, the impairment and negative FFO wouldn’t have occurred and perhaps, the market wouldn’t have been scared as much. Regardless of the accounting aspect, the main takeaway is that HCP’s cash flow will be decreased.

This isn’t the first time HCP has been hit by an impairment charge. In the first quarter 2015, they recorded an impairment charge of $478 million because HCP and HCR ManorCare amended the original lease, reducing the rental payments by more than 10%. There were also minor impairments associated with HCR ManorCare in the fourth quarter of 2014 and the third quarter of 2015.

The US Department of Justice (DOJ) has been severely scrutinizing Medicare reimbursements to HCR ManorCare, which relies heavily on government reimbursement programs. In April of 2015, the DOJ filed a complaint reporting that HCR ManorCare had requested Medicare reimbursements they were not eligible for. The complaint also reported that the company consciously increased Ultra High billing, the highest daily rate for Medicare, from 39% in October 2006 to 81% in February 2010 (percent of all days that it billed for rehabilitation therapy). The complaint is still under investigation.

chart03 HCP is well aware of its dependency on top tenants. HCR ManorCare accounts for 23% of HCP’s total revenue. HCP has been working with HCR ManorCare to sell 50 non-strategic assets and have managed to sell 21 facilities so far. In addition to HCR ManorCare in SNFs, Brookdale is also a major tenant in senior living whose revenues represent 10% of the total.

The main thing to take away from this is that HCR ManorCare’s problems are far from over and new impairments could easily happen again, especially if the company has to make more adjustments to their billing. The worst outcome, of course, is bankruptcy. For HCP, the best thing to do now is focus on protecting itself even more.

Source: HCP, Inc.(NYSE:HCP), Yahoo!Finance, US Department of Justice (DOJ)

Disclaimer: This newsletter is not engaged in rendering tax, accounting, or other professional advice through this publication. No statement in this issue is to be construed as a recommendation to buy or sell any security or other investment. Please do your own due diligence before making any investment decision. Some information presented in this publication has been obtained from third-party sources considered to be reliable. Sources are not required to make representations as to the accuracy of the information, however, and consequently the publisher cannot guarantee accuracy.

Disclosure: The author has no positions in any shares mentioned, and no plans to initiate any positions within the next 72 hours.