The SeniorCare Investor: Fourth Quarter 2009 Results--
Occupancy Performance Improves, Stability Returning
As the economy slowly improves, and with the housing market appearing to be stabilizing (at least for now), the expectation is that seniors housing occupancy rates should be rebounding. The problem, however, is the size and duration of that rebound. Many people have been expecting a sudden burst of move-ins as the pent-up demand is let loose as more homes are sold and as financial portfolios strengthen. While this may yet happen, with each passing month of treading water, at least as the housing market goes, that pent-up demand may begin to dissipate. So it is with those thoughts that we have been waiting for news from the public companies on what really happened in the fourth quarter, and perhaps the early part of 2010.
Perhaps the best place to look for trends is the largest seniors housing company, Brookdale Senior Living (NYSE: BKD). With 565 communities serving more than 35,000 residents across 35 states, it represents the largest slice of the seniors housing industry, especially since it also covers the full spectrum of seniors housing and care. One caveat, however, is that nearly 50% of its units are in just five states (Florida, Texas, North Carolina, California and Colorado), and almost 70% are in 10 states, so its geographic diversity is not as great as it may appear. Still, with its combination of assisted living, Alzheimer’s care, skilled nursing, independent living and entrance-fee independent living, the company represents the best cross-section of the market that we know of.
Every quarter we are waiting for a company to just break out of the pack, produce results that recapture some of the lost 12 to 18 months with outsized occupancy gains. With three of the six seniors housing companies reporting year-end earnings by the end of February, we are still waiting. Brookdale’s results were mostly in line with expectations, but certainly nothing to get shareholders excited about. In fact, the stock barely moved the day of the earnings release, and didn’t move over the next two days either. Treading water is the best way to describe it, and not because the performance was bad, it’s just that investors want to see more than a modest improvement, even in this market. On the other hand, at least there was not really any bad news.
On the occupancy front, Brookdale’s same-community average occupancy in the fourth quarter last year increased by 20 basis points sequentially to 89.4% from the third quarter. In more normal times, that may not be a huge cause for celebration. But in our times, that is extremely positive news and an indication, even though a small one, that Brookdale has stabilized at least one aspect of its operations, with the expectation of further improvements. According to the recently released NIC MAP data, which showed seniors housing occupancy declining sequentially to 88.2% in the fourth quarter of 2009, Brookdale is doing quite well. Compared to the fourth quarter of 2008, consolidated occupancy was down by just 80 basis points, and we say “just” because practically everyone else has reported (or we expect them to report) much worse year-over-year occupancy levels during that rather traumatic period of time.
The other good news was that average monthly revenue per unit in the fourth quarter was up by 4.5% from the fourth quarter of 2008, and full year monthly revenue per unit was up 5% compared with the full year 2008. At the beginning of 2009, and remembering that the financial world did look as if it was coming to an end, year-over-year revenue per unit increases were expected to be in the 2% to 3% range, with 5% certainly at the high end. So Brookdale did well in that regard, and while we assume most of that increase came from ancillary services and not from increases in the base rental rate, it still represents a positive outcome. In addition, management has been able to control expenses as well. Excluding ancillary services, facility operating expenses increased by just 1.5% from the fourth quarter of 2008.
Perhaps the best news from the fourth quarter, and a development that may shed a brighter light on the future of other providers, Brookdale reported 80 fourth quarter CCRC entrance fee sales, compared with 65 in the year-ago quarter and representing the highest level of sales in three years. The CCRC market has been the hardest hit in this housing market crisis, sometimes in perception and sometimes in reality, so it was extremely positive to see this size of an increase in sales when others may be reporting declines, again. Total cash proceeds were up 20% to $13.6 million compared with the third quarter 2009 and up 12% from the year-ago-quarter. There could be some discounting going on to move the units, but that is not much of a concern in this market environment. Who knows, maybe people are finally using Elderlife Financial’s CCRC product to remove the home sale problem out of the decision-making process.
Finally, Brookdale’s facility operating margin increased to 34.1% from 33.3% in the fourth quarter of 2008. While not a huge jump, having margin expansion during one of the worst years we can remember (at least six months of it), is a solid accomplishment. In addition, the company’s adjusted EBITDA increased by 12% to $84.9 million in the fourth quarter of 2009 compared with the year-ago quarter, and the full year adjusted EBITDA jumped by 15%. All in all, a solid quarter in this difficult environment, but they do need to improve upon it. And it was apparently good enough for Brookdale’s lenders to agree to an increase in the company’s revolving credit facility to $100 million with an option to increase it to $125 million.
We also hear that during the fourth quarter Brookdale took a serious look at purchasing Sunrise Senior Living (NYSE: SRZ), and decided to take a pass. Perhaps it was merely a rumor, but when you hear about it enough times, you start to believe it is beyond a simple rumor. While we assume “the look” was for the entire company minus, most likely, the foreign operations, we don’t know the depth of the analysis or whether there was any price thinking. We do know that Sunrise still has some major issues to work out before there could be any serious discussions anyway, with anyone, but we never thought that taking over SRZ’s management business would be a good strategic move for Brookdale. Obviously, they thought so too.
Speaking of Sunrise, perhaps the most memorable thing about the company’s fourth quarter earnings announcement was the conference call with analysts and investors. The only interesting part of these conference calls for any companies is the Q&A, even though there are mostly soft-ball questions and the obligatory congratulations on a good quarter. But sometimes heated discussions evolve, especially when a company is underperforming. In SRZ’s fourth quarter call, there was just one person with any questions. That’s unusual anytime, but especially for a company with so many moving targets that is also in default on its debt.
Management keeps on telling us that things are getting better, and while we have been reluctant to believe them in the past, they could be turning the corner, finally. Year-over-year results were somewhat dismal, at least on the occupancy front. Same-community occupancy plunged by 350 basis points from the fourth quarter of 2008 to the fourth quarter of 2009 to just 86.5%. This is nearly 300 basis points lower than Brookdale’s fourth quarter occupancy. On the other hand, fourth quarter EBITDAR was $25.2 million compared with just $2.2 million in the year-ago quarter, part of which came from a 32% reduction of its bloated general and administrative expense (decreased by $13.2 million), something which management had promised and delivered on. Excluding the debt on its German assets, which are being held for sale, the company’s overall debt is now down to $240 million, thanks to the sale of 21 properties late last year. Even though a significant portion of that debt remains in default, management has been successful in getting extensions from lenders, who really don’t have many other options since foreclosure would not get them much, other than a nudge towards Chapter 11. Just a few weeks ago, Sunrise extended $56.9 million of debt that was either past due or in default at the end of the year, handing the lenders a $5.0 million principal payment with the promise of another $5.0 million by July 31, 2010. This has been the life of management the past few years, winning little reprieves hoping that the larger war will be won. The battles seem to be getting smaller, but they are not over.
Sunrise is still tied up in litigation with its landlord HCP Inc. (NYSE: HCP), which would like to remove them from management of several portfolios owned by HCP. In the case of the 79 communities owned by Ventas (NYSE: VTR) but managed by Sunrise (not leased), operations seem to be stabilizing, although we are sure Ventas would like to see even better results. The 78 same-community stabilized properties had an average occupancy rate of 88.8% in the fourth quarter, which was a 70 basis point sequential increase from the third quarter. Despite this increase, the net operating income of these 78 communities, most of which flows directly to Ventas, declined slightly from $33.0 million in the third quarter to $32.7 million. However, compared to the year-ago quarter, the net operating income actually increased despite a 190 basis point drop in occupancy. Sunrise’s value at this point is in its management contracts, but to the extent that some landlords may still want to remove them, that value diminishes very quickly. The best way to prevent that from happening is obviously through performance, if they are given the time to accomplish their goal.
Skilled Nursing Companies. While occupancy trends have been the focus for seniors housing companies, it is the reimbursement outlook that has the largest impact on the future performance of skilled nursing companies. Occupancy is still important, and there is certainly room for improvement, but the reimbursement overhang is great right now, both for Medicaid and Medicare. The skilled nursing industry has survived reimbursement turmoil before, although the last time there was a major change it contributed to the bankruptcy of several large chains. This time around it is less a profound change and more a chipping away at reimbursement rates, in particular, Medicare. This overhang is keeping valuations down in the public equity market, and it may be just one of the reasons why the much-talked about IPO from HCR Manor Care will be in the form of a REIT and not the operating company, because REIT multiples are higher than for operating companies. We hear that if they go the REIT route it will be in the structure with a taxable REIT subsidiary, so all the earnings will flow upward in the corporate structure, much like the Ventas/Sunrise assets.
Just like the seniors housing companies, only three of the public skilled nursing companies reported fourth quarter results in February. And similarly, while there was nothing too bad, there was not too much to get investors excited either. Skilled Healthcare Group (NYSE: SKH) reported a slight decline in revenues in the fourth quarter compared with the year ago quarter, and EBITDAR fell by 5% while EBITDAR margins dropped by 110 basis points from a year ago as well. The company started a cost reduction program in the fourth quarter which should yield some results this year, perhaps as much as $3.0 million or more annually. Despite these cuts, management’s EBITDAR and EPS guidance for fiscal 2010 are lower than analyst expectations. All of this, of course, excludes the whopping $170.6 million goodwill impairment charge taken in the fourth quarter of last year. Occupancy at SKH declined slightly from 83.2% in the third quarter to 83.1% in the fourth quarter, but by January 2010 it had bounced back to 83.4%. Similarly, its Medicare mix declined from 22.4% in the third quarter to 22.1% in the fourth quarter, bouncing back in January to 22.8%.
Ensign Group (NASDAQ: ENSG) reported results in line with estimates, except that fourth quarter occupancy of 78.7% was higher than some previous estimates. This occupancy level is lower than its peer group, but despite this EBITDAR increased by almost 17% from the fourth quarter in 2008 with the margin posting a very slight decline. The company has been very active in the acquisition market, especially in the past several months, and several of these transactions involve some previously underperforming skilled nursing assets. If they can turn them around during the year, that will be a big boost to earnings and cash flow, and eventually to its share price. In addition, ENSG has relatively little long-term debt, which will provide some flexibility for future growth.
Like Brookdale on the seniors housing side, Kindred Healthcare (NYSE: KND) is the largest publicly traded skilled nursing company, although its LTAC division is almost as large as its skilled nursing business on a revenue basis, but larger on an EBITDARM basis. Although the fourth quarter results were somewhat positive, the better than expected earnings from continuing operations came almost entirely as a result of year-end adjustments to its medical malpractice insurance, which contributed $0.09 per share of extra earnings. So without this earnings bump and a lower fourth quarter tax rate, earnings would have been at or slightly below consensus estimates. There was a bit of a mixed bag on the skilled nursing side, as KND’s Medicare census declined sequentially from the third quarter, but its Medicare Advantage census increased slightly. The skilled nursing EBITDARM margin increased sequentially from 13.6% to 14.2%, but declined from the year-ago quarter of 15.4%. Skilled nursing patient days declined sequentially and from the year-ago quarter, but the declines were not too significant. Management lowered its guidance for the first quarter of 2010, and the level of uncertainty is higher for KND because they have the LTAC reimbursement as well as the SNF reimbursement risk. That said, Kindred’s got the management team to deal with it.