The SeniorCare Investor: Occupancy On The Rebound--
Second Quarter Earnings Results Show Positive Progress
We really hate to be short-term oriented, awaiting each quarter’s earnings releases from the public companies in order to obtain something more concrete than finding out, off-the-record, what a few private companies are seeing from an occupancy and cash flow perspective. For better or worse, when the public companies report quarterly earnings we have to use that as a mini-proxy for the larger market, partly because they represent most of the larger companies and a decent share of the total market, as well as a wide geographic reach, and partly because that is all we have from a factual rather than hearsay perspective. What they represent in size and scope, however, can sometimes get lost in the inability to be nimble and adapt to rapidly changing market conditions.
The second quarter this year produced mixed results, but the overall tone seemed to be that the worst is behind us. Of the five companies which analysts are still following with estimates, three beat consensus earnings estimates—Assisted Living Concepts (NYSE: ALC), Brookdale Senior Living (NYSE: BKD) and Emeritus Corporation (NYSE: ESC)—while Capital Senior Living (NYSE: CSU) and Five Star Quality Care (AMEX: FVE) had earnings misses. Even though only one company (Emeritus) posted any occupancy gains, and ESC had an impressive same-community 50 basis point increase over the first quarter 2009 and a 120 basis point increase compared with the year-ago quarter, most of the other companies gave the sense that occupancy was beginning to stabilize and maybe increase. For example, Brookdale had just a 40 basis point drop in occupancy from the year-ago period (and 20 basis points from the first quarter 2009), and occupancy at June 30 was higher than at March 31. Even though some of the others posted much larger occupancy declines, there was more optimism than during the first quarter.
Occupancy is obviously very important for the long-term stability of the industry, but it is not the only measure of success or economic progress. In the second quarter, all five seniors housing companies recorded higher profit margins at the facility level compared with the year-ago quarter (Five Star was left out because it also operates skilled nursing facilities and a few rehab hospitals). Capital Senior Living had the highest facility-level operating margin at 38.85%, which makes sense since it also has the highest proportion of independent living units, but the year-over-year increase was only 35 basis points. The other four had facility-level margin increases ranging from 100 basis points (Brookdale) to 180 basis points (Assisted Living Concepts).
We have also tried to calculate an estimate for the actual facility-level operating profit per occupied room per day. While all five had a year-over-year increase, the range in the increase was from $1.58 per occupied unit (Capital Senior Living) to $4.72 per occupied unit (Emeritus, helped by the addition of some high-rent former Sunrise properties). The two leaders in operating profit per occupied room are not surprising because of their relatively high average rents (Sunrise) and additional services (Brookdale). Both of these companies lead the pack with a facility-level operating profit of about $48.50 per occupied room.
This was followed by Emeritus at $44.29, Assisted Living Concepts at $40.62 and Capital Senior Living at $35.00. On a same-facility basis, ESC’s year-over- year increase was $2.88 to $42.61 per occupied unit. Our point is that despite occupancy declines, or in some cases small increases, companies seem to be weathering the storm much better than most people expected, which is one of the reasons why so many of their stock prices jumped so much in August, although not quite the performance of last April. Rates are still being increased and costs are getting under control, but in one case we are not sure whether the company has gone too far.
Readers may remember back in April 2008 when we declared that the share price of Assisted Living Concepts was too cheap to be ignored as it dipped down to $5.50 per share (which would be $27.50 in today’s price after the March 2009 one-for-five reverse split). The price did subsequently rise by more than 30% in the following few weeks, and some of the attractions were that the company owned a higher percentage of its properties than most of its peer group, and its balance sheet was strong with relatively little debt. Those features are still true today, but when the company reported second quarter results in August, investors liked what they saw and pushed the share price up by 40% from the July 31 close.
What they saw was that despite quarterly revenues coming in lower than analysts’ estimates (and actually declining a bit from the year-ago quarter), net earnings were higher than estimates because of lower operating costs. Operating costs went down because occupancy declined, and ALC benefited from lower utility costs and becoming part of a group purchasing organization which lowered certain other costs. The reality is that operating costs actually increased slightly from $5,929 per average occupied unit in the second quarter of 2008 to $6,084 per average occupied unit in this year’s second quarter. This makes intuitive sense because even though average occupancy has declined by 376 residents over the past 12 months, there is a certain level of fixed costs that is present regardless of occupancy rates. What is difficult to determine is what those fixed costs really are as opposed to the variable costs in the case of ALC. We have to assume that the fixed costs are at the bottom end for the assisted living industry.
The other thing that investors may have focused on is that the number of occupied private pay units on June 30 was 92 units higher than on March 31, even though average private pay occupancy declined from the first to the second quarter. This was the result of some of the 400 new units they are adding to existing campuses coming on stream at the end of the quarter, with 30 to 40 new private pay residents in June alone. Unfortunately, the private pay census in July was flat with June, so we don’t know whether it will be slow going for the next several months or what will happen when the remainder of the units open.
We are surprised, however, that analysts have not questioned how the company can be so profitable at an overall occupancy rate of 64.1%, which was ALC’s average for the second quarter. And we are talking about a GAAP profit after depreciation, lease payments, interest expense and taxes. ALC had the highest EBITDAR margin (32.0%) of the five comparable companies despite having an average occupancy rate more than 20 percentage points lower than the other four companies, which ranged from 84.9% to 88.5%. And three of these four produced a GAAP net loss. Although we realize the net loss of these three has a lot to do with their respective capital structures, we still find it somewhat inconceivable that a company with more than one-third of its units empty can have that high of an operating margin.
We were always of the belief that between 50% and 65% occupancy was when a facility (or company) was turning the corner from losing money on an operating basis to breaking even and moving on to profitability. The only rational conclusion is that ALC is operating on a bare-bones basis and that can’t last very long when the local competition figures it out and competes on service and quality. This is coming, of course, at a time when the company is getting out of the Medicaid waiver programs in various states, when it should be stepping up its services to attract that private paying resident. Operating a tight ship in this environment is obviously important, but too tight can lead to problems of quality and oversight.
Obviously, if Assisted Living Concepts can reach the industry average occupancy level, the growth in profits could be remarkable. But given the negative publicity it received regarding the treatment of its Medicaid residents (whether real or perceived), plus the trouble it may get into in Iowa for what is perceived as getting around state licensing regulations (see last month’s story), it may be a very long road to reach 85% occupancy with private paying residents. That’s an additional 1,800 residents at a time when everyone else is trying to fill their units, and in some markets going after the same residents. To accomplish this, we assume they will have to compete on rates or service and quality. Either way, it would seem that the margins would have to decline, or else we just don’t get how their model really works. But we are not alone with that thought.
And speaking of occupancy, which should never be downplayed, on December 7-8 there will be the 13th annual "Advanced Sales & Marketing Summit" for seniors housing and care in Naples, Florida. If you aren’t at 90% or better occupancy, find out why and what you can do to change that in this two-day conference sponsored by Tony Mullen’s Best Practice Seminars. Or find out how a company filled its new community in 30 days, even in this recession-challenged market. If now is not the time, we don’t know when it would be better.