An Interview with Equity Analyst Jerry Doctrow

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Steve Monroe, editor of The SeniorCare Investor

Jerry Doctrow, Managing Director, Stifel Nicolaus Disclosure About Jerry

How are investors looking at the seniors housing public equity market? Will there be more IPO, or are there too few senior care companies big enough to go public? Are equity values at a peak? Listen to Stifel Nicolaus equity analyst Jerry Doctrow, The Wall Street Journal's number one ranked stock price picker in this sector last year, talk about these issues. Listen now Posted November 4, 2006

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Interview Transcript:

Steve Monroe: We are here today with Jerry Doctrow. He’s the managing director of Stifel Nicolaus and has been an analyst, equity analyst, covering seniors housing for many, many years. Jerry, there are two large cap seniors housing companies, with market caps well above a billion dollars, Brookdale Senior Living and Sunrise Senior Living. But they are very different models.

One, Brookdale, is growing by acquisition, the other, Sunrise, by development, acquisition and expansion into ancillary services. One, Brookdale, is paying out nearly all its cash flow in a dividend, while the other, Sunrise, has a relatively small dividend and is reinvesting its cash flow. How you do describe the difference between the two companies to investors and to Stifel’s salesmen?

Jerry Doctrow: Thanks, Steve. They are very different models. I would describe them maybe only slightly differently than you do, in that Sunrise’s management company does not own its real estate, uses joint venture partners, owns a minority interest, and, as you say, they are funding internal growth—driven by internal growth development, some acquisitions and also beginning now just to move into ancillary services.

Brookdale owns or leases all their real estate, is trying to capture 100 percent of their real estate upside, and is focused on internal growth and acquisitions. They are also, with the ACR acquisition, doing a major expansion of ancillary services. So they, even more than Sunrise, are going to grow with ancillaries.

And, you know, from an investor’s standpoint, they’re very different also, where Sunrise does not have any dividend, and is focused on sort of gap EPS historically for evaluation, where Brookdale has no gap earnings, no positive gap earnings, but drives cash flow. And I think it has redefined the whole valuation metric really to focus much more on cash flow.

So, I mean, we describe them that way. I think that our opinions on them, and I think from a long-term perspective, I’m more comfortable with the Sunrise strategy. I think management provides less downside risk. I think development is more predictable, where, if you’re dependent on large acquisitions, and, certainly, Brookdale, at this scale, needs a lot of acquisitions to drive growth, it’s just harder to make that happen, although they’ve been very successful to date.

The thing that makes Brookdale—I mean, we now cover both companies. We have a buy on Sunrise. We think the pullback on the accounting issues makes that attractive again. With Brookdale we have a hold on the stock. And in the near term, I think the valuation is very rich, but the American Retirement acquisition is very positive for them, drives a lot of earnings growth, and kind of offsets what we see as some integration risk in a pretty rich valuation.

Steve Monroe: Are you, when you talk to retail investors, are they looking at the seniors housing business as more of a real estate play and operating business play, or a demographic play? How do they—what are they looking at?

Jerry Doctrow: Right. And I really don’t, at my job, talk to retail investors that often. I mean—

Steve Monroe: Or institutional investors.

Jerry Doctrow: Yeah, I mean, Stifel has 400 or so retail brokers, but I interact with them less. I really interact more with the big institutions. And institutions, I think, are first and foremost looking at this pretty much now as a growth industry. You know, the industry has come back strong. Valuations are up. So you’ve got to be comfortable with the growth rather than seeing it as kind of a deep value opportunity.

And it’s interesting in that this does attract both real estate and, I would say, conventional kind of healthcare operating company investors. I think there’s more operating company investors in it, and they’re looking at it primarily from growth. And I think, if anything, the real estate is somewhat of a complexity for them. They’d almost rather it be a clean operating company, which is kind of one of the things that drove Sunrise, I think, to their strategy originally.

Steve Monroe: What’s—when you do talk to the institutional investors or the salesmen, what’s the most common question they ask you about the seniors housing space?

Jerry Doctrow: You know, I think it’s the question all of us are asking at this conference, which is, “How long can the good times last?” And is it going to get overbuilt or when will it get overbuilt? Those are the key issues. Our view on this is we think demographics certainly over the next few years are very strong. It does appear that development is staying under control, based on the stats that you’re seeing and I’m seeing. I think the development juices are starting to flow, but we’ve got a year or two when I think the supply-demand is still very good.

Steve Monroe: The last IPO that the industry saw was late last year by Brookdale Senior Living, and it was overwhelmingly successful, to say the least, up about 50, 60 percent in just a few months. Will we see more, a few more IPOs, or do the companies have to have the size of a Brookdale for investors to get interested again? Has Brookdale basically set the bar higher?

Jerry Doctrow: Well, and Brookdale is a very unique company and a very unique story, because of the Fortress backing, because of its scale, because of its whole strategy to really drive cash flow rather than anything else. And it is, I think, to some extent, the lens through which everybody else, both already public and future potential public companies, will be measured. And I think it has maybe raised the bar some.

You know, we are going to have a reentry of Assisted Living Concepts back into the public market as a standalone. I think there’s one or two other potentials out there. John Moore, from Atria, was just speaking, and they’re certainly the one that most people talk about as the next potential. But I think—I don’t see a lot more coming, and I probably think that the potential for further consolidation here is greater than we see a lot more additional companies in the public markets.

Steve Monroe: And in the past three years, I mean, the industry pretty much, from a property value perspective, from a stock value perspective, hit bottom in 2003. Since then, skilled nursing stock prices have soared, the assisted and independent living equity market, although it’s a little bit tempered this year, has produced astounding returns over the past few years. Everything is up. Are we near the peak? And, if not, how much higher can they go?

Jerry Doctrow: Sure. I think we, like everybody else, is, after you see these things run, you start asking yourself, “How much more room is there to grow?” Again, we still see the basic fundamentals being pretty attractive. The valuations among the public companies out there, you know, there’s actually a fair amount of variance, so that while you see a very high valuation for Brookdale, using a number of metrics, certainly Manor Care on the nursing home side, the valuations are up there by historic standards, other companies in that space, somebody like a Five Star on the private pay side, somebody like a Genesis on the skilled nursing side, the valuations are still a lot more reasonable. So it’s not—even though stocks have run, the valuations are not uniformly high from historic standards.

I think what I would say is it’s unlikely that we’ll see the same kind of rebound. I think over the course of sort of ’05, ’06, people really recognized this industry has turned, and valuations really ran, and we’ve had tremendous earnings growth. Going forward, it’s much more going to be driven, I think, by individual company performance and by sort of back to the basics. How much can these guys really grow earnings? And that’s really the key.

Steve Monroe: So now they’ve turned it around. So now they’ve just got to do it quarter to quarter, year to year, and kind of fulfill their promises that got them to where they are today.

Jerry Doctrow: Yeah, I think so. And could you see some—could you see a new entrance? Could you see a big consolidation play that would cause some kind of jump? Certainly you can, but kind of on a day-to-day basis, it’s really companies being able to demonstrate that they can grow the earnings and deliver on kind of what they’re promising. That’s the key.

Steve Monroe: Okay.

Jerry Doctrow: Less exciting, but…

Steve Monroe: Less exciting. Have you heard any more news on the Kindred Healthcare rent reset with Ventas? I know, I think the appraisals are due soon. Have you heard any more news on that, and have you increased your rough—I think you had, your last estimate I heard was at least a $30 million up to $50 million rent increase?

Jerry Doctrow: Yes, I’m sure you and I both have been running around this conference, among other things, quizzing people on what they’re hearing on the Kindred-Ventas reset. My estimate right now is $50 million in terms of the reset. I’m feeling actually pretty comfortable with that number. The news out yesterday was that Ventas has won an additional court ruling requiring or compelling Kindred to provide information on kind of their intercompany profits on things like rehab and pharmacy. That’s one of the bones of contention in terms of setting the reset amount.

A week from Friday, so I think that’s October 6, if my dates are right, the appraisers are scheduled to deliver their rent reset and annual escalator numbers to the parties. So we are certainly coming down to the end. I don’t know that there’s anything convincing I heard from anybody about where that number’s going to come out. There’s a lot of speculation. I mean, my own view is that ultimately there’s still going to be some kind of negotiated settlement here. I think it’ll either come just before they sort of pull the number out of the envelope or perhaps after.

But what I think investors should look for is certainly the number, but, beyond the number, I think we will see some negotiation that could involve Kindred either buying down the reset with cash or Kindred certainly buying out underperforming assets or Kindred buying some liberalization of the current term, so that you’ll end up with a final outcome that will certainly have higher rent for Ventas, but also hopefully produces some benefits for Kindred in terms of getting out of some of the requirements for insurance and giving them more operating flexibility and certainly getting rid of some underperforming assets that may soften the pain in terms of increasing the rent.

Steve Monroe: Maybe try to have a little bit of the win-win for both sides, if that’s possible.

Jerry Doctrow: Yeah. If that’s possible.

Steve Monroe: If that’s possible. Last question for you, last year, don’t want to embarrass you here, last year you were the number one stock picker in the seniors housing and care sector in the annual Institutional Investor rankings. That must’ve been a pretty good feeling. What do you think your best pick will be this time around?

Jerry Doctrow: Well, it was actually The Wall Street Journal, not—

Steve Monroe: Oh, it was The Wall Street Journal.

Jerry Doctrow: —not Institutional Investor, but—

Steve Monroe: Sorry to give credit to them.

Jerry Doctrow: —but just for the sake of clarity. You know, I think it’s been somewhat of a tougher year. Year to date we, in my group, really, we did very well with Manor Care, although one of my colleagues is a lead on that. Sunrise was disappointing earlier, but I feel very good about Sunrise from here on out. It’s about 20 percent off its bottom, and I think there’s more upside as we get this accounting issue resolved, which I’m hoping comes soon.

And the other one I like here a lot, honestly, is Five Star, which is a little different in that it has a mix of skilled and mostly private pay. They should drive a lot of earnings growth by buying out these Sunrise management contracts. I think they’re a very decent operator. They’re pouring a lot of money into buildings to kind of upgrade, which should drive some additional earnings. And the valuation there is attractive. So I think if you had to pick one right now, actually I think Five Star probably, on a percentage basis, will do a little bit better, but I like both Five Star and Sunrise here.

Steve Monroe: Okay. Very good. We’ll maybe check in at the end of the year and just see how it comes out. Thank you very much for joining us today, Jerry.

Jerry Doctrow: Sure. Thanks.

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