EXPERT OPINION: A Conversation with...
 Frank
G. Morgan, CFA
Managing Director, Equity Research
Jefferies & Company, Inc.
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Transcript
In this “Expert Opinion” interview, analyst Frank Morgan of Jefferies &
Company examines the market forces that sparked the volatility in seniors
housing stocks this year, and what lies ahead for the industry.
Frank G. Morgan, CFA, joined Jefferies & Company, Inc., as a Managing
Director in August, 2000, as part of a newly opened healthcare services
research and investment banking office in Nashville, Tennessee. Mr.
Morgan’s current research universe is dedicated to facility-based
healthcare services, including: acute-care hospitals; senior living
services, including skilled nursing and assisted living; and a range of
specialty service providers, including institutional pharmacies, hospice
care, long-term acute-care, rehabilitation, and behavioral health
services. Mr. Morgan has earned recognition as a master stock picker in
The Wall Street Journal’s “Best on the Street Analysts Survey.” Prior to
joining Jefferies, Mr. Morgan was a partner and senior healthcare services
analyst with J.C. Bradford & Co. In addition he previously served as a
member of the Alabama State Healthcare Planning and Development Council
Certificate of Need review board as well as the State Health Coordinating
Council. He holds a B.S. in microbiology (1982) and a M.B.A. (1986) from
the University of Alabama.
Contact:
Frank G. Morgan, CFA
Managing Director, Equity Research
Jefferies & Company, Inc.
2525 West End Avenue, Suite 1150
Nashville, TN 37203
(615) 963-8312
fmorgan@jefferies.com
Listen now Recorded
October 4,
2007
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Interview Transcript:
SeniorCare Investor Editor Steve Monroe
interviews Frank Morgan, managing director and health care equity analyst
for Jefferies & Company.
Steve Monroe: We’re here today with Frank Morgan, managing director
and healthcare equity analyst with Jefferies & Company.
Good morning, Frank. Most of the seniors housing stocks got whacked
earlier this year. Were investors justified or did they just overreact to
economic news?
Frank Morgan: Well, you’re certainly right about the “whack” part.
From the 2007 yearly highs until the end of the third quarter, the average
stock was down about 26% with the worst one down about 32%. The best
performer was down only 16%. Now, fortunately, the stocks have bounced off
those lows recently, so you’re definitely correct in terms of the stocks
got hit and were very volatile.
Was a correction justifiable? Correction probably justified to some
degree, but as usual, things usually get overdone. Don’t forget, we’ve
actually been in a multi-year bull market in these stocks and the two
factors that have been driving the stocks were and still are what’s
happening with real estate values and then the fact that you’ve had very
good positive operating trends in terms of occupancy and rates, so I would
certainly attribute this weakness and volatility to a couple of things. I
think there was, once again, something quietly going on that a lot of
investors on my side of the world, on the operator side, really weren’t
paying attention to, was this big sell-off that you saw with REITs. And
certainly those stocks peaked out about two months, really back in
February, about two months before you saw the operators start to roll
over. So, if part of the reason the stocks went up was rising real estate
values, then certainly you would expect the opposite to occur if there is
a decline and certainly looking at what’s happening in the healthcare REIT
market, it certainly looks like the valuations have declined.
And, certainly, the operating trends in the first and second quarter, you
know, spooked people. A little bit of soft occupancy numbers and people
started worrying about the housing market and construction and a lot of
other things. So, to some degree, I think it was justified and probably
was actually a little bit—was healthy.
Steve Monroe: It also seemed that investors really did not
differentiate that much among the various companies and threw them all
together. Was that a bit of a herd mentality?
Frank Morgan: Yes, I mentioned earlier, when the mood on Wall
Street turns, it usually is not very discerning. They all went down and it
wasn’t like the trends of an individual company were stronger than the
industry outflows that we saw. You look at individual stocks – Assisted
Living Concepts [ALC], Brookdale, Emeritus and Five Star – group averages
all reached yearly lows within two weeks of each other. So we did look at
correlation in terms of asset ownership, leased portfolios, strong or weak
earnings visibility and cash flow. Basically, nothing really conclusive
there; they basically all went down. Sunrise was probably the anomaly.
Obviously, for some different reasons, it was down, but certainly I think
takeout talk there probably helped that one.
Steve Monroe: And we’ve been hearing talk about maybe a little
over-building in the seniors housing market. Of all the publicly traded
companies, do you know of any that are seeing new construction in their
markets that is at all worrisome?
Frank Morgan: Well, you know, we went back and looked at all our
second quarter calls and then we’ve actually talked to a lot of people
here at the NIC [National Investment Center for the Seniors Housing and
Care Industry] conference. And, you know, we just really don’t see
anything that’s alarming. I know that Five Star is seeing construction in
three out of their 162 markets; Capital Senior Living is seeing it in one
market. The other guys really, from Brookdale, ALC, Sunrise, nothing
that’s alarming that we see out there.
And, interestingly, here at the NIC there seems to be a lot of people, the
people that we talked to or out in the field basically say there’s a lot
of people talking about what they’re going to do, but nobody’s really
doing it and, certainly, with what’s happened in the markets here, the
credit markets, it might actually make it more difficult.
Steve Monroe: Well, speaking of the credit markets, with the
problems we’ve had in the debt markets combined with the residential
housing market slowdown, do you think seniors housing companies will focus
more on organic growth next year?
Frank Morgan: Well, you know, it’s interesting, most of the
providers actually were emphasizing organic growth. Now, I do count
expansions as part of that story. It just doesn’t look like there’s a
significant amount of new construction, de novo construction going on. So
the biggest acquirer in the business certainly stopped late last year.
And, yeah, there is certainly focus on things like ancillary services and
really just focus on improving occupancies. ALC has a couple of
expansions, about 400 units underway, Brookdale has a good expansion
program. But you’re right, I think it’s more focused really on the organic
side and there’s a big opportunity left for all the companies with what
they have today and it’s probably a safe and healthy thing to do to really
not go out too much and particularly with what might be changing in the
acquisition market with valuations.
Steve Monroe: What do you think has happened to acquisition values
and cap rates, given the problems this summer?
Frank Morgan: Well, I think certainly if you look at what’s
happened in the healthcare REIT stocks, it would tell you that cap rates
are going up, that underlying asset valuations are declining. But it’s
really interesting, as we’ve walked around the conference here, we don’t
see a lot of transactions that have actually occurred and you probably
have a better handle on that than me, but it does seem like the offer side
of the market is kind of holding, the bid side’s dropping, so there’s a
widening gap between bid and asked on transactions. But it looks like most
people are sitting tight.
But, I would have to think valuations, when transactions start to occur
again, you’ll start to see a little bit higher cap rates. And, by the way,
I think that’s probably a healthy thing. Certainly you could argue that as
valuations retreat here a little bit, it probably takes a little bit of
the luster out of actually going out and doing new capacity growth.
Steve Monroe: And then looking at the skilled nursing market, are
you concerned at all about Medicare reimbursement changes in 2008 and
beyond?
Frank Morgan: Well, you know, it’s one of those yes-and-no answers.
It’s always a relative thing. But not overly concerned. You had CMS
[Centers for Medicare and Medicaid Services] come out with their final
market basket update for fiscal ’08, but certainly most of us expect to
see at some point, if we get some additional Medicare legislation passed,
probably you will see a haircut to that market basket. So they may get one
quarter, they may get the fourth calendar quarter of this year at this
full market basket update, but I think most people are certainly
anticipating that they’ll have to give a little bit of that back, as
Congress comes up with a doctor fix and some other pieces of legislation
related to Medicare they have to fund.
So, you know, I think that’s probably the biggest thing. Certainly
Congress, we think, will get around to also fixing this Part B doctor fix,
we think that definitely will end up happening, so I’d say a slight
haircut to the market basket probably doesn’t freak out investors. I think
if you had a freeze like you saw in the CHAMP act, certainly that would
probably catch folks off-guard.
I think there are some other good trends, though. You always worry about
reimbursement, but I do think that there are some very good operating
trends in terms of Medicare census growth. SNFs continue to pick up
incremental Medicare volume from the impact of what you’re seeing going on
in the rehab industry and in the LTAC industry. On the Medicaid side, it’s
state-by-state analysis, but in general I’d say things are pretty much
okay in that world.
Steve Monroe: Do you, and when you talk to Jefferies’ investing
clients, do investors ever, in the senior housing and care space, do
investors ever target companies known for higher quality care? Is that a
concern for them?
Frank Morgan: Well, yeah, sure. Health care investing is already
difficult enough and just trying to stay ahead of the reimbursement
environment, like you were asking about, that’s a full-time job and given
all the bad things that can happen if there are quality issues, like
investigations or decertifications, the headline noise and the financial
consequences of that, you certainly try to focus on what you perceive as
higher-quality names. And you look at, Manor Care is a perfect example of
that, certainly perceived as the best-in-class from an asset standpoint
and as an operator. And that stock, by the way, has always been rewarded
with a nice premium valuation, so certainly investors want to look at
that.
Steve Monroe: Do you think landlords will ever be held accountable,
legally or financially, for the quality of care provided by their tenants?
Frank Morgan: You know, I’m not a lawyer here, but it certainly
doesn’t make sense. I have talked to lawyers about this topic and the
legal theory there is a real stretch to happen. I know obviously there’s a
lot of concern about what’s been written with New York Times articles and
some concerns there, but I think, absent any kind of change in law, it
probably is hard to do, but I’m probably not your best source there. But
the people I’ve spoken with think that it’s a very hard leap to make. You
start opening up the door to things like, well, are medical liability that
occurs when a physician practices, is that the responsibility of a REIT
that owns the M.O.B.[medical office building]? So I think you just opened
the door for a lot of things that are very difficult.
Steve Monroe: Right, I agree, I don’t think it’ll ever come to
pass, but people may be trying to. All right, thank you, Frank, for your
time and we’ll catch up again soon.
Frank Morgan: Thanks, Steve.
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