DHCNL - Diversified Healthcare Trust: Extremely Speculative REIT With 12.48% Yield Bonds

2023-04-10 09:18:57 ET

Summary

• Diversified Healthcare Trust is trading at less than 88.3% of its book value with market concerns around its debt burden, rising rates, and poor cash flow driving underperformance.
• The REIT currently pays out a peppercorn quarterly dividend which works out to be a 3.17% forward yield against a stock price that has collapsed.
• Shareholders can grab a speculative 12.2% yield by going with the 6.25% Senior Notes Due 2046.

Diversified Healthcare Trust ( DHC ) is not for risk-averse investors with common shares of the senior living communities ("SHOP") and medical office buildings REIT down by 56.4% over the last year. The quarterly dividend payouts have also been on a sustained decline, falling from $0.38 per share in the first quarter of 2019 to $0.15 per share just before the pandemic. The REIT last declared a quarterly cash dividend payout of $0.01 per share , in line with its prior payment and for a 3.17% forward yield.

Zoom out over the last 5 years and the commons are down by 91.7%. What's happening? Indeed, the REIT's tangible book value ("TBV") was $2.6 billion for its fiscal 2022 fourth quarter versus a current market cap of $302 million. TBV per share was $10.82, broadly flat from $10.94 in its year-ago comp meaning that the common shares are trading at an 88.3% discount to TBV. To be clear here, Diversified Healthcare is trading just under 12 cents on the dollar which seemingly indicates a near-bankruptcy level of distress for a REIT. The company's price-to-book value is around 92% lower than its peer group median with a trailing 12-month price-to-revenue multiple that at 0.23x is 94.7% lower than its peer group.

Diversified Healthcare held 379 properties as of the end of its fourth quarter. This included 8.8 million square feet of medical office buildings and life sciences spaces with 27,408 senior living community units spread across 237 communities.

Dual Beats Against The 88% Discount To TBV

The REIT's fiscal 2022 fourth-quarter earnings saw the REIT bring in revenue of $336.89 million , flat year-over-year but a beat by $7.64 million on consensus estimates. The REIT splits its operations into two; office buildings and SHOP. The former held an occupancy of 84.7% for the fourth quarter, down from 91.3% in the year-ago comp with SHOP seeing its occupancy rise by 380 basis points to 76.3% from 72.5% in the year-ago period.

Medical offices formed 43% of same property net operating income of $46.7 million during the fourth quarter with the REIT entering into new and renewal leases for 181,660 rentable square feet at weighted average rents that grew by 8.9% over previous rents for the same space.

The core issue facing the REIT, and the core driver of its underperformance is operating expenses and lack of positive cash flows. Diversified Healthcare held a total debt balance of $3.07 billion, which was equal to 30.6% of gross assets. The REIT has no significant maturities until 2024 when $250 million comes due. Another $500 million will have to be repaid in 2025, which presents a headwind with cash and cash equivalents and restricted cash of $688.3 million as of the end of the fourth quarter.

Total expenses have been in excess of revenue since 2021 with rising interest expenses further contributing to what was a cash loss from operations of $3.4 million for the fourth quarter. Cash loss from operations stood at $40.4 million for 2022. Further, total capital expenditure for last year came in at around $300 million with management stating during their earnings call that they intend to maintain this level of expenditure through 2023. Interest expense for the fourth quarter also came in at $49.3 million, down $63.5 million in the year-ago period and partially offset by interest and investment income of $10.3 million.

FFO, The Speculative Bonds, And Closing The TBV Gap

Diversified Healthcare Trust 6.25% Senior Notes Due 2046 ( DHCNL ) are currently swapping hands for $12.50 per note after a 33.5% decline over the last year. The 50% discount to their $25 par value mirrors the distress of the common shares but still highlights confidence from noteholders that the REIT will be able to remain a going concern. They pay out a $1.56 annual coupon for a 12.48% yield on cost.

This represents a safer way to play the REIT with a yield that's 931 basis points more than what's currently being paid to common shareholders. However, the play here for more risk-taking investors would be the commons with a best-case scenario seeing the REIT move to perhaps trade just 20% below TBV. But this is unlikely to happen. Bears would be right to flag that TBV would be set to decline on the back of continued operating cash burn and capital expenditure. FFO of $0.03 during the fourth quarter, whilst a beat by $0.05 on consensus estimates, was not backed by actual operating cash flow.

The aggregate of 2023 capital expenditure and debt coming due over the next two years means the company faces a total cash outlay of $1.05 billion. Hence, with no clear pathway to operating expenses moderating as inflation continues to push higher wage and energy bills on their operators, the near-term outlook for performance looks cloudy. I'd have liked the external manager RMR Group ( RMR ) to perhaps cut back on capital expenditure as the company now faces the prospect of refinancing at materially higher interest rates than when its debt was originally issued. This is one to monitor but I'll hold off on recommending it as a buy.

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