HTIBP - Healthcare Trust: Concerns On Dividend Coverage Weigh On Preferreds

2023-10-18 14:16:52 ET

Summary

• We believe Healthcare Trust Inc. may struggle to pay interest on its preferred stocks due to its history of burning cash and relying on debt.
• The company owns healthcare real estate, with different income mixes between Medical Office Buildings and Senior Housing Operating Properties.
• The rapid increase in the cost of debt may now pose an issue with their ability to pay dividends, as their revolvers cost more than 7% in interest.

We believe that Healthcare Trust Inc. (HLTC) will face some difficulties in paying interest on their preferred stocks (HTIA) (HTIBP) going forward. The company went on for roughly 10 years burning cash and financing the negative FCF with additional debt and issuance of preferred stocks. Now, with rising rates and low RE valuations, we think they may face a dead end on their expensive interest payments on the preferreds.

The company, the assets, and the concerning profitability

Healthcare Trust Inc. owns and manages a portfolio of healthcare real estate, which is composed of Medical Office Buildings (MOBs) and Senior Housing Operating Properties (SHOPs). The two segments have a roughly 50/50 share of total gross assets value, but they have very different economics, leading to a different income mix.

Indeed, the MOBs segment generates around $130 million in annual (2023E) property income, with a NOI margin of 73%, which translates into a NOI of $95 million. On the other hand, the SHOP segment has very different margins. They produce around $210 million in annual revenues (2023E) with a NOI margin of just 15%. This means around $32 million in NOI from these properties.

Historically speaking, revenues from properties remained quite stable over time, but these failed systemically to translate positively to the bottom line.

The result is a constantly deeply negative net income, caused by unproportionate interest expense, operating fees, and general and administrative expenses that impact NOI.

Another interesting measure is taking the cumulative NOI and computing the cap rate they are earning on their total real estate assets. This gives a perspective also on the alignment between market valuations and their own computations of fair value. Right now Healthcare Trust has around $2.6 billion of gross real estate investments, which are $1.9 billion net of cumulative D&A. This translates into a cap rate of $127 million / $1.960 billion = 6.48%. This is a useful metric to understand if the RE value we are using is aligned with market value. This article confirms that the median cap rates were around 6.5% in 2023, which means that Healthcare Trust valuations are aligned with the current market rates.

The issue is that the stated NOI at the segment level, which looks very generous, is then impacted by many large expenses that virtually erode value for shareholders.

This left the company with one single option: financing operations with increasing debt and capital injections from preferred stocks.

This is what the phenomenon looks like visualized. Growing debt while RE assets are slowly decreasing, meaning that debt is used to compensate shareholders rather than create new assets. It is not healthy behavior and cannot be sustained over a prolonged period of time in our view. Now the point is that in the last 10 years, debt was very cheap. This bought some time. However, now they are paying north of 7-8% interest rates on their revolvers, or roughly $350 million of debt. Clearly not a feasible option to pay preferred dividends.

The current balance sheet and interest coverage

To better understand our concerns around the timely payment of dividends on the preferreds, it is useful to look at the balance sheet as of today. The company has the aforementioned $1.9 billion of real estate assets, $800 million of fixed-rate mortgage notes, and around $350 million of credit facilities debt (revolvers) outstanding.

Then always above the common stocks, we have the preferreds in question. Two series of stocks, A and B, with very similar conditions but slightly different coupons. Series A has a 7.375% annual coupon, computed on a $25 liquidation preference value, which is $1.84 per year. Series B has a 7.125% coupon, computed on the same $25 liquidation preference, that yields $1.78 per year.

Since it has a higher coupon, and apparently also a lower price, we will be focusing on Series A stocks.

There are 3.97 million Series A stocks outstanding, and 3.6 million Series B, for a total amount of around $190 million. After we subtract the net debt from the asset value, we get to $750 million available to repay the preferred. It is a good LTV ratio that assures downside risk.

However, on the income and cash side, things are not so bright. For the six months ended June 2023, the company generated $10 million in CFO, spent $35 million in Capex and new acquisitions, and accessed an additional $50 million of mortgage notes financing. Assuming that this last part will not be accessible forever, we will find that the simple math behind FCF - negative of $25 million ($10 - $35) - makes the $13 million of interest payments on the preferred more and more unlikely.

We believe the loss will need to be financed mostly entirely with debt since the company has virtually zero cash on hand - $70 million with more than $1 billion of liabilities and burning $40 million per year.

What could go right for Healthcare Trust?

We believe in one main positive catalyst that is common to virtually any other REIT in the same situation: lower rates, and higher valuations. This would immediately translate into lower cap rates, which make it much easier to sell some properties, lower leverage, and all while remunerating shareholders.

In the case of Healthcare Trust Inc, we find that a lower rates environment similar to Covid or even pre-Covid crises would immediately benefit the preferreds for two main reasons: (1) high yields in the 9% would become immediately attractive, and (2) coupon payments coverage will not be an issue because of the company's ability to sell assets at generous valuations.

While we believe the current rates are higher than a normalized level. We also believe that long-term rates will eventually settle at higher levels than in the past years. This means that RE valuations will likely remain lower for longer in our opinion.

Conclusion

We believe that Healthcare Trust Inc. preferred stocks are at risk of seeing their dividend payments stopped soon. The company has been financing dividends with debt for a long time. However, debt has become much more expensive lately, and will likely force a reduction of dividends paid out to shareholders.

We think investors should focus on other opportunities in this period of high yields in much safer securities.

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