2023-09-28 08:15:00 ET
Summary
- Welltower has seen strong fundamentals and stock price performance over the past 12 months.
- Its higher revenue than expense growth has resulted in higher operating leverage and NOI growth.
- WELL's strong balance sheet and lower competition from new supply position it for healthy growth.
- The shares appear to be soundly valued at present, and I see better opportunities elsewhere in the healthcare REIT space.
It pays to stick with quality, especially in times of uncertainty with respect to high interest rates and the economy. Many REITs with higher leverage have seen material drops in the share price, and this is in stark contrast to conservatively managed Welltower ( WELL ), which as shown below, is actually up by 26% over the past 12 months.
I last covered WELL here back in May with a 'Buy' Rating, noting material same-store NOI growth. The stock has performed respectably since then, giving investors a 4.8% total return, slightly edging out the 4.7% rise in the S&P 500 ( SPY ) over the same timeframe. In this article, I revisit the company and the stock, and discuss whether if it's currently a Buy or Hold, so let's get started!
Why WELL?
Welltower is one of the "Big 3" diversified healthcare REITs, alongside peers Ventas ( VTR ) and Healthpeak Properties ( PEAK ), and is a member of the prestigious S&P 500 index. Its properties include seniors housing, post-acute communities and outpatient medical properties, and are well-located in attractive markets across the U.S., Canada, and the UK.
Longtime investors in WELL know that it along with its seniors housing peers saw significant challenges during the early pandemic years, with occupancy declines during that time. In addition, labor challenges and wage growth further pressured the company and its peers over that timeframe.
However, the company has seen a dramatic turnaround since then, with RevPOR (revenue per occupied room) exceeding ExpPOR (expenses per occupied room). As shown below, this turnaround began in the first quarter of 2022, and has since accelerated since the end of last year.
Having expense growth that's in-line with revenue growth is par for the course, and in WELL's case, higher revenue than expense growth results in higher operating leverage and NOI growth. This is reflected by WELL's strong SSNOI growth in recent quarters, including Q2, during which SSNOI grew by 13% YoY, driven by robust Seniors Housing SSNOI growth of 24% YoY.
Most everyone who understands real estate know that higher interest rates represent a headwind for the industry. However, there's almost always a silver lining to adversity. In WELL's case, higher rates mean that the days of "easy money" are over, and that higher leveraged private market players are priced out of bringing new supply onto the market. As shown below, new construction starts are now 80% below the peak level, and sit close to where it was immediately after the Great Financial Crisis.
This bodes well for well-capitalized players like Welltower, considering that it carries a solid BBB+ investment grade credit rating from S&P, and net debt to EBITDA ratio of 5.6x. As shown below, WELL carries significant liquidity of $7.6 billion and improvements to its EBITDA in have resulted in its leverage ratio trending below the important 6.0x level.
Having a strong balance sheet has enabled WELL to opportunistically deploy capital, including the $1.3 billion capital deployments in Q3 so far. This is a part of the $10.7 billion in capital deployed since the company pivoted to office in the fourth quarter of 2020. WELL's growth strategy combined with low competition positions it for strong potential returns, considering that demographic tailwinds remain intact.
The age 80+ senior population continues to grow and is expected to accelerate over the next decade and beyond with a 4.4% CAGR between now and 2030, as shown below. The 80+ age cohort also enjoys unprecedented wealth creation no seen in previous generations, resulting in greater affordability and thereby pricing power for WELL.
My main complaint around WELL is that it currently appears to be soundly valued at the current price of $80.20 with a forward P/FFO of 22.6. As such, I believe the current valuation fully bakes in the 11% annual FFO/share growth rate that analysts expect over the next 2 years without considering the downside risk. Risks include a potential slowdown in WELL's external growth as it taps out its balance sheet capacity and potential for higher interest expenses as debt rolls over.
While I was bullish around WELL's prospects in my last piece, when it was about 5% cheaper, I simply see too many other compelling choices in the healthcare REIT sector to warrant a 'Buy' rating at present. WELL's EV/EBITDA sits materially higher than that of diversified peers VTR and PEAK, as well as outpatient medical properties owner Healthcare Realty ( HR ).
All 3 peers carry investment grade credit ratings and currently give higher dividend yields than WELL. Considering the opportunity cost of deploying capital in to WELL shares at present, I'm downgrading the stock to a 'Hold' rating.
WELL & Peers EV/EBITDA (Seeking Alpha)
Investor Takeaway
WELL is clearly a quality player in the healthcare REIT space. The company has emerged as a strong performer from the pandemic era, and this looks likely to continue into the future with strong fundamental growth, a solid balance sheet, and external acquisition opportunities.
However, the market has also caught onto WELL's quality making the shares pricey, particularly considering that other diversified peers are trading at a discount compared to WELL stock. In my view, investors may be well served in holding off on buying WELL at today's prices while looking at its peers for higher yield an potentially better total returns.
For further details see:
Welltower: Strong Vital Signs, But Better Opportunities Elsewhere