2024-01-22 06:30:00 ET
Summary
- Welltower is a health care REIT with abysmal long-term growth of per-share FFO.
- More recently, their actions and disclosures surrounding Genesis Healthcare are very poor, in my view.
- More broadly, this company, in my view, does not clearly and openly give you the bad news, of which there has been plenty.
The first annual revisit to my Go-Fishing Portfolio again made me aware of Welltower ( WELL ). They are distinguished by their abysmal long-term growth of per-share FFO, or Funds From Operations.
Of course, Welltower is one of the two big kahunas among the health care REITs, the other being Ventas ( VTR ). Welltower is rock-solid financially, carrying a BBB+ credit rating and massive liquidity, more than three times their maximum annual maturing debt over the next 4 years.
Their portfolio Net Operating Income, or NOI, shown in their supplemental , shows ownership of properties in four categories. Senior housing properties they operate are 48%, another 18% is in senior housing properties they own and lease using triple-net leases, 22% is in outpatient medical facilities, and 12% is in long-term, post-acute care.
The one they are actively growing is the latter. But my focus today is not on the granular details, because there are company-wide issues that make these irrelevant.
For full disclosure, let me express at the start my general skepticism of health-care properties. Much of the sector is centrally dependent on politics and regulation, hardly trustworthy economic partners.
And senior housing, aside from its notorious troubles with oversupply, faces increasing headwinds as technology enables seniors to stay longer in their houses. Some friends of mine recently went into senior housing and back out into a simpler house within a couple years, to improve their quality of life.
But, in my eyes, these issues too are small compared with things discussed below.
History of Earnings
The preferable measure of cash earnings is Funds Available for Distribution, or FAD. But Welltower quit disclosing that in 2017, giving reasons that make no sense to me.
In my view, every REIT should explicitly disclose to their owners the size of their cash earnings. Alas, most do not. This leaves a lot more scope for management to sweep negative developments under the rug.
As poor proxies for cash earnings we will look at FFO/sh and also CfO/sh, where CfO is cash from operations, less changes in working capital. These both leave out necessary capex and some other items. But when those don’t change as a fraction over time, the growth rates should match that of cash earnings.
So here is the long-term history of FFO/sh and CfO/sh for Welltower. I chose not to research the large difference between these two during the 2000s, before impairments were taken out of the FFO calculation.
Superficially, the earnings growth seems OK from 2002 through 2016. But if you had looked quantitatively in 2016, you would have found that the CAGR from 2002 was under 3%.
This is poor for a REIT. So if you had enough sense to sell then you would have saved yourself the subsequent years of abysmal economic performance. Had you stayed in you would have gotten the total return CAGR since then of nearly 9%, which makes no sense to me as is discussed below.
Value is some multiple of earnings per share. Even though the market has been forgiving to date, objectively Welltower managed to burn up a third of cash earnings and therefore a third of shareholder value in the subsequent 6 years.
Yet the mantra of delivering value to shareholders remains common in their earnings calls. This, from Q2 2023: “Last year, I described to you that we as capital allocators strive to create partial value by compounding over a long period of time. By doing what's right in the long-term for our continuing shareholders may result in short-term pain.”
What the Cash Flows Tell Us
We can check the cash flows to see what business model this REIT is trying to run. And whether the past few years reflect financial distress.
Here we see a reduction of debt (gray) in 2009, 2016, 2017, and 2020. We all see net dispositions (acquisitions are yellow) in 2021. The changes associated with the pandemic and the Great Recession make sense, but the reason for the problems in the mid-teens is unclear.
The rest of the time we see small retained earnings (cash flows less dividends, green). Mostly, the acquisitions are funded by issuing stock (red).
First, there is no sign of financial distress, which would be seen in large debt reductions funded by stock issuance or dispositions. Instead, what we have is large acquisitions funded by the issuance of stock and some debt.
Welltower is running a common REIT business model of pure external growth. To be accretive to shareholder value, this does depend on having an adequately high stock price, and Welltower has in 2023 expressed their intent to avoid dilutive stock issuance.
But if all this growth were accretive then we ought to be able to see the impact in FFO/sh. What one usually sees for REITs is that the increase in gross assets less the increase in share count is approximately the growth in FFO/sh. FFO usually increases about as much as gross assets. Here are some numbers for Welltower:
First focus on the earlier period, through 2016. Gross property grew at a 24% CAGR but FFO only grew at 22% (as did Net Operating Income or NOI). FFO/sh growth should have been near a 6% CAGR, but was 3%.
What is clear is that the returns on the Welltower portfolio were dropping with time. This is really unusual for a REIT. Even minimal inflationary rent increases tend to support and grow FFO/sh.
The later years, from 2016 through 2023, shows the FFO/sh decline, of course. The share increase, at a 4.9% CAGR, only produced a 5.8% increase in gross property because it was not paired with much debt.
So the cash flows show us that Welltower appears to be a poor long-term steward of shareholder capital. But they do not explain the disaster of the past 7 years.
The Genesis of Trouble
We see in the 2016 10-K that Genesis Healthcare had become a major tenant in 2011.
In April 2011, we completed the acquisition of substantially all of the real estate assets of privately-owned Genesis.
For the year ended December 31, 2016, our lease with Genesis accounted for approximately 27% of our triple-net segment revenues and 8% of our total revenues.
Then tone of the earnings call for that quarter was extremely self-satisfied. But Welltower must have had poor insight into the financials of this major tenant or poor judgement about their implications.
The very next year, in 2017, Genesis declared bankruptcy. Welltower rental revenues dropped $200M that year and another $60M the next one. That was 6% of the 2018 total. Some offsetting positives meant that FFO only dropped by $190M across the two years.
But in that Q4 earnings call Welltower bragged about how Genesis was now a much stronger tenant, after the restructuring, saying
We negotiated a successful restructuring of Genesis Healthcare that has significantly enhanced the credit quality and sustainability of the Genesis business model.
also saying
So, so far we have sold $1.9 billion of Genesis loans and real estate with a realized IRR of 10.3%
Somehow that IRR did not do much good.
It appears to me that in that first Genesis restructuring the creditors tried to have their cake and eat it too. From the Genesis 2017 10-K:
In total, the Restructuring Transactions are estimated to reduce our annual cash fixed charges by approximately $62 million beginning in 2018 and are estimated to provide $70 million of additional cash and borrowing availability, increasing our liquidity and financial flexibility.
Genesis reported several flavors of EBITDA, of which by far the largest was the $632M of Adjusted EBITDAR.
So the post-restructuring business gained only about 10% of EBITDAR as headroom. The ratio of long-term liabilities to EBITDAR remained above 8x. Definitely secure, eh?
Plus Welltower, who already had loaned Genesis money, written off losses, and dropped their rent, loaned them more money. [Sound familiar, holders of Medical Properties Trust ( MPW )?]
Things seem not to have gone well, even before the pandemic. By the Q4 2018 Welltower earnings call, only one year later, we hear:
…we sold 22 Genesis assets that were below market coverage for $252 million at 8.95% yield. …
While we keep reading about how skilled nursing facilities should be around two times EBITDA on coverage, this Genesis transaction highlight the significant gap between theoretical worth [and] how practitioners behave.
While selling Genesis assets diluted short-term earnings to the tune of $0.025 per share, we believe our shareholders achieved significant value and an improved growth profile for the enterprise going forward.
Then in 2020 came the pandemic, which was very hard on healthcare in general and on the skilled nursing facilities owned by Genesis in particular. But most operators of those facilities did not go bankrupt. Genesis did and ended up liquidating.
We see in the Welltower Q4 2020 earnings call:
EBITDAR coverage declined by 0.012x sequentially to 1.0x, which was almost entirely due to deterioration in largest long-term post-acute tenant Genesis HealthCare. … Genesis HealthCare, which makes up approximately half of our long-term post-acute exposure raise concerns around its ability to continue as a going concern in the second quarter financials filed on August 10.
By the end of 2021 Welltower reported
Over the course of 2021 we completed $458 million of long-term post-acute dispositions at a blended cap rate of 8.7%. With an additional $108 million under contract for sale at year-end. As a result, our long-term post-acute portfolio represented just 5.2% of total in-place NOI at year-end versus 10.1% at the end of 2020. A 490 basis point decline driven largely by the exit of our Genesis relationship.
As I parse the numbers from 2011, Welltower bought those Genesis properties at a cap rate below 5%.
Hide the Bad News?
A recent article by an Italian author whose investment focus differs greatly from mine provided a quote from Warren Buffet that spans such differences:
At Berkshire, we believe in Charlie’s dictum –Just tell me the bad news; the good news will take care of itself– and that is the behavior we expect of our managers when they are reporting to us.” (Warren Buffett, 1995 annual letter)
So what did Welltower do?
First, in the press release for Q4 2016, they stated "Going-forward, we will no longer report FAD." In my opinion this was written when the bad news was probably known to be coming. Second, in the 2017 Q4 earnings call all they had to say about earnings was this:
Overall, we delivered $4.21 of normalized FFO per share for 2017 in total.
I’ve discussed before how “normalized” or “core” FFO are vehicles REITs use to hide actual cash costs from their investors. What is entertaining about Welltower is that the reconciliation is not provided in their 8-K supplementals, which is where nearly all REITs put it. (An example is here , for Q4 2022, and you can find them all using the EDGAR search function at sec.gov, if you like.)
One finally finds it only in the press releases (same source). That is definitely going the extra mile….
Here is a relevant page from the press release for Q4 2017
You can see in the magenta boxes that FFO/sh declined 28% from 2016 to 2017. This reflects the huge impact of having a major tenant stop paying rent. The blue boxes show the large items presented as actual cash costs that “do not count.”
So over that same period “normalized FFO” declined only 7.5%. And this was, again, the only number provided in the earnings call. The 8-K supplemental has zero information on per share earnings of any kind, focusing on total NOI and EBITDA only.
My long-term readers can see the steam coming out of my ears upon coming to know this story. In my opinion one should not invest in any REIT that does not tell you the bad news explicitly and up front and does not focus on per-share results.
Perhaps my moralistic approach here seems over the top to you. Note that it did lead me to exit MPW near the end of 2020.
Perspectives on Valuation
So here are a few things we know about Welltower.
- They have managed over the very long term to see the earnings on their Gross Property decreased. This is something one just does not see from REITs and especially from blue-chip REITs.
- They have long run on an external growth model. But they have not seen the accretion to per share cash earnings that has been typical of other REITs running that model across the 2010s.
- In my opinion, they completely botched the selection and management of Genesis Health Care as a tenant. The consequence was massive losses in FFO/sh and other sensible measures of earnings.
- In their earnings calls they shared only heavily adjusted earnings numbers that did not reveal the magnitude of the disaster. In my view, they did not satisfy Buffet’s demand for clear disclosure of bad news.
Even without the fourth item, this REIT should be priced to account for the real and substantial risks. Their earnings seem far riskier to me than those of EPR Properties ( EPR ).
But WELL has always had a lower yield than EPR and today their yield is well below half that of EPR. Mr. Market, this is just stupid.
And then for me the fourth item makes WELL uninvestable at any yield. You have to decide for yourself.
For further details see:
Why Avoid Welltower