CareTrust REIT, Inc. (NASDAQ:CTRE) Q4 2022 Earnings Call Transcript

CareTrust REIT, Inc. (NASDAQ:CTRE) Q4 2022 Earnings Call Transcript February 10, 2023

Operator: Good morning. My name is Devin and I’ll be your conference operator today. At this time, I’d like to welcome everyone to CareTrust REIT announces Fourth Quarter and Full Year 2022 Operating Results Conference Call. All lines have been placed on mute to prevent any background noise. After the speakers’ remarks, there will be a question-and-answer session. Thank you for your patience. I’ll now turn the call over to Senior Vice President, Lauren Beale. You may begin the conference.

Lauren Beale: Thank you and welcome to CareTrust REIT’s fourth quarter 2022 earnings call. Participants should be aware that this call is being recorded and listeners are advised that any forward-looking statements made on today’s call are based on management’s current expectations, assumptions and beliefs about CareTrust’s business and the environment in which it operates. These statements may include projections regarding future financial performance, dividends, acquisitions, investments, returns, financings and other matters and may or may not reference other matters affecting the company’s business or the businesses of its tenants, including factors that are beyond their control, such as natural disasters, pandemics such as COVID-19 and governmental actions.

The company’s statements today and its business generally are subject to risks and uncertainties that could cause actual results to materially differ from those expressed or implied herein. Listeners should not place undue reliance on forward-looking statements and are encouraged to review CareTrust’s SEC filings for a more complete discussion of factors that could impact results as well as any financial or other statistical information required by SEC Regulation G. Except as required by law, CareTrust REIT and its affiliates do not undertake to publicly update or revise any forward-looking statements where changes arise as a result of new information, future events, changing circumstances or for any other reason. During the call, the company will reference non-GAAP metrics such as EBITDA, FFO and F-A-D or FAD and normalized EBITDA, FFO and FAD.

When viewed together with GAAP results, the company believes these measures can provide a more complete understanding of its business, but cautions that they should not be relied upon to the exclusion of GAAP reports. Yesterday, CareTrust filed its Form 10-Q and accompanying press release and its quarterly financial supplement, each of which can be accessed on the Investor Relations section of CareTrust’s website at www.caretrustreit.com. A replay of this call will also be available on the website for a limited period. On the call this morning are Dave Sedgwick, President and Chief Executive Officer; Bill Wagner, Chief Financial Officer and James Callister, Chief Investment Officer. I will now turn the call over to Dave Sedgwick, CareTrust REIT’s President and CEO.

Dave?

Dave Sedgwick: Thank you, Lauren and good morning, everyone. Many of themes from last quarter’s call are still applicable today, starting with the macro dynamics at play, the Fed’s response to inflation has had a significant impact on the credit market as intended, even with our sector leading leverage, the rapidly risen rates undeniably eat into earnings and slow what has also been a sector-leading FFO per share growth rate over the past five years. The good news is that even with the elevated cost of capital, we can still make accretive investments and intend to do so and positively, as we mentioned last quarter, the flip side of the tighter credit market continues to be a tipping of the scales in our direction for brokers and sellers who are looking for certainty to close.

Our operators are also poised to find some relief to the staffing challenges if and when a recession begins to drive people back to work, where jobs are secure here in healthcare. Rent in the fourth quarter came in at 95.5% inclusive of about $750,000 of deposits applied. Today, I’m pleased to report that of the original 32 assets we identified as candidates to sell, reposition or restructure, we’ve made significant progress with only a handful of smaller assets remaining on the market. We provide a detailed update in our supplemental, but I will emphasize a few key points here. Ultimately, after running an exhaustive process, we sold 13 properties and decided to retain 14, leaving five facilities on the market. The 13 sold for $68.8 million, those properties paid essentially no rent in 2022.

Photo by alexas fotos on Unsplash

For the 14 properties retained, in 2022, we collected about $5.2 million of $8.6 million of contractual rent. For 2023, we estimate that eight of these 14 will produce cash rent of about $3.5 million. We hope to give more clarity on the timing of rent commencement for the remaining six next quarter. That leaves just five smaller seniors housing facilities from the original 32 that, as we sit here today, are still on the market. Two of those are under contract to sell, one is under LOI, leaving two being actively marketed. These five assets on the market, only one paid rent last year, for a total of $377,000. In terms of portfolio strength, you’ll see a portfolio with the 10 ten tenants, who represent 89% of contractual rent, with property level EBITDAR lease coverage of 2.01 times, excluding HHS funds.

We have confidence in the few operators in the top 10 that on the surface, appear vulnerable and believe it’s just a matter of time until their results reflect the hard work they’ve been putting in to turn certain facilities. Last year, you may recall us repeatedly talking on this call about elevated risk associated with one Midwest skilled nursing operator outside of our top 10 who has had negative lease coverage for quite some time. They account for 2.8% of rent as of 12/31 annualized. In 2022, due to partial payments, we applied and exhausted their $1.2 million security deposit, and no rent payment has been made for January or February yet. A week ago, they informed us of a change in CEO and the need to work together on a plan that works for both of us.

We’ve just started active discussions with them about the best path forward, and we expect to have a concrete plan to share with you next quarter. Like I highlighted before, without this operator, our EBITDAR lease coverage outside our top 10 goes from 1.08 times to 1.84 times, excluding HHS funds. Considering the toll that COVID has taken on our sector, the way the vast majority of our operators have managed through these past few years is gratifying on many levels, and we feel proud to affiliate with some of the best operators in the country, both large and small. The strength of our company enables us to turn more attention to external growth this year. So as we begin 2023, our strengths continue to be our balance sheet, our portfolio, and our experienced team.

With that, I’ll turn it over to James to update you on our investment outlook.

James Callister: Thanks, Dave, and good morning, everyone. Looking to the market, we continue to see an uptick in seniors housing, skilled nursing and behavioral deals, coming across our desk. Many of the facilities being sold consist of distressed seniors housing assets with owners that are facing high interest variable rate loans and have to exit. Deal flow continues to increase on the skilled nursing side, with incoming transactions primarily consisting of a single to a few assets that are nonstrategic to the seller or at some stage of operational distress. We are also seeing a few smaller portfolios from operators looking to sell as they exit the business, and a few larger portfolios in states where Medicaid rates remain very low.

Some REITs and private equity owners are also disposing of assets to help operators shed negative cash flowing assets or assets that are no longer geographically strategic. These trends may accelerate with the end of the public health emergency. We expect the upsurge in deal flow to continue, with sellers placing an emphasis on certainty of close and low execution risk. Price discovery continues, though we are seeing signs that motivated sellers are starting to adjust expectations in some cases. We will remain disciplined as we look for further adjustment to seller expectations, given the high interest rate environment, tightness in the debt markets and other factors. With our strong balance sheet and access to capital, we are poised to pursue actionable acquisition opportunities with a focus on those states with favorable Medicaid rates and access to labor, and where we have a strong bench of existing operators, or where we are actively pursuing new relationships with operators we have long admired.

Our commitment to a side-by-side underwriting approach with our operators will be more important than ever as we face the challenges of underwriting labor, occupancy and other difficult assumptions in the current environment. Turning to the pipe, it currently sits in the $100 million to $125 million range. As we sit here today, the pipe is primarily made up of skilled nursing, but also includes some seniors housing assets. The deals include some of our standard one to two facility acquisition opportunities in addition to small or medium-sized portfolios that would allow us to not only enter new states, but also expand in states where we have a limited presence. And with that, I’ll turn it over to Bill.

Bill Wagner: Thanks, James. For the quarter, normalized FFO decreased 0.8% from the prior year quarter to $37 million. Normalized Fad decreased by 1.9% to $39 million. On a per share basis, normalized FFO decreased a $1 to $0.38 per share. Normalized Fad also decreased $1 to $0.40. Rental income for the quarter was $47.7 million, compared to $47 million in Q3. The increase of $657,000 is due largely to the following four items. One, we received approximately $1.3 million of cash related to a prior tenant that was recognized in the quarter. I expect a little more of this in Q1 of 2023, but it will not be material. Two, an increase in rents from CPI bumps of $182,000; three, a decrease in cash collections of $427,000 from tenants who are on a cash basis of accounting and four, a write-off of straight line rent receivable of $440,000 relating to a tenant we moved to cash basis of accounting during Q4.

Interest income was up $860,000 due to the originations we closed in Q3. Interest expense was up $1.3 million from Q3 due to higher interest rates of $1.5 million, slightly offset by lower borrowings under our revolver. During the quarter, we took an additional impairment of $5.4 million, G&A expense was down $346,000 from Q3 due to lower compensation expense of $618,000, offset by other corporate related items of $272,000. Cash collections for the quarter came in at 95.5% of contractual rent and includes the application of $750,000 of security deposits. Without the application of the security deposits, cash collections was 94% of contractual cash rent. In January, we collected 94.5% of contractual rents due from our operators. A couple of notes regarding the balance sheet in Q4.

We issued $2.4 million shares under our ATM for gross proceeds of $48.1 million, and we extended our revolver another four years. Our liquidity remains extremely strong with approximately $20 million in cash and $465 million available under our revolver. Leverage also continued to be strong with a net debt to normalized EBITDA ratio of 3.7 times, which is below our stated range of four to five times. The net debt to enterprise value is 28% as of quarter end and we achieved a fixed charge coverage ratio of 6.5 times. And with that, I’ll turn it back to Dave.

Dave Sedgwick: Great. So we hope our report has been helpful and thank you for your continued interest and support and happy to answer your questions at this time.

 See also 35 Most Expensive Countries in the World and 10 Most Advanced Countries in Battery Technology.

Q&A Session

Operator: Our first question comes from Jonathan Hughes with Raymond James.

Jonathan Hughes: Hey, good afternoon or good morning out there. I was just hoping we could talk maybe about the outlook for this year. And I know you’ve given us some building blocks of how things are expected to play out. I guess, why not give us the official guidance. It seems like we have kind of 95% of what we need. Obviously, there’s still a few properties left to sell or retain it and figure those out and there’s obviously that 3% or so operator that hasn’t paid rent since November. And I do get the models not that complex, and we can certainly make our own assumptions, but just trying to understand what’s preventing you from resuming your tradition of giving us annual guidance?

Dave Sedgwick: Yes. So I think you’ve kind of pointed to the answer in your question. We feel like there’s still enough uncertainty around the timing of when the rents are going to commence with these retained facilities and the outcome of this Midwest operator that we talked about to not issue guidance yet. But we’re hopeful that in the next quarter, we should be able to do that because I think by next quarter, we will have a lot of clarity and things agreed to. And so then as soon as we’re able to, which I think will be next quarter, we’ll be able to issue guidance.

Jonathan Hughes: Okay, that sounds good. And then on the

Dave Sedgwick: You’ll remind us of that next quarter.

Jonathan Hughes: I certainly will. That Midwest operator, the 2.8% operator that hasn’t paid since November, are they still on accrual accounting since I don’t think I saw a straight line write-off in the quarter. And if so, does that mean at this point you are still hopeful to recover what’s not been paid? And maybe there is a chance, as the discussions progress, they will commit to the current rent under the new CEO, as you said and also I think they have some pretty strong financial backing.

Dave Sedgwick: Yeah, they’re on cash accounting. They’re not accrual and the conversations with the group over there is very fresh. We literally got the news from them last week of the change in CEO, so it’s hard to handicap how this year goes, although I’ll tell you that they are expressing to us commitment to the portfolio and to the turnaround. This operator is primarily operating facilities in the state of Iowa, just to give you a little bit more color on them. And Iowa so far has really proven to be one of the least supportive states in the country for nursing home providers. Unlike other states, they’ve refused to pass on any of the FMAP federal funds. And I saw a report last week, or in recent days where about 39 Iowa nursing homes have been closed in the last couple of years.

So that makes the environment pretty difficult. However, there is reason for hope because there’s a Medicaid rate increase going into effect this July, but for some, it’s just going to be too little too late. So we’re going to be working with this operator to figure out a path forward that makes sense for both of us. But it’s so early in those discussions that we just — we can’t really give you an indication of how it’s going to play out yet.

Jonathan Hughes: Just one more. It has been a while since you’ve used the ATM to raise equity, but you did so in the fourth quarter. And at those levels of low teens premium to NAV, kind of low seven implied cap rate, how do you think about raising equity proceeds with no publicly identified opportunities to deploy that capital? Could we expect that trend to continue to keep hanging down your facility to create more capacity and more optionality for future external growth?

Dave Sedgwick: Yeah, I think, look, we saw a pipeline that we feel like is going to be able to — that we feel like we’ll be able to execute on in the coming months and so with visibility into that and the ability to pay down the line a little bit, it just made sense to pull that ATM trigger in the quarter.

Jonathan Hughes: All right, I look forward to hearing a lot more next quarter. Thanks for the time.

Operator: Our next question comes from Austin Wurschmidt with KeyBanc Capital Markets.

Austin Wurschmidt: Hey, good morning, everybody. Just wanted to go back to that Midwest operator, Dave, I believe in sort of past discussions, you’ve talked about that roughly of that $5 million, $5.5 million contractual rent, there being maybe a couple of million dollar delta seemingly at risk relative to maybe where market rent would be based on facility level performance. And I’m just curious if that’s still the right sort of range today, and then how are you thinking about a potential rent cut or even looking to sell these communities?

Dave Sedgwick: Yes. I don’t think our view on the value of these buildings has really changed over the last few quarters. Their performance has stayed essentially the same with negative EBITDAR. And so you’re looking at a portfolio that would value probably on a per bed basis if taken to market. But in terms of what we’d be willing to do, it’s just given where we are in the discussions, it’s not something that we should be talking about publicly yet.

Austin Wurschmidt: That’s fair. And then switching over then to the eight tenants that you retained, I guess, on one hand, you clearly flagged these within your original sort of portfolio optimization grouping. So presumably there was something about these assets that wasn’t optimal, but they did pay all of their contractual rent in 2022. So can you just shed a little bit of light on the need for the rent cut and sort of how you landed on the magnitude of that cut to be sure that there’s sufficient room going forward?

Dave Sedgwick: Yeah, great question. And I appreciate the way you laid out the question, because you’re right, there was something in these buildings that we saw early on, even though they were current with rent. If you’ll remember, this time last year when we announced the plan for these 32, we said we were responding to a couple of operators that hit the wall and then that caused us to look at the rest of our portfolio and sort of try to anticipate who was going to be next and these operators or facilities made that list. They paid rent in the year, but that was largely subsidized with government stimulus and if not for that, we would not have received the full contractual rent in the year. And as we look forward to this year, then we say, okay, what is it going to take to keep these guys current, to keep them engaged and incentivized to run these buildings well?

And I think that’s the number that we arrived at. We very well may revisit bringing these assets to market when conditions improve for buyers and we’ve set a rent and come to an agreement that gives us the right to either sell or retain it at any time.

Austin Wurschmidt: Thanks for that. And then just last one with respect to kind of the rest of the retained facilities, I’m just wondering if you could give us — is the rent commencement on the four specifically, is it a ’23 event? Is it more likely a ’24 event? Just even some range, even though I know you don’t maybe know specifically today when that may occur. And then also curious if these now will be reflected on sort of a cash or GAAP basis going forward, so we can understand sort of the FFO impact once rent does commence.

Dave Sedgwick: Yeah, so I would expect of the four retenanted that are showing are supplemental at $825,000 for year one contractual rent, that we would see some of that this year and again, I’m sorry that we can’t be more clear on the timing of that. There’s some licensing requirements that need to get checked, and sometimes those things take some time. But, yeah, I would expect that we’ll get a chunk of that $825,000 this year. Then once all the redevelopment and retenanting transitions are complete, the properties will prevent use as it shows a full year one rent of 5.7%. Unfortunately, I can’t give you today the timing of when that 5.7% really starts; but that will be followed by a step up in year two to 6.7%. And you’ll have a better idea, I think, next quarter of the timing of when we’ll get all of that rent commenced.

Austin Wurschmidt: Helpful. Thanks for the time.

Operator: Our next question comes from Steven Valiquette with Barclays.

Steven Valiquette: Great. Thanks for taking the question. I guess first in the earnings release today, you guys went out of your way to sort of flag the official end of the PHE coming up in May, and you discussed how it could cause some additional displacement and lead to some property acquisition opportunities, which is obviously the positive side of the equation. I guess. On the risk side, I can’t remember if you guys shared any color around this previously, but knowing it’s a moving target, have you guys taken the time to determine internally what you think the average negative percent impact might be on EBITDAR for the average SNF provider? If we’re just losing some of the benefits related to the PHE, do you think it’s material or not material because you guys also talked about some states implementing some policies to support or make up for what’s going to be lost in the PHE.

I just want to get your thoughts around that as far as just the potential impact on either coverage ratios or just average EBITDAR in the back half of ’23 into ’24. Thanks.

Dave Sedgwick: Thanks for that question. It’s a good one. It’s a bit of a crystal ball question that’s hard to answer because there are so many levers at play and the answers it really depends on the state that you’re in. In some states, I think it’s going to be sort of a non-event, particularly for those operators who are already kind of operating at the historical skilled mix numbers. Those states have already put in Medicaid rate increases and so it really shouldn’t be that big of a deal in some states. In others it might be. So it’s hard to answer for the industry or on an average, some operators in some states will be negatively affected and I think others it won’t be that big of a deal for them.

Steven Valiquette: Okay, but for your portfolio though, do you think it will move the needle on the coverage ratios or do you think it could be absorbed and just offset by other factors? When we think about just forward progression of your reported coverage ratios for the next six to eight quarters, I guess give or take.

Dave Sedgwick: Yeah, I think on the whole net effect, it should have a negative effect on lease coverage just because there are going to be those who theoretically their skilled mix will probably come down a little bit. And if occupancy stays flat, then by definition, their margin is going to be eaten away a little bit. However, if occupancy continues to recover, which we’re seeing signs that while slow, it’s steady recovering, then that could offset it. So it’s a little bit tough to handicap, frankly.

Steven Valiquette: Yeah, no doubt about it. Okay. I appreciate the color, though, in the meantime, it’s definitely helpful. Thanks.

Operator: Our next question comes from Michael Carroll with RBC Capital Markets.

Michael Carroll: Yes. Thanks. Dave, can we talk a little bit more about the 14 properties that you’re planning on retaining that were in the portfolio optimization plan? How many different operators are those going to and are those going to be new operators operating those facilities versus the ones that were in there previously?

Dave Sedgwick: So in the 14, we have a couple of operators that are coming in new, meaning transitioning from the prior operator. We have the two conversions to Behavioral Health. So those are going to landmark a new operator for us. And then among the eight properties that are retained that we classify as retained type, those are staying with the two operators there.

Michael Carroll: And then how many of these are seniors housing versus skilled nursing? It sounds like two of them are behavioral, but what’s the breakout?

Dave Sedgwick: Of the 14, they’re all seniors housing and the two behavioral are seniors housing that are converting into behavioral.

Michael Carroll: Okay. And then of the $3.5 million of rent that you expect from the , did that commence, or have they been paying that in the fourth quarter? And is that going to continue to be paid through January, or is there a different timing of that rent commencing or ramping up throughout the year?

Dave Sedgwick: That’s commenced as of January 01.

Michael Carroll: Did they pay that in the fourth quarter?

Dave Sedgwick: It’s a step down from what they paid in the fourth quarter.

Michael Carroll: What did they pay in the fourth quarter?

Dave Sedgwick: It’s a difference there on slide seven where we show 2022 contractual rent of 5.1%. That goes down to 3.48%.

Michael Carroll: Okay, great. And then on the 2.8% tenant, when did those — I guess how much of that security deposit was paid in the fourth quarter? Did that reflect their full contractual rent in the fourth quarter, or did they short pay their contractual ones in the fourth quarter even if you exhausted that security deposit?

Dave Sedgwick: Yeah. So this operator, they made a partial payment in the fourth quarter. So their last payment to us was in November.

Michael Carroll: And then you said, you applied and exhausted the $1.2 million security deposit. Did that reflect the full contractual rent payments in the entire fourth quarter?

Dave Sedgwick: No. Sorry for the confusion on that. In the fourth quarter, we applied about $700,000 — $750,000 of their security deposit to make up what was due. They still ended up a little bit short for the year, but security deposits for this operator was applied, if memory serves, in the first quarter, in the third quarter, and in the fourth quarter. And so what would happen is we would apply a security deposit in the first quarter, and then they would make up for that, they would replenish it, and then in the third quarter, same type of thing. They would make their payments, replenish part of it. And so it was sort of an ongoing late payment situation, which is why we started really talking about them in August last year, about being elevated risk.

Michael Carroll: Okay. And then, I guess I know you kind of talked a little bit about this on the call, so I’m not sure if you can answer any more details, but what’s the ultimate plan? I think we’re just waiting to see if they can recover, and we’re seeing if they can start repaying rent as soon as the results start to recover from that. Or is this a potential sale opportunity that you see in the marketplace?

Dave Sedgwick: Yes, sorry, Mike, it’s just too early to comment on it. The conversation is about a weekend.

Michael Carroll: Okay, great. Thanks. I appreciate it.

Operator: Our last question comes from Juan Sanabria with BMO Capital Markets.

Juan Sanabria: Hi. Just a follow up to Mike’s line of questioning. So what was the total amount of rents booked from the 2.8% tenant in the fourth quarter, realizing that 750K was from the security deposits?

Bill Wagner: Well, I’m guessing it’s was about 1.25% inclusive of the security deposit.

Juan Sanabria: What? Sorry.

Dave Sedgwick: 1.2%.

Juan Sanabria: Okay. And then just curious if you could talk a little bit more about the acquisition pipeline and where do you think cap rates have moved to or where they’re heading to for your kind of $100 million plus pipeline find that you talked about in your prepared remarks.

James Callister: Yeah. Hey, Juan, it’s James. I think that — if we talk about it in terms of lease yield we’re looking for, I think that’s definitely crept up a little bit. I think we’re testing, trying to put the money to work at ten or high nines for skilled nursing and maybe mid to low nines on seniors housing and working hard to find opportunities where that works. It’s just really dependent state by state right now. When you look at which states have been favorable with respect to the Medicaid rate and which states have access to labor and which don’t kind of drive what our basis is going to be and whether or not we can get that yield at a ten or high nine for the skilled nursing.

Juan Sanabria: And then just a question for Bill, any thoughts on the balance sheet on terming out some of the floating rate debt as we think about modeling out 2023?

Bill Wagner: Yeah, I would expect as a percent of total debt, variable rate debt will increase over the course of the year as we utilize the revolver to match fund deals as well as, but also keeping in mind, we’ll likely use the ATM to fund those investments.

Juan Sanabria: And then just last one, if you’d indulge me. Any update in terms of your conviction or maybe a lack thereof for kind of the three top ten tenants that have kind of meaningfully below one times coverage and covenant asset and tenant.

Dave Sedgwick: Yeah, I talked about them in my remarks. We’re confident that their hard work will pay off in a matter of time and we got good corporate credit behind them beyond the buildings that they have with us and so not much to share beyond that. I guess the one thing I would highlight is with Bayshire, their lease coverage all of last year was north of one times, and so because of the way we report, you’re not seeing their real performance reflected in those numbers yet. So we’ll see that continue to creep up and get out of the sub one times category soon.

Juan Sanabria: Okay, thank you.

Operator: Our final question comes from Austin Wurschmidt with KeyBanc Capital Markets.

Austin Wurschmidt: Thanks for taking the follow-up. You guys might have implicitly answered this on Juan’s question about initial yields on future transactions, but I guess as you look at those future deals and think about sort of the recovery in operations in some of these various segments, how are you thinking about setting initial rent and any participation in upside as fundamentals recover?

Dave Sedgwick: I think we’ve really offering upside and participation. I think that we work really close with the tenants we’re looking to put in on some of these value add, if you will, transactions to work really closely side by side to try and come up with the best we can in terms of underwriting run rate for labor and what the occupancy can do. Those are difficult assumptions to make right now and I think the closer we work with the incoming operator to look at historic, where, if we have assets in the area, what they’ve been doing on their turnaround with respect to labor and occupancy and trying to mimic that with the deals we’re looking at, I think we just try to get to the best assumptions we can with the tenant, who has the more local knowledge and localized expertise to come up with a stabilized rent structure.

And if a ramp is needed, then we definitely are open to looking at that and look at other creative ways to help them get to the point where we feel like the facilities will be stabilized.

Austin Wurschmidt: Thanks for taking the question. End of QA

Operator: There are no further questions at this time. With that said, concludes today’s conference. Thank you for attending today’s presentation. You may now disconnect.