However, HCP is a reliable cash flow generator because of its long-term leases with customers, the industry’s slow rate of change, and the non-discretionary nature of healthcare spending. Some of these factors make healthcare one of the best stock sectors for dividend income. As seen below, HCP has generated free cash flow in nine of its last 11 fiscal years.
Source: Simply Safe Dividends
HCP’s Key Risks
HCP’s main risks are its customer concentration, dependence on government reimbursement programs, and reliance on capital markets.
Whenever a business is highly concentrated with a customer or two, its fate will largely be determined by how those customers perform. In 2015, HCP generated 23% and 10% of its total revenue from HCR ManorCare and Brookdale, respectively.
HCP, Inc. (NYSE:HCP) acquired a large stake of real estate from HCR ManorCare for about $6 billion in 2011, which significantly increased its customer concentration.
Prior to the deal, HCP’s two biggest customers in 2010 were Emeritus (10% of sales) and HCR ManorCare (9%). In other words, the magnitude of its two largest customers has about doubled over the past five years from 19% of sales in 2010 to 33% last year. The company’s mix of post-acute/skilled nursing revenue also increased from 12% of revenue in 2010 to 24% in 2015.
Despite HCP’s status as a dividend aristocrat, it has much more customer concentration risk today than it did five years ago. Many income investors assume dividend aristocrats are invincible, but it’s important to be aware of how a company’s business has evolved (for better or worse).
Unfortunately, both HCR ManorCare and Brookdale are struggling, which is hurting HCP’s stock and creating greater risk for its dividend payment.
Brookdale is the biggest provider of senior living care in the U.S. and is dealing with lower occupancy levels. Many of HCR ManorCare’s issues are being caused by unfavorable trends in skilled nursing facilities and the company’s dependence on Medicare and Medicaid reimbursements.
HCP estimates that about 25% of its annualized rental payments received from tenants are dependent on Medicare and Medicaid reimbursements. This is a high level of government assistance and creates risk because reimbursement rates can unexpectedly shift and make certain areas of healthcare more or less attractive and profitable.
In addition to customer concentration and government reimbursement risk, HCP’s margin of safety is also less than many other companies because REITs are required to pay out 90% of their taxable earnings as a dividend to keep their REIT classification.
As a result, REITs have less capital to reinvest in the business for growth and have to turn to the capital markets more often than other types of companies.
As seen below, HCP has maintained a reasonable debt to capital ratio near 50%, but its diluted shares outstanding have more than tripled over the last 10 years from 136 million shares in 2005 to 463 million shares last year.
Source: Simply Safe Dividends
Source: Simply Safe Dividends
If HCP experiences unfavorable business developments, it could quickly become financially strained due to its high payout ratio and interest expense payments.
If banks are unwilling to lend money to the company at reasonable rates and HCP’s share price is in the dumps, making it costly to issue equity, the company will have a hard time sustaining its dividend and growth spending.
Many investors in master limited partnerships (MLPs) have already experienced the pain that capital market risk can inflict, and we wrote an article covering the topic last year.
Dividend Analysis: HCP
We analyze 25+ years of dividend data and 10+ years of fundamental data to understand the safety and growth prospects of a dividend. HCP’s long-term dividend and fundamental data charts can all be seen by clicking here.
