Here’s the Bad News for HCP Dividend Investors
Since 2014, as ManorCare started becoming a larger and larger drain on HCP’s overall profitability, dividend investors have seen only token increases in the payout. In other words, $0.01 per quarter hikes just large enough to keep the dividend growth streak alive, but really only big enough to offset inflation.
Source: Simply Safe Dividends
Well, things are about to get worse after the Quality Care spinoff is completed on October 31, 2016. HCP will likely reduce its dividend by 20-40% as a result of the spinoff.
That’s because HCP is expecting its FAD to decline by about $500 million once QCP becomes a standalone REIT. In addition, HCP is still divesting other assets to try to bring its debt down, which means that 2017’s FAD per share is likely to look even weaker due to its far smaller and still shrinking property portfolio.
Over the last 12 months, HCP’s FAD payout ratio sits near 82%. However, if we back out the $250 million in FAD that ManorCare provided in the first half of 2016, then HCP’s existing dividend FAD payout ratio becomes an unsustainable 134.6%.
In other words, without QCP, HCP’s current dividend is unsustainable after the spinoff. A 20-40% dividend reduction would bring the FAD payout ratio back to 80-90%, which is in line with peers and more sustainable.
HCP is going to lose its dividend aristocrat status unless you hold onto the shares of QCP that you’ll get once the deal goes through on October 31. That’s because QCP, as a REIT, will be legally obligated to pay out 90% of taxable income as unqualified dividends (click here for a basic guide to REIT investing).
Which means that the combined HCP and QCP shares might be able to maintain the current payout, and potentially even offer a tiny bit of growth. However, there are two main reasons that I still consider this a loss for long-term HCP investors.
First, Quality Care Properties is essentially a collection of distressed assets that the parent company is trying to wash its hands of. After all, its properties will be mainly run by ManorCare and Brookdale, both of whom have struggled immensely in recent years.
What’s more its cash flow just barely covers its existing liabilities, and its cost of capital is likely to be very high, which is largely why I am skeptical of management’s claim that QCP on its own will be better off.
For example, without the larger scale and investment-grade credit rating of HCP, QCP is looking at much higher borrowing costs. In fact, here are the most recent debt terms that it just obtained.
– $750 million in 7 year senior secured bonds at 8.125%
– $1 billion 6 year term loan at LIBOR + 5.25% (with a 1% minimum LIBOR floor)
– $100 million 5 year revolving credit facility, or RCF, at LIBOR + 5.25%
LIBOR, or the London Interbank Offered Rate, is the interest rate banks charge other banks to borrow from them. Currently US 1 Year LIBOR is 1.59%, which means that, assuming QCP borrows all $100 million from its RCF, its weighted average cost of debt would be an unfortunately high 7.36%. The only reason for such high interest rates is because Quality Care Properties is essentially a collection of high risk (i.e. “junk bond”) assets.
Worse yet, these high rates were obtained while interest rates are currently at their lowest point in history.
Unless QCP management can turn around its troubled properties in a hurry (and obtain an investment-grade credit rating), Quality Care Properties is going to face the prospect of interest rates rising over the coming years. This would only raise its debt costs all the more, further reducing profitability and making a successful turnaround less likely.
In other words, HCP, Inc. (NYSE:HCP) is basically telling dividend investors, some of whom have owned shares for decades, that in order to avoid a dividend cut, they must hold onto shares of QCP.
Since Quality Care Partners is going to start out as an unproven, junk bond bearing REIT whose largest tenants can barely pay their bills, I don’t consider this spin off a benefit for dividend investors. Sure, QCP can get more attention as a standalone company, but its weakness will also be all the more glaring to capital providers.
After all, conservative investors bought HCP because it was a highly diversified medical REIT with a secure and generous yield, a great dividend growth record, and an investment grade balance sheet. QCP will have none of those things, making it a riskier and more speculative holding for investors’ portfolios. I imagine its Dividend Safety Score will be below average once data is available.
Meanwhile, HCP’s yield is likely to drop drastically without the added benefit of ManorCare’s cash flow. In fact, I calculate that, assuming an 80% to 90% FAD payout ratio, HCP’s quarterly dividend will need to be cut from $0.57 per share to $0.34 to $0.3825, resulting in a yield of 3.8% to 4.2%.
That’s lower than both Welltower and Ventas, which offer better yields, proven management teams, high profitability, much stronger balance sheets, and superior long-term dividend growth prospects.
That’s especially true given that HCP’s poor track record on execution over the past few years means that it has a lot to prove when it comes to growing the dividend post-spinoff, especially with a balance sheet that is going to get only more leveraged and likely take many years to fix.
