CareTrust REIT, Inc. (NYSE:CTRE) Q4 2023 Earnings Call Transcript

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CareTrust REIT, Inc. (NYSE:CTRE) Q4 2023 Earnings Call Transcript February 9, 2024

CareTrust REIT, Inc. isn’t one of the 30 most popular stocks among hedge funds at the end of the third quarter (see the details here).

Operator: Thank you for standing by, and welcome to the CareTrust REIT Fourth Quarter and Full Year 2023 Operating Results Call. I would now like to welcome Lauren Beale, SVP, Controller, to begin the call. Lauren, over to you.

Lauren Beale: Thank you, and welcome to CareTrust REIT’s fourth quarter 2023 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 FAD, 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. In addition, certain operator coverage and financial information that we discuss is based on data provided by our operators that has not been independently verified by CareTrust. Yesterday, CareTrust filed its form 10-K and accompanying press release and its quarterly financial supplement, each of which can be accessed on the Investor Relations section of the CareTrust website at 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’ll now turn the call over to Dave Sedgwick, CareTrust REIT’s President and CEO. Dave?

Dave Sedgwick: Well, good morning everyone, and thank you for joining us. Before I talk about our outlook for 2024, let me first thank the entire CareTrust team for their great work in ’23. It was a year of growth for the company on several fronts. Internally, the team is more capable, creative, and collaborative than ever before. It’s a real privilege to work every day with this team. I also want to thank our operators, who we consider by and large to be among the very best in the business. It’s their relentless dedication to their staff, residents, and patients, that is making this world a better place and we’re honored to help them expand their influence. Now, this time last year, we started to sense a window of opportunity open to return to external growth in a meaningful way, as the bulk of our repositioning work concluded and the credit market tightened.

Sellers and brokers prioritized the execution certainty that we bring to the table and deal flow picked up. I’m very pleased to report $288 million of new investments last year at a blended stabilized yield of 9.8%. And as good as those numbers are, maybe more exciting is the fact that we ended the year with the full $600 million available on our line of credit and just under $300 million of cash on the balance sheet. We have never had this amount of dry powder. Why? Because we expect 2024 to be a strong year of investments, and we positioned ourselves accordingly. As we’ve reported, we’ve kicked off the year with $63 million of new investments, $52 million of that are secured loans. Let me reiterate briefly our philosophy for lending. Loans in this space are generally shorter terms, somewhere between two to five years, which can cause some lumpiness to earnings as paybacks occur.

So for us, in order to lend, three criteria must be met. First, the investment will be run by a top-shelf operator with whom we want to start or expand our relationship. Second, the investment meets our historic underwriting criteria and is accretive in year one. And third, the transaction provides for a path to future real estate acquisitions, either built into the deal directly or simply from the relationship. Since 2022, and not including the loans announced this week, we’ve made about $170 million worth of loans, each one meeting these criteria. Now here’s what’s remarkable. As we examine the real estate acquisitions made last year and those in our current pipeline, we count over $300 million, largely off-market deals, that are a direct result of the relationships with the investors, borrowers, and operators, that we established from that strategic planning activity.

That is a virtuous cycle we will continue to feed. James will give you more color on the investments in the quarter and year-to-date and on the current pipeline, which as we sit here today, is about $250 million, not including larger deals that we regularly review. Now, turning to the portfolio, you’ll see in the supplemental, lease coverage slightly improved overall. Occupancy for the quarter for both skilled nursing and seniors housing was basically flat compared to Q3. And I wanted to follow up on a couple of operators. The transition of two Eduro facilities to another operator today is on track for a March 1 transition. Eduro’s pro forma lease coverage, excluding those two facilities goes from just under 1 times to just north of it. Also, we’re still under contract to sell the portfolio of 11 skilled nursing assets with negative EBITDA, primarily in the Midwest.

Understandably, financing has been challenging, but the buyer continues to make good-faith efforts that lead us to believe a deal will get done. Finally, we’re pleased to issue guidance again. Bill will walk you through our several assumptions, that result in 2024 normalized FFO per share in the range of $1.43 to $1.45. Please remember that when we issue guidance, we do not include assumptions for new investments for a couple of reasons. First, due to regulatory and licensing requirements that always accompany these transactions, timing of deals can be tricky. And second, we do not set arbitrary growth targets, so that we can retain our customary discipline model for growth. Now, before I hand it over to James to talk about investments, let me just summarize our outlook for 2024 like this.

We have a favorable cost of capital that allows for accretive investments. We have a balance sheet that provides enormous flexibility and capacity. And we have a macro environment that has opened a window of opportunity as long as the credit market remains challenging, which leads me to believe that 2024 should be a strong year for external growth for CareTrust. With that, James will talk to our recent investment activity and pipeline. James?

An aerial view of a REIT healthcare facility, emphasizing the imprint of the company on the local landscape.

James Callister: Thanks, Dave. Good morning, everyone. Since the end of Q3, we have closed on investments totaling over $106 million, including the acquisition of two California skilled nursing facilities that we discussed on our last earnings call. With respect to our more recent investment activity, in Q4, we closed on the funding of a $6.3 million mortgage loan to one of our existing tenant relationships, Bayshire Senior Communities. The loan is secured by a 26-unit assisted living facility located in Vista, California, carries an interest rate of 9.9% and an initial term of 30 months. The loan facilitates Bayshire’s ongoing growth in San Diego County and helps further synergies with the nearby skilled nursing facility that we acquired in Q3 of last year and leased to Bayshire.

In January, we closed on the joint venture acquisition of a 78-unit assisted living and memory care facility in San Bernardino, California. CareTrust’s $10.8 million of contributed capital constituted 97.5% of the total required investment amount, with an initial contractual yield of approximately 9.3%. In connection with the acquisition, the venture entered into a triple net lease agreement with Oxford Health Group, a midsize California seniors housing operator. The lease provides for a 10-year initial term with four- or five-year extension options and 2% fixed annual rent escalators commencing with the third lease year. Also, as announced earlier this week, in late January and early February, we closed on the funding of over $52 million in mezzanine loans, secured by three portfolios of skilled nursing facilities in Virginia, Missouri, and California.

In connection with the Virginia and Missouri loans, CareTrust provided approximately $45 million in proceeds at a variable interest rate of SOFR plus 8.75% with a SOFR floor of 6%. We also funded a $7.4 million mezzanine loan to a regional investor in healthcare real estate to acquire a 130-bed skilled nursing facility in Pasadena, California. This loan accrues interest at a fixed rate of 11.5% and has a five-year term. As Dave indicated in his remarks, our investment pipeline remains active and primarily consists of skilled nursing facilities with a few assisted living and multi-use campus opportunities mixed in. Today, the pipeline is approximately $250 million, made up largely of singles and doubles. The pipe we are quoting today does not include some chunkier regional opportunities that we are evaluating.

Deal flow remains strong and at a level largely consistent with the past several quarters. We expect the skilled nursing transaction market to become increasingly active with a continued bifurcation between assets that are cash-flowing and distressed product. Pricing on stabilized or close to stabilized SNF portfolios continues to hover at historical cap rates, helped by increases in state Medicaid rates and some easing in labor challenges. Many regional operators appear hungry to grow, and that appetite for expansion is driving healthy acquisition demand. Sellers in today’s SNF market include owners with non-profit affiliations, moms and pops fatigued by difficult years in the industry and looking to exit. As well as regional owners’ operators have stabilized portfolios, looking to sell and recycle capital into underperforming portfolios with upside potential.

Pricing on distressed skilled nursing product has softened slightly as we continue to see more offerings entering the market for SNF portfolios that are facing variable rate and maturity date risk on bridge to HUD and other similar loans. We expect this trend to continue and to lead to potential acquisition opportunities, as performance fall short of that needed to be in a position for a HUD loan takeout. Our balance sheet and dry powder together with opportunistic market dynamics have set the table for growth. While always adhering to our disciplined underwriting approach, we are actively using our flexibility and creativity in sourcing and structuring transactions to pursue and execute on accretive investment opportunities. With that, I’ll turn it over to Bill.

Bill Wagner: Thanks, James. For the quarter, normalized FFO increased 17.2% over the prior year quarter to $43.4 million, and normalized FAD increased by 16.3% to $45.4 million. On a per share basis normalized FFO decreased $0.02 to $0.36 per share and normalized FAD decreased $0.03 to $0.37 per share. As a result of our robust pipeline, we issued $643.8 million of equity under the ATM during 2023, resulting in us having $294 million of cash on the balance sheet at year-end. Since year-end, we have used a chunk of that for investments and our dividend, leaving us with approximately $220 million as we sit here today. In yesterday’s press release, we issued guidance for 2024 with a range for normalized FFO per share of $1.43 to $1.45 and for normalized FAD per share of $1.47 to $1.49.

This guidance includes all investments made to-date, a diluted weighted average share count of 130.5 million shares, and also relies on the following assumptions: One, no additional investments nor any further debt or equity issuances this year. Two, CPI rent escalations of 2.5%. Our total cash rental revenues for the year are projected to be approximately $204 million to $206 million. There is a range on rental revenues this year as we have included a general reserve of 2% to 3%. This reserve is not related to any specific operators, rather it is a function of conservatism, as we issued guidance for the first time in a while and we expect to refine that reserve as the year progresses. Not included in this number is the amortization of a below-market lease and intangible that will total about $2.3 million, but this will be in the rental revenue as required by GAAP.

Three, interest income of approximately $36 million. The $36 million is made up of $25 million from our loan portfolio and $11 million is from cash invested in money market funds. Four, interest expense of approximately $33 million. In our calculations, we have assumed an interest rate of 6.5% for the term loan. Interest expense also includes roughly $2.4 million of amortization of deferred financing fees. And five, G&A expense of approximately $21 million to $23 million and includes about $5.9 million of deferred stock compensation. Our liquidity remains extremely strong. We have approximately $220 million in cash today and our entire $600 million available under our revolver. Leverage hit an all-time low with a net debt to normalized EBITDA ratio of 1.4 times.

Our net debt to enterprise value was 9.5% as of quarter-end, and we achieved a fixed charge coverage ratio of 7 times. I said last quarter, that I wouldn’t be surprised to see leverage tick further downward as we continue to fund our pipeline with equity, which we did. Now, I would expect that leverage would begin to tick up as we deploy the cash into accretive investments. And with that, I’ll turn it back to Dave.

Dave Sedgwick: Great. Thanks, Bill. We hope our report has been helpful, and thank you for your continued support. And I’ll be happy to answer your questions.

Operator: The floor is now open for your questions. [Operator Instructions] Our first question comes from the line of Connor Siversky with Wells Fargo. Please go ahead.

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Q&A Session

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Connor Siversky: Hi. Happy Friday. Thank you for the time. So, quick question on these acquisition opportunities. It seems some of the peer group is also moving in the direction of underwriting these loans. And I’m wondering if you get the sense that this increased competition for that kind of instrument could lead to downward pressure on the associated yields. Or more broadly speaking, how do you expect those return profiles to change over the course of the next year?

James Callister: I think, Connor, it’s a good question. It’s James. I would say that, you see that a little bit right now on lower kind of dollar amount loans that we’re looking at where there is more players kind of knowledgeable about the SNF industry and willing to extend some of those loans, whether it’s [B] (ph) product or mez. I think we see much less of that competition in the higher dollar loan amounts for mez and whatnot. And that kind of absence of experienced competition in that area seems to really up to this point continue to allow the yields to be pretty significant. I think you see that in our mez loans from last week. So, I don’t expect too much change in the higher kind of dollar loan amounts. I think the lower amounts will continue to be competitive and stay close to where they are because that really — that competition is already there.

Connor Siversky: Okay, thanks for that. And maybe just in your opinion, what do you think it takes to see the market for real assets start to open up again?

James Callister: Really guiding it takes more sellers entering the market of cash flowing facilities or close to. I think that’s really going to be what it takes is more groups deciding to exit or recycle capital in assets that are close to stabilization, where you can underwrite them a little closer to traditional underwriting versus kind of the value add that we look at a lot right now.

Connor Siversky: Okay, understood. And then maybe quickly for Dave. We have this CMS announcement that they look to finalize the minimum staffing ruling in short order. I’m just wondering, broadly speaking around a high level, how do you look at the labor market now compared to maybe this time a year ago? Do you see any indication that the market or the availability of labor is improving? Or if there is still a very big discrepancy between the urban and rural markets?

Dave Sedgwick: Yeah, I’d say, as we look at our data, it’s clear that the worst is behind us when it comes to labor, and yet there is still quite a bit of opportunity for improvement in labor costs going forward. Just taking one data point, for example, looking at agency, third quarter ’22 our agency PPD in the portfolio was around $13, Q3 of ’23, it’s down to $8. But before the pandemic, it was down near $3. And so, there’s still quite a bit of excess labor costs built in there, that we hope will continue to decline as time goes on. So it’s actually pretty encouraging to know that there’s some opportunity there going forward for our operators to continue to improve there. Having said that, it’s still a difficult labor market. But I think during times like this, you see the best operators really distinguish themselves by first becoming that operator, that employer of choice, so that they can then become the provider of choice in their communities.

Connor Siversky: Okay. And if I may squeeze one more in there on labor. Do you get the sense that over the course of 2023, we saw some significant rate hikes in both Medicaid and Medicare, or some of these operators now able to push through those hikes directly into wages such that maybe you get better retention?

Dave Sedgwick: Yeah, I think what happened actually, Connor, the operators in this space really got ahead of those rate increases. They really had to. We lost so many employees in the skilled nursing space due to the pandemic, that by and large, the operators adjusted well before those rates caught up with them. And so last year’s rate resetting and increases in activity by the state, I think recognized that those costs had gone up significantly. And because of that, those states had a lot of rationale for making the adjustments they did to those rates.

Connor Siversky: Okay. Thank you for the color. I’ll leave it there.

Operator: Our next question comes from the line of Jonathan Hughes with Raymond James. Please go ahead.

Jonathan Hughes: Hey, good morning out there. Just sticking with the loan activity that Connor was asking about, and I do appreciate the prepared remarks as to why you’re making those investments. Do you expect debt investments to be a continuing part of your investment activity in future years? Or is this something that’s a bit more temporary and when the capital markets normalize and banks return to lending, your investment activity would return to more, just the equity ownership and acquisitions?

Dave Sedgwick: Yeah. I think it’s a fair assumption that if the banks come rushing back with cheap money is that there will be less need for us, less opportunity coming our way. And that lending activity in the future, under that hypothetical scenario, would be back to what it was before. But even before the last couple of years, we have made some big loans. And again, if there is a clear belief, a clear path to this relationship leading to real estate acquisitions in the future, we’ll continue to do that, because a lot of times what those real estate acquisitions in the future are off-market deals. That’s what we’ve seen. And that we wouldn’t have seen without doing that and building those relationships. So I think, I would not be surprised to see more of it this year and opportunistically after, if and when the banks ever come back with their free money.

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