CareTrust REIT, Inc. (NYSE:CTRE) Q1 2024 Earnings Call Transcript May 3, 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. My name is Mark, and I will be your conference operator today. At this time, I would like to welcome everyone to CareTrust REIT First Quarter 2024 Operating Results. All lines have been placed on mute to prevent any background noise. After the speaker remarks, there will be a question-and-answer session. [Operator Instructions] I would now like to turn the call over to Lauren Beale, Senior Vice President and Controller. Please go ahead.
Lauren Beale : Thanks, Mark, and welcome to CareTrust REIT’s first quarter 2024 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 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-Q 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 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; and Bill Wagner, Chief Financial Officer; our Chief Investment Officer James Callister is unable to attend the call today.
I’ll now turn the call over to Dave Sedgwick, CareTrust REIT’s President and CEO. Dave?
Dave Sedgwick : Well, hello everybody, and thank you for joining us. Let me kick things off today by first excusing our Chief Investment Officer, James Callister from the call. Given how busy we have been with acquisitions, you would be justified and guessing that he is just too busy for you. But this morning he has a family matter that trumps his participation with us. While we’re on the subject of investments, I’d like to start by talking about our current robust phase of growth. The sharp increase to interest rates has resulted in a unique situation in our nearly 10 years of business. On the one hand, like everyone, our borrowing costs have increased significantly. But on the other hand, because we conservatively established a fortress balance sheet for times like this, and because of strategic relationships we’ve formed and because our cost of equity is remarkably a, a touch lower than our cost of debt today, we are better positioned to invest and grow than any time in our company’s history.
It’s extraordinary to be able to say that we view interest rates staying higher for longer as a net positive for CareTrust in so far as it should continue to drive investment opportunities in our direction. Those of you who know us best know a couple important guiding principles we follow when it comes to capital allocation. First, we do not grow for growth sake. Healthcare real estate, skilled nursing in particular requires a high level of discipline. Every acquisition should immediately or quickly be accretive and must be matched with the right operator. Second, we are building a company to outlast all of us. We’re not nearly as sensitive as the algorithms are to quarter-to-quarter numbers. We run the business for long-term value creation and will at times when the pipeline justifies it, take some short term dilution to lock in permanent financing and accretion and thereby set the table for future growth.
We started this year with about $300 million of cash on the balance sheet because we saw the potential for 2024 to be a record year of investments. I want to congratulate the team for such a strong start. They’re the best pound for pound investment team I know and are tireless when it comes to sourcing and closing deals. With the investment on May 1st, we’ve already closed approximately $205 million in new investments. Approximately $154 million of that has been either acquisitions or loans with purchase options at an average yield of 9.4%. The other $52 million of deals closed our mezzanine loans at an average yield of 13.6%. Last quarter, I elaborated on our strategic approach to lending. You may recall that we are not agnostic between acquisitions and lending.
Lending results in lumpiness to earnings and does not by itself result in long-term growth. However, we do enthusiastically lend the strategic borrowers and operators who we believe will result in real estate acquisitions in the future. Let me put a finer point on that. As of today, we attribute about $260 million of real estate acquisitions in the last 12 months alone and another $200 million of acquisitions in our current pipeline that came from this strategic approach to lending in recent years. If we don’t have at least a handshake deal with the borrower or operator for acquisition opportunities in the future, chances are pretty low that we will lend. The deal we closed on Wednesday is a perfect example of this philosophy and action. In case you missed it.
On Wednesday, we closed on a mortgage loan of $26.7 million at an annual interest rate of 9.1% in connection with the borrower’s acquisition of a two properties skilled nursing portfolio in Tennessee with Ensign as a long-term triple net master lease tenant. The relationship with this borrower goes back many years. They understand our strong preference to own the real estate and they provided us a purchase option beginning in the fourth year of the loan. After yesterday’s Tennessee deal. Our pipeline today sits at approximately $260 million and is roughly 50% acquisitions and 50% loans. It includes one larger deal we have been pursuing for some time that we now feel confident enough to include in our quoted pipe. Furthermore, the pipe today is almost entirely skilled nursing properties in addition to today’s quoted pipe, we are also interested in some other large deals that at this point are not tracking at a high enough probability to include in that number.
So with our line of sight on a reloaded pipeline, we have continued to position the balance sheet to capitalize on this window of opportunity, while it remains wide open. We are pleased to report a net debt to EBITDA of 0.6x. High level, if we don’t use any more equity, we can now deploy the $345 million of cash on hand plus the undrawn $600 million line of credit, and still only arrive at 3.6x net debt to EBITDA. In other words, we are locked and loaded to grow in a meaningful way for the next few years. Remember how we quote our pipe, we only quote deals that are at least under LOI that we believe have a strong likelihood of closing and should close within the next 12 months. Now turning to the portfolio, you will see in the supplemental lease coverage continues to show tremendous strength and security overall.
Property level EBITDA with a 5% management fee and EBITDA coverage was reported at 2.18x and 2.78x respectively. You may have noted in the supplemental both priority management group and WLC reported declining coverage from Q3 to Q4. This was due to large 1x reserve accruals for workers’ comp and or bad debt had the reserves been better accounted for during 2023, you would not have seen the type of decline they reported. They had occupancy and labor headwinds in the quarter as well. However, both have favorable state Medicaid rate increases this year. That should, among other things, drive coverage higher by year end. We are not worried about either of them or anyone in our top 10. The transition of two Eduro Colorado facilities to Ensign took place on March 1st as expected.
Ensign stepped in at a lower rent and Eduro is covering the difference across the remaining seven CareTrust properties in the master lease. Therefore, we do expect to see fairly tight lease coverage for Eduro this year, but we also expect that coverage to increase going into next year. Also, we are still under contract to sell the portfolio of 11 skilled nursing assets with negative EBITDA 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. On the regulatory front, a couple items. First, CMS announced a 4.1% Medicare rate increase for fiscal year 2025, effective this October. And second, as we expected CMS issued their final rule on the minimum staffing mandate.
We remain disappointed with a rule that is impossible to implement given the widely publicized staffing shortage in skilled nursing and throughout healthcare today. Furthermore, an unfunded mandate of more staff will not magically make those employees appear. We remain hopeful that reasonable heads will prevail in DC to modify or reverse course altogether before the mandate takes effect. Now, before I hand it over to Bill, let me conclude like this. First, the investment environment is very healthy. Second, we have a balance sheet that provides enormous flexibility and historic capacity for both the near term and midterm. Third, we have an interest rate environment that has opened wide a window of opportunity as long as borrowing costs remain higher for longer.
And fourth, we are at the start of demographic tailwinds that should last for decades to come. Bill will now provide you with cover on the numbers we reported yesterday.
Bill Wagner : Thanks, Dave. For the quarter, normalized FFO increased 32.9% over the prior year quarter to $46.5 million and normalized FAD increased 33.1% to $48.7 million per share basis. Normalized FFO was flat at $0.35 per share. Normalized FAD was also flat at $.037 per share. Because of our replenishing robust pipeline, we continued to take advantage of our ATM and issued $273 million of equity under the ATM during the first quarter, resulting in us having $451 million of cash on the balance sheet at quarter end substantially up from year end when the balance was $294 million. Since quarter end, we have used a chunk of that for investments and our dividend leaving us with approximately $345 million as we sit here today.
In yesterday’s press release, we updated guidance for 2024 with a range for normalized FFO per share of $1.42 to $1.44 and normalized FAD per share of $1.46 to $1.48. This guidance includes all investments made to date, a diluted weighted average share count of 140 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 $210 million to $211 million. We have lowered the reserve of 2% to 3% last quarter to 1.5% to 2%. Not Included in this number is the amortization of a below market lease intangible that will total about $2.3 million, but this will be in the rental revenue number as required by gap; Three, Interest income of approximately $44 million.
The $44 million is made up of $27 million from our loan portfolio, and $17 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 6.9% for the term loan. This interest expense also includes roughly $2.4 million of amortization of deferred financing fees. And five, G&A expense for approximately $23 million to $24 million, and includes about $5.9 million of deferred stock comp. Our liquidity continues to strengthen as we march to a record setting year for investments. We have approximately $345 million in cash today, and our entire $600 million is available under the revolver. Leverage hit an all-time low with a net debt to normalized EBITDA ratio of 0.6x.
Our net debt to enterprise value was 4.1% as of quarter end, and we achieved a fixed charge coverage ratio of 7.5x. It 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 it did and then some. I also said, I would expect that leverage would begin to pick up as we deploy the cash into accretive investments. I still believe that this will occur, but given the price of our equity relative to the current cost of a long-term debt issuance, we believe that it makes much better sense to continue to lock in increasing using equity on a robust and replenishing investment pipeline. Our net debt to EBITDA range of 4x to 5x is still our range. It just may take some time and a lot of investments to get back there, which we plan on doing.
And with that, I will turn it back to Dave.
Dave Sedgwick : Great. Well, we hope our report has been helpful and happy to take your questions now. Mark, are you there to conduct the questions? We are waiting for our host to conduct the Q&A portion.
Dave Sedgwick: I hope he’s okay. Mark, are you there to conduct Q&A. In the meantime, for our analysts who are in the queue, if you want to email or text us your questions, I suppose we can adapt that way to our missing post. Please stand by as we wait for the host and or your questions to come in. We’ll try to manage this from our end. Jonathan, we’re going to unmute you on our screen and see if that works. Unfortunately, it doesn’t look like we have that capability after all. So again, if you have any questions. We got a question in from Jonathan here. He says, I think it’s fair to say expectations are very high for continued acquisition activity given the cash on hand and leverage profile. And with that comes pressure to get deals done.
I know James isn’t on, but Dave, I was hoping you could talk about how you managed to balance those expectations for continued investment activity while maintaining underwriting discipline. And how much investment capacity can your current team handle before needing to meaningfully increase head count?
Dave Sedgwick: All right. Let me touch on those. It always makes James a little bit nervous when I answer questions on investments in pipeline because I tend to not manage those expectations as well as he does. Look, it is — in my prepared remarks and what you’ve seen from us so far this year, we certainly feel and see a flow of deals coming our way, and we’ve been able to execute on those now for a good 18 months in an accelerated pace. We expect that to continue going forward. And so we just want to like Bill and I talked about lock in that accretion, be prepared to take advantage of that regardless of what happens at a macro level. The discipline though has got to be there. It’s always been part of our story, and we haven’t changed.
We’re not going to grow for growth’s sake. In terms of capacity, the current team can handle certainly the pace of growth that we’re looking at today. We have added head count in the last 18 months or so. And we can always evaluate that, but I think we’re positioned really well to take advantage of the window of opportunity that we’re in. And then last one from Jonathan here. Bill can take that. It’s about our preference to settle equity proceeds now versus raising on a forward basis.
Bill Wagner: Yes, Jonathan, the reason we are settling our ATM issuances right now, instead of putting them on a forward is, we have some better visibility as to the closing dates, as Dave said in his remarks, of less than 12 months that we expect to close on the investment pipeline. So that’s really — and the minimal dilution that is about taking the cash now as opposed to putting it on a forward. Mark, are you back?
Operator: Yes, I’m sorry for what happened. I just had a system error on my end, but we’re ready to go to the Q&A session again.
Bill Wagner: Great. If you want to take the first question in the queue.
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