Ventas (VTR): This Stable High-Yielder Just Went on Sale

Ventas, Inc. (NYSE: VTR) is a real estate investment trust that owns a diverse set of healthcare properties and currently pays investors a growing 5.8% dividend yield. They have senior housing properties, hospitals, medical offices, university life sciences buildings, and more.

And the market just put its shares on sale:

Ventas vs SPY

Source: Google Finance

Compared to the S&P 500 which has continued ever-upward over the past several months towards unusually high valuations, Ventas shares recently experienced a big sell-off.

This was due to a broader sell-off in real estate investment trusts, as well as concerns about an oversupply of senior housing, rather than any unique problems at Ventas, which continues to be one of the most well-run businesses in the healthcare property industry.

Over the past couple months, Ventas shares dropped from over $65 to under $55, which made the dividend yield higher and the overall investment more attractive. In the mid-$50’s, it’s now one of my top investment ideas.

The Industry Faces Headwinds

Over the past month, the entire Vanguard REIT ETF (VNQ) dropped in price from over $85/share to about $78/share, mainly due to rising interest rates by the Federal Reserve.

There are two main reasons why REIT prices and interest rates tend to be inversely correlated. The first is that REITs pay high dividend yields, and so when bond and bank account interest rates start to rise, they give more competition to dividend-paying equities. Investors start to demand higher dividend yields from their equity holdings, which means paying lower share prices. Secondly, the real estate industry requires high levels of leverage to make decent returns on capital, and higher interest rates will eventually translate into higher debt interest for them to pay.

But to put it into perspective, the federal funds rate, set by the U.S. Federal Reserve, has risen by less than 150 basis points (1.50%) over the past two years, and the most recent increase in December was only 25 basis points (0.25%).

In addition to all REITs facing pressure from rising interest rates, healthcare REITs are facing challenges related to oversupply in the senior housing market. Everyone reading this knows that the aging Baby Boomer generation is an investing super-trend, with the over-75 demographic increasing massively as a percentage of the population. This puts a lot of pressure on the social systems of the United States, but also presents financial opportunities for certain industries. Tons of companies have raced to build retirement homes and other healthcare facilities, because the demand keeps rising. But in the past couple years, the industry has become over-eager, and supply has outpaced even this growing demand.

This affects Ventas, because senior housing is over half of their property portfolio:

Ventas Portfolio

Source: Ventas’ NAREIT REITWorld 2017 Presentation

When properties have above-ideal levels of vacancy, it generally translates into lower returns on capital, because the company gets less money in return for its property costs. And it could take several years of less construction for the industry’s demand to catch up with this oversupply.

3 Reasons Ventas is Solid

With such headwinds, one could argue it’s best to avoid REITs altogether, and especially healthcare REITs.

But the best time to buy is during periods of uncertainty and low prices, and when great companies see their share prices decline along with their weaker competitors. Prudent investors can then swoop in and buy the best-of-breed companies at compelling prices.

1) Ventas Has Superior Management

The current CEO and Chairwoman of the Board, Debra Cafaro, has been leading Ventas since 1999, and during that time shareholders have enjoyed ridiculous 25% annualized returns.  This was partly from improvements in valuation, but the bulk of it was due to the company seriously outperforming most of its competitors.

Ventas Chart

Source: Ventas’ NAREIT REITWorld 2017 Presentation

During Cafaro’s nearly two-decade tenure, the market capitalization of Ventas has increased one hundred times over, from about $200 million to about $20 billion.

Now, it’s important to note that this won’t happen again. Simply due to its size now, Ventas can’t possibly continue to give shareholders the same type of growth it has in the past, and it won’t triple your money within a few years either.

But when the S&P 500 is as highly valued as it is, it’s important to be realistic with the risk-adjusted rate of return you can expect from your investments. Ventas offers a safe 5.8% dividend yield that grows every year, and is already well over 20% down from its 52-week high.

Going forward, Ventas is less about outsized returns and more about reliability. Under Cafaro’s leadership, for example, Ventas spun off most of its skilled nursing facilities, which leaves 94% of its revenues from private-pay sources rather than government funding. This gives the REIT less political risk than all of its deeper-value higher-yielding competitors.

In fact, for aggressive investors, the industry has potentially better bargains and even higher dividend yields out there. Ventas is the premium pick, the lower-yielding but rock-solid core holding type of company.

2) Ventas Has Lower Debt (and Mostly Fixed-Rate)

Ventas maintains lower levels of leverage and higher levels of interest coverage than most of its peers:

Ventas Debt

Source: Ventas’ NAREIT REITWorld 2017 Presentation

In addition, 80% of the company’s current debt is fixed-rate, while the other 20% is variable-rate.

This means that in a rising-rate environment, the interest rates on most of their existing debt won’t be affected. The interest rates on the 20% of their debt that is variable-rate will gradually increase, but it would take a 300 basis point (3.00%) or higher rate increase for this variable-rate debt to be at higher rates than their existing fixed-rate debt. In addition, as they issue new fixed-rate debt and pay off existing debts, their interest rates on that new debt will likely be gradually higher.

So, rising interest rates do negatively affect Ventas, but not in a very large or immediate way, and not as much as many of their business peers.

3) The Industry Remains Fragmented

Although senior housing oversupply is a genuine concern, its not as though there aren’t growth opportunities for a business like Ventas.

Compared to many other property industries, healthcare properties remain highly fragmented:

Healthcare Consolidation

Source: Ventas’ NAREIT REITWorld 2017 Presentation

Despite having a market capitalization of $20 billion, Ventas still represents just a tiny fragment of the industry they operate in. There are countless small property holders for them to continue to acquire and fold into their property portfolio.

It All Comes Down to Price

The S&P 500 currently pays less than a 1.8% dividend yield on average, and based on most valuation metrics is extremely expensive.

Jack Bogle, the founder of Vanguard, predicts that the S&P 500 will return just 4% per year on average over the next decade, and a century of evidence for current market valuations and subsequent long-term returns backs him up on that estimate.

Therefore, a business that can safely pay a 5.8% dividend yield and grow that dividend by a few percentage points each year should do quite well in comparison.

For example, if Ventas grows its dividend by just 3% per year from this point on, then investors can expect solid high-single-digit returns by buying anywhere in the $50’s and up into the $60’s:

Ventas Dividend Discount Model

Source: Dividend Discount Model Overview

Overall, Ventas offers a good balance of yield, growth, and safety, and the recent decrease in its share price gives investors a nice entry point into the business.

Disclosure: The author is long VTR.

Ventas on Yahoo Finance

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