Description

Care Capital Properties (CCP) is a health-care REIT recently spun-off from Ventas, another publicly-traded REIT with a market cap of $18 billion.

Care Capital Properties owns and leases out facilities used primarily in the Skilled Nursing industry. The company has 355 properties (prior to acquisition announced two days ago) operated by 41 different tenants across 37 states. These assets have historically generated stable rental income of about $290-$300 million, growing at 1-2% per year via rent escalators and rent renewals.

 CCP has a quarterly dividend of $0.57/sh (prior to recent acquisition), so at $31.50 the current annual yield is 7.2%.

The Company has a debt to capitalization of 50% ($1.3 billion of debt at 3.8%), which is in line with many of its peers and slightly more conservative than ParentCo Ventas's leverage. Competitor Omega Healthcare (OHI) had leverage of 63% prior to its acquisition of Aviv, which was funded entirely with equity. 

Here are a list of comps and their respective dividend yields:

HCP Inc (HCP): 6.3%

Omega Healthcare (OHI): 6.8%

Health Care Reit (HCN): 5.4%

Healthcare Trust (HTA): 5.1%

Healthcare Realty (HR): 5.4%

Aside from the fact that most of the operators in this space are very uncreative when it comes to naming themselves, note that the average dividend yield of all these companies is 5.8%.

I will propose that CCP should have a dividend yield lower than this average, and I expect that the yield will be 5.5% or lower in 2 years' time.

Here's why:

I believe the company's CEO, Ray Lewis, has a plan to run this company exceptionally well with top quartile growth in the health care REIT sector.

Let's have a look at the foundation Ray has put in place for his new company.

From pages 67-69 of the Form 10, we can see that same-store rents increased 0.3% in 2013 and 1.6% in 2014. Pretty much what you would expect for a business that has long-term leases ranging from 10-20 years in length with inflation-like escalators. 

But on page 66, we see a very scary figure: same-store rents in the first quarter of 2015 declined 5.2%! How is this even possible? Even if 20% of their leases all came up in just one quarter (most unexpected as usually less than 10% of leases come up in any given year), the average lease rate would have had to fall over 25% to have the entire portfolio's leases decline 5.2%.

So what happened? It turns out that Mr. Lewis does not want to take over a company that has a lot of uncertainty and lease risk. He also likes the idea of stable and predictable rent growth. In the first quarter of 2015, CCP renegotiated a substantial number of its leases, resetting many of them to market rates while at the same time changing the escalators and terming out the portfolio.

A pretty genius move if you ask me. Now he has a company whose average lease doesn't expire for nine years, with a long-term growth profile of 2.3% (while not exciting, its not bad, either). Further, since much of the leases were all just reset, there is much less risk of occupancy changes or problems in the near term.

But we are going to need a little more excitement on the growth front to make this a truly compelling investment opportunity. It turns out that the the Skilled Nursing Facility (SNF) industry is very fragmented, and less than 15% of properties nation-wide are owned by publicly-traded REITs.

Slide 15 of the Company's recent investor presentation (http://carecapitalproperties.com/docs/ccp-investor-presentation-august-2015.pdf) shows that CCP has identified a pipeline of $900 million worth of acquisitions, with an expected yield of 7.9%. 

Just over two weeks after CCP's shares began trading, CCP has already announced a significant acquisition. On September 1st, CCP purchased a $210 million portfolio of properties with an initial cash yield of 8.25%.  I expect more acquisitions in the next 12 months, as this management team appears to be incredibly prepared to operate on its own and pursue meaningful growth opportunities.

All in, I am hoping for about $500 million of acquisitions per year for the next three years. 

I estimate that each $500 million worth of acquisitions at an 8% yield should cause the company's FFO to grow about 10% per year.

Valuation

Conservatively, I estimate the company will grow its dividend at 8%/year for the next three years.That puts the dividend near $2.90 per share in 2018. With this performance, CCP will likely trade at a 5.5% dividend yield or less. This would put the shares in the low-to-mid $50s in 2-3 years' time, and you collect a 7.2% yield (and growing) in the mean time.

An even better scenario, which I believe is realistic and would not surprise me, is the company grows the dividend at 10%/year for the next three years and earns a premium valuation in recognition of its excellent management and the growth opportunities presented by the fragmented SNF market. That would put the dividend closer to $3.00 per share in 2018, and if the company receives a yield of 5% or less, the stock will trade in the $60s or higher.

I believe CCP deserves a premium valuation to reflect a lease portfolio that has recently been substantially de-risked, a conservative balance sheet, top-tier management and attractive growth prospects.

Catalyst

Growth in the dividend and analyst coverage