REITs often attract a great deal of investors because of their strong cash flows and dividends, and those investors often overlook other parts of the business, choosing to analyze the company under a different set of criteria than companies in other sectors. This can create a problem in that it becomes difficult to compare a REIT to an industrial, which is fine if you use the typical top-down approach to stock selection; however, a top-down approach invites speculation in the fact that you are theorizing which sector will perform well going forward. Benjamin Graham taught that we should avoid speculation as much as possible, which is why it is critical to develop a system for analyzing companies that will allow them to be compared across industries. This is best done by utilizing a systematic approach to analysis that will provide investors with a sense of how a specific company compares to another investment opportunity. By using the ModernGraham method one can review a company’s historical accomplishments and determine an intrinsic value that can be compared across industries. What follows is a specific look at how Health Care REIT fares in the ModernGraham valuation model.
Company Profile (obtained from Google Finance): Health Care REIT, Inc. is a real estate investment trust (REIT). The Company’s portfolio has range of seniors housing and healthcare real estate, including seniors housing communities, skilled nursing/post-acute facilities, medical office buildings, inpatient and outpatient medical centers and life science facilities. The Company operates in three segments: seniors housing triple-net, seniors housing operating and medical facilities. Its properties primarily consists of land, building, improvements and related rights. The Company’s hospitals and seniors housing triple-net properties are leased to operators under long-term operating leases. Its medical office building portfolio is primarily self-managed and consists principally of multi-tenant properties leased to health care providers. In October 2013, the Company announced the acquisition of the Willows at Hamburg from Health Care REIT, Inc.
Defensive Investor – must pass at least 6 of the following 7 tests: Score = 4/7
- Adequate Size of Enterprise – market capitalization of at least $2 billion – PASS
- Sufficiently Strong Financial Condition – current ratio greater than 2 – FAIL
- Earnings Stability – positive earnings per share for at least 10 straight years – PASS
- Dividend Record – has paid a dividend for at least 10 straight years – PASS
- Earnings Growth – earnings per share has increased by at least 1/3 over the last 10 years using 3 year averages at beginning and end of period – FAIL
- Moderate PEmg ratio – PEmg is less than 20 – FAIL
- Moderate Price to Assets – PB ratio is less than 2.5 or PB x PEmg is less than 50 – PASS
Enterprising Investor – must pass at least 4 of the following 5 tests or be suitable for a defensive investor: Score = 2/5
- Sufficiently Strong Financial Condition, Part 1 – current ratio greater than 1.5 – FAIL
- Sufficiently Strong Financial Condition, Part 2 – Debt to Net Current Assets ratio less than 1.1 – FAIL
- Earnings Stability – positive earnings per share for at least 5 years – PASS
- Dividend Record – currently pays a dividend – PASS
- Earnings growth – EPSmg greater than 5 years ago – FAIL
|Value Based on 3% Growth||$6.21|
|Value Based on 0% Growth||$3.64|
|Market Implied Growth Rate||68.39%|
|Net Current Asset Value (NCAV)||-$37.59|
Balance Sheet – 12/31/2013
Earnings Per Share
Earnings Per Share – ModernGraham
Health Care REIT does not qualify for either the Defensive Investor or the Enterprising Investor. For the Defensive Investor, the turn offs are the low current ratio, lack of earnings growth over the last ten years and the high PEmg ratio. For the Enterprising Investor, the issue is the high level of debt relative to the current assets and the lack of earnings growth over the last five years. As a result, value investors seeking to follow the ModernGraham approach based on Benjamin Graham’s methods should explore opportunities through a review of 5 Undervalued Companies for the Enterprising Investor and other screens from MG Stocks & Screens. From a valuation perspective, the company appears to be overvalued after seeing its EPSmg (normalized earnings) drop from $1.27 in 2009 to $0.43 for 2013. This demonstrated lack of growth does not support the market’s implied estimate of 68.39% earnings growth, and leads the ModernGraham valuation model to return an estimate of intrinsic value that falls well below the price.
The next part of the analysis is up to individual investors, and requires discussion of the company’s prospects. What do you think? What value would you put on Health Care REIT (HCN)? Where do you see the company going in the future? Is there a company you like better? Leave a comment on our Facebook page or mention @ModernGraham on Twitter to discuss.
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Disclaimer: The author did not hold a position in Health Care REIT (HCN) or any of the other companies listed in this article at the time of publication and had no intention of changing that position within the next 72 hours.
Logo taken from the Wikipedia; this article is not affiliated with the company in any manner.