REIT Stocks

HCP Inc. Annual Stock Valuation – 2014 $HCP

logoREITs 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 HCP Inc. (HCP) fares in the ModernGraham valuation model.

Company Profile (obtained from Google Finance): HCP, Inc. (HCP) is a real estate investment trust (REIT). The Company invests primarily in real estate serving the healthcare industry in the United States. HCP acquires, develops, leases, manages and disposes of healthcare real estate and provides financing to healthcare providers. The Company’s portfolio consists of investments in the five healthcare segments: senior housing, life science, medical office, post-acute/skilled nursing and hospital. The Company makes investments within its healthcare segments using the five investment products: properties under lease, debt investments, developments and redevelopments, investment management and RIDEA, which represents investments in senior housing operations. In October 2012, Emeritus Corp announced that HCP closed the acquisition of 127 of the 133 senior housing communities. In February 2014, Kindred Healthcare Inc’s subsidiaries completed the acquisition of real estate associated with two nursing centers which it leases from HCP.

HCP Chart

HCP data by YCharts

Defensive Investor – must pass at least 6 of the following 7 tests: Score = 5/7

  1. Adequate Size of Enterprise – market capitalization of at least $2 billion – PASS
  2. Sufficiently Strong Financial Condition – current ratio greater than 2 – FAIL
  3. Earnings Stability – positive earnings per share for at least 10 straight years – PASS
  4. Dividend Record – has paid a dividend for at least 10 straight years – PASS
  5. 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
  6. Moderate PEmg ratio – PEmg is less than 20 – PASS
  7. 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 = 3/5

  1. Sufficiently Strong Financial Condition, Part 1 – current ratio greater than 1.5 – FAIL
  2. Sufficiently Strong Financial Condition, Part 2 – Debt to Net Current Assets ratio less than 1.1 – FAIL
  3. Earnings Stability – positive earnings per share for at least 5 years – PASS
  4. Dividend Record – currently pays a dividend – PASS
  5. Earnings growth – EPSmg greater than 5 years ago – PASS

Valuation Summary

Key Data:

Recent Price $42.54
MG Value $60.05
MG Opinion Undervalued
Value Based on 3% Growth $31.66
Value Based on 0% Growth $18.56
Market Implied Growth Rate 5.49%
Net Current Asset Value (NCAV) -$19.38
PEmg 19.48
Current Ratio 1.22
PB Ratio 1.81

Balance Sheet – 6/30/2014

Current Assets $497,000,000
Current Liabilities $407,000,000
Total Debt $8,674,000,000
Total Assets $20,144,000,000
Intangible Assets $528,000,000
Total Liabilities $9,384,000,000
Outstanding Shares 458,600,000

Earnings Per Share

2014 (estimate) $2.99
2013 $2.13
2012 $1.90
2011 $1.29
2010 $1.00
2009 $0.40
2008 $1.79
2007 $2.71
2006 $2.66
2005 $1.12
2004 $1.11

Earnings Per Share – ModernGraham

2014 (estimate) $2.18
2013 $1.63
2012 $1.35
2011 $1.20
2010 $1.34
2009 $1.58

Dividend History
HCP Dividend Chart

HCP Dividend data by YCharts

Conclusion:

HCP Inc. does not qualify for either the Defensive Investor or the Enterprising Investor at this time.  The Defensive Investor has concerns with the current ratio as well as the level of earnings growth over the last ten years.  The Enterprising Investor is concerned with the level of debt relative to the current assets.  As a result, value investors following the ModernGraham approach, based on Benjamin Graham’s methods, should explore other opportunities at this time.  As for a valuation, the company appears undervalued after growing its EPSmg (normalized earnings) from $1.34 in 2010 to an estimated $2.18 for 2014.  This level of demonstrated growth is greater than the market’s implied estimate of 5.49% earnings growth and leads the ModernGraham valuation model, based on Benjamin Graham’s formula, to return an estimate of intrinsic value above the market price.

Be sure to check out ModernGraham’s previous valuations of HCP for greater perspective!

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 HCP Inc. (HCP)?  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.

Disclaimer:  The author did not hold a long position in HCP Inc. (HCP) or any other company mentioned in the article at the time of publication and had no intention of changing that position within the next 72 hours.  Logo taken from wikipedia or the company website for the sole purpose of identifying the company; this article is not affiliated with the company in any manner.

6 thoughts on “HCP Inc. Annual Stock Valuation – 2014 $HCP

  1. Ben,

    I would love to chat with you about the sudden change in HCP being highlighted on September 20th as an “Elite” Defensive and Undervalued company to a “Bad” Speculative but Undervalued company. It appears that the only metric that changed is the ten year earnings growth. I looked back at the July valuation and the earnings numbers that you list there differ quite a bit from the ones you list on the current analysis. Please take a look and share your thoughts.
    Thanks!

    Jim

    1. Jim,

      This resulted due to a change in my data source. Previously, I was using MSN Money to find the 10 year earnings data, but they recently redesigned the site and no longer have that information. As a result, I’ve switched to using Guru Focus for that information. I’m not sure why the data is different from one site to another, but I compared the data a few times to other sources such as Value Line and found Guru Focus to be reliable.

      HCP was always on the border of being a speculative company because of its debt levels. Since it didn’t qualify for the Enterprising Investor, and already failed one of the Defensive Investor tests (the current ratio), if it fell in any other area it would no longer be suitable for Defensive Investors or Enterprising Investors. REITs in general have a very difficult time satisfying these requirements, in large part because the market seems to believe that having a strong cash flow should somehow make up for weak earnings growth.

      -Ben

      1. Here are adjusted operating earnings* from Fast Graphs: 2004:1.03 2005:1.04 2006:0.97 2007:0.67 2008:0.95 2009:1.04 2010:1.14 2011:1.63 2012:1.84 2013:1.97 2014:2.03

        The average of the last three years of adjusted operating earnings is a 118% increase over the 2005-2007. Have you considered using adjusted operating earnings for your calculations?

        *Adjusted (Operating) Earnings – The problem with basic and diluted earnings are that they may not accurately or adequately reflect the health of the business or the underlying earnings power of the company, because of the potential inclusion of unusual items that are not expected to occur every year.
        Consequently, many companies will report “adjusted,” “non-GAAP” or “operating” earnings. Since this version of earnings excludes special items and nonrecurring charges, they are thought to better reflect or perhaps paint a clearer picture of the actual operating results of the respective company’s business. In other words, special items are excluded because they are not considered regular or constant expenses or benefits required for the day-to-day operations of the business.

        1. I have considered adjusted operating earnings, but I strongly oppose using the metric. The goal of an intelligent investor is to be as conservative as possible. How can that be achieved by ignoring extraordinary items? I’d much rather keep everything that affects the bottom line in the analysis, because at some point down the road there is bound to be more extraordinary items. The only way to account for them is to include them. Adjusted operating earnings are useful for considering the profitability of a single line of business, but when reviewing an entire company’s results, the investor should be sure to include special items.

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