Universal Health Realty Income Trust — Form 10-Q Summary
Reporting period: Three and six months ended June 30, 2018; filed August 8, 2018. The REIT owns and leases healthcare and human-service facilities. As of July 31, 2018, the portfolio comprised 69 investments across 20 states, including hospitals, medical office buildings, free-standing emergency departments, and childcare centers.
Business Context
Universal Health Services, Inc. (“UHS”) provides advisory and administrative services, employs the Trust’s officers, and is a significant tenant. UHS-related tenants represented approximately 28% of consolidated revenue in the second quarter and 30% for the first six months of 2018. Three hospital leases are with UHS subsidiaries, and UHS has renewal and purchase options on certain facilities.
Financial Performance and Key Metrics
| Metric | Q2 2018 | Q2 2017 | Six months 2018 | Six months 2017 |
|---|---|---|---|---|
| Revenue | $20.1 million | $18.1 million | $38.7 million | $35.9 million |
| Net income | $5.8 million | $4.0 million | $15.4 million | $35.6 million |
| Basic and diluted EPS | $0.42 | $0.30 | $1.12 | $2.62 |
| Funds from operations | $12.0 million | $10.5 million | $23.5 million | $21.3 million |
| FFO per diluted share | $0.88 | $0.77 | $1.71 | $1.57 |
| Net cash from operating activities | Not separately provided | Not separately provided | $23.2 million | $20.3 million |
Second-quarter revenue increased approximately 10.8%, while six-month revenue increased approximately 7.7%. Second-quarter net income increased approximately 44%, and the implied net margin rose to approximately 28.9% from 22.2%. Six-month net income declined approximately 56.7%, primarily because the prior-year period included a $27.2 million gain on the Arlington transaction. The six-month 2018 net margin was approximately 39.9%, compared with approximately 99.2% in the prior-year period, reflecting that unusual gain.
FFO increased 15% in the second quarter and 11% for the first six months. Management attributes the improvement primarily to a $1.7 million lease termination payment, lower nonrecurring repair and remediation costs, increased property income, and 2018 hurricane business-interruption recoveries.
Balance Sheet, Debt and Liquidity
| Balance-sheet item | June 30, 2018 | December 31, 2017 |
|---|---|---|
| Total assets | $491.0 million | $490.0 million |
| Cash and cash equivalents | $5.7 million | $3.4 million |
| Line of credit borrowings | $197.3 million | $181.1 million |
| Non-recourse mortgage notes, net | $52.8 million | $75.4 million |
| Total liabilities | $283.0 million | $279.4 million |
| Total equity | $208.0 million | $210.6 million |
On March 27, 2018, the Trust replaced its revolving credit facility, increasing capacity by $50 million to $300 million and extending maturity to March 2022, with two optional six-month extensions. At June 30, 2018, $102.7 million remained available. The facility’s applicable LIBOR margin was 1.15% and the facility fee was 0.20%.
The Trust repaid three mortgages totaling approximately $21.7 million at maturity using revolving-credit borrowings. Eight non-recourse mortgages remained outstanding, with aggregate principal of $53.2 million before financing fees and debt premium. The nearest listed mortgage maturity is July 2019. Management reported compliance with all credit covenants, including total leverage of 39.9%, secured leverage of 8.1%, unencumbered leverage of 36.2%, and fixed-charge coverage of 4.1x.
Operating cash flow of $23.2 million exceeded the $18.3 million of dividends declared during the first six months. The Trust declared a second-quarter dividend of $0.67 per share, paid July 3, 2018. Management stated that operating cash flow, cash, available credit, and capital-market access should provide sufficient resources for the next twelve months, while noting that financing may not be available on acceptable terms.
Material Changes Versus the Prior Comparable Period
- Revenue increased due to higher tenant reimbursements, property activity, and acquisitions, including properties acquired in 2017.
- Second-quarter results included a $1.7 million early lease termination fee related to a Texas medical office building lease scheduled to expire in July 2020.
- Hurricane Harvey recovery activity contributed $1.2 million of business-interruption proceeds and $4.5 million of insurance recoveries in excess of property damage write-downs during the first six months.
- All occupied space at the five Houston-area buildings damaged by Hurricane Harvey had been reconstructed and operations had resumed by June 30, 2018.
- The Trust acquired the Beaumont Medical Sleep Center Building in Michigan for approximately $4.0 million in June 2018; it was fully leased under a remaining approximately 9.5-year initial term.
- The prior-year six-month period included a $27.2 million gain and approximately $57.3 million of net cash proceeds from the Arlington/St. Mary’s property transaction, creating a difficult comparison.
- McAllen Medical Center exercised a five-year lease renewal option, extending the lease at the existing rate through December 2026.
- The Trust adopted new cash-flow and revenue-recognition standards. Management reported no significant financial-statement impact from the revenue standard and no cumulative adjustment.
Outlook, Commentary, Risks and Unusual Items
No specific earnings or revenue guidance was provided. Management expects to fund capital expenditures, acquisitions, and dividends through internally generated cash and additional financing, including the revolving credit facility, mortgage debt, equity issuance, or other long-term debt.
- Tenant concentration: A substantial portion of revenue depends on UHS and its subsidiaries. Lease expirations, nonrenewal, purchase options, or changes in UHS’s financial condition could reduce revenue.
- Related-party governance: A UHS subsidiary is the Advisor, the Trust’s officers are UHS employees, and the Trust pays advisory fees to UHS. Advisory fees were $948,000 in the second quarter and $1.9 million for the first six months.
- Interest-rate and refinancing risk: Revolving-credit borrowings bear variable rates, and the Trust must refinance or repay mortgage debt as it matures. Interest-rate caps totaling $60 million of notional value expire in March 2019.
- Healthcare and regulatory exposure: Changes in Medicare, Medicaid, the Affordable Care Act, reimbursement rates, licensing, and healthcare policy could affect tenants and property values.
- Real-estate risk: Competition, occupancy, rental rates, property values, development activity, and local economic conditions may affect operating results.
- Insurance and weather events: Hurricane Harvey caused temporary closures and lost income, although management stated that insurance recoveries covered substantially all remediation, reconstruction, and business-interruption costs.
- Unusual items: Results include hurricane recoveries and a lease termination fee; these items may not recur. FFO is a non-GAAP measure and should not be treated as GAAP net income, liquidity, or operating cash flow.
Important Facts for Investors to Verify
- Reconcile recurring rental income and FFO excluding the $1.7 million lease termination fee and hurricane-related recoveries.
- Review UHS’s financial condition, tenant concentration, advisory relationship, lease renewal terms, and purchase options.
- Assess the $197.3 million revolving-credit balance, variable-rate exposure, March 2022 maturity, covenant headroom, and July 2019 mortgage maturity.
- Confirm whether post-Hurricane Harvey occupancy, rents, operating costs, and insurance recoveries normalize as reported.
- Evaluate dividend coverage using recurring operating cash flow after capital expenditures and debt service, rather than net income alone.
- Review the four unconsolidated LLC/LP investments, their non-recourse debt, funding commitments, and potential buy-sell provisions.
- Monitor the effect of healthcare reimbursement, regulatory, and broader real-estate market changes on facility operators and property valuations.