National Health Investors, Inc. — Q3 2018 Form 10-Q
Business context and period. NHI is a healthcare real estate investment trust investing in senior housing and medical properties through leases, mortgages and other loans. This unaudited filing covers the quarter and nine months ended September 30, 2018, compared with the same 2017 periods. At quarter-end, the portfolio comprised 219 owned properties and notes receivable involving 11 borrowers, across 33 states. Real estate was leased to 29 lessees.
Financial performance and position
| Metric | Q3 2018 | Q3 2017 | Nine months 2018 | Nine months 2017 |
|---|---|---|---|---|
| Total revenue | $74.9 million | $71.4 million | $220.6 million | $207.6 million |
| Net income | $41.0 million | $39.1 million | $117.3 million | $121.6 million |
| Diluted EPS | $0.97 | $0.94 | $2.80 | $2.97 |
| Operating cash flow | Not separately provided for quarter | Not separately provided for quarter | $156.0 million | $146.0 million |
- Revenue mix and growth: Q3 rental income rose 5.1% to $71.7 million; nine-month rental income increased 7.0% to $210.8 million, primarily from investments made since September 2017. Nine-month interest income from notes declined 4.1% to $9.7 million.
- Profitability: Q3 net income increased 4.8%. Nine-month net income fell 3.5%, largely because 2017 included $10.1 million of gains on marketable securities. Nine-month income before investment gains and losses increased 5.3% to $118.0 million. Depreciation and interest expense rose with new investments and higher LIBOR, respectively.
- Supplemental REIT measures: Nine-month diluted normalized FFO per share increased 4.6% to $4.12; normalized AFFO per share rose 6.2% to $3.76. Normalized FAD increased 8.6% to $159.9 million. These non-GAAP measures are not substitutes for GAAP earnings or operating cash flow.
- Cash flow and investment: Nine-month investing cash use was $149.5 million, including $129.6 million for real estate and $16.1 million for notes receivable, partly offset by loan collections. Financing cash use was $6.9 million, including $123.2 million of dividends paid, offset in part by borrowings and $47.9 million of common-stock issuance proceeds. Cash declined to $2.6 million from $3.1 million at year-end 2017.
- Debt and liquidity: Debt carrying value was $1.220 billion at September 30, versus $1.145 billion at December 31, 2017; principal debt was $1.234 billion. NHI reported $527 million available on its $550 million revolving facility. Consolidated net debt to annualized Adjusted EBITDA was 4.2x; fixed-charge coverage was 6.1x for the nine months. A 50-basis-point rate increase was estimated to add about $1.6 million to annual net interest expense, or $0.04 per diluted share.
- Dividends and equity: Dividends declared were $3.00 per share for the first nine months. Management’s 2018 annual dividend projection was $4.00 per share, versus $3.80 in 2017. Shares outstanding increased to 42.23 million from 41.53 million at year-end 2017.
Material changes and outlook
- During the first nine months, NHI invested $130.3 million in property acquisitions, including Ensign skilled nursing facilities, a five-property Bickford senior housing portfolio and two Comfort Care assisted living facilities. Total new lease and note investments reported were $159.0 million.
- On September 17, NHI added a $300 million bank term loan, converting that amount of revolving borrowings into a five-year term loan. The expanded unsecured facility totals $1.1 billion. The new term loan remains exposed to variable rates; existing swaps hedge $250 million of term debt.
- Management aims to grow normalized AFFO and regular annual dividends by at least 5% per share. It said it would continue evaluating investments and expects to use operating cash, debt and its ATM equity program; larger acquisitions could require an underwritten equity offering. No specific earnings or AFFO forecast was provided.
- Management noted rising interest rates and pressure on the spread between financing costs and investment returns. It expects higher property capitalization rates and lease rates may partly offset that pressure, but gave no assurance. NHI reported that its debt covenants were within limits, while leverage was near the upper end of its current pricing tier.
Risks, contingencies and unusual items
- Holiday lease amendment, subsequent event: On November 5, 2018, NHI agreed to a settlement providing $65.8 million in cash and other specified consideration, subject to diligence and NHI’s election of the form of consideration. Assuming no property is taken in lieu of part of the consideration, a new lease for 25 properties is to begin January 1, 2019, at $31.5 million initial annual rent, with 2%–3% escalators and a term through 2035. Original contractual rent was scheduled to be $39.0 million in 2019.
- East Lake/Regency dispute: Litigation involves alleged lease and reporting defaults and NHI’s efforts to obtain relief and transition the tenant. After quarter-end, NHI sought appointment of a receiver and pre-judgment possession; hearings were pending. NHI continued collecting scheduled rent and recorded $1.82 million of straight-line receivables at September 30. Management reported no impairment at quarter-end, but said a later write-off could be probable if rents fail and/or eviction rights are upheld. Management believes the dispute’s eventual resolution will not materially harm the company.
- Tenant and credit risks: Two tenants were non-compliant with lease coverage or working-capital requirements but remained current on rent, with no concessions. A Wisconsin property lease was classified as non-performing; NHI wrote off $1.44 million of straight-line rent and reported about $362,000 in arrears. Nine-month loan and realty losses totaled $1.85 million, including a $413,000 note receivable write-off. No real estate impairment was recorded for the two non-compliant operations.
- Concentration and sector exposure: Holiday, Senior Living Communities, NHC and Bickford each generated at least 10% of rental income. Skilled nursing operators receive significant Medicare and Medicaid revenue; about 26% of NHI’s revenue was derived from operators of skilled nursing facilities. Management considered near-term Medicare reimbursement increases adequate for its operators, while noting Medicaid funding may not keep pace with inflation and that future effects are uncertain.
- Commitments and accounting: Remaining loan commitments were $45.4 million, development commitments $11.0 million and contingent commitments $30.4 million. NHI expected to fund the remaining $2.5 million of Timber Ridge Note A during 2018. The company was evaluating the effect of adopting lease accounting standard Topic 842 in 2019; it expected little balance-sheet impact but had not determined the gross presentation effect on operations.
Most important facts for investors to verify
- Completion, form and timing of the $65.8 million Holiday settlement, and the economics and security of the replacement lease versus the former contractual rent.
- Outcome of the Regency litigation and tenant transition, continued rent collections, and recoverability of the $1.82 million straight-line receivable.
- Tenant operating coverage and payment capacity, particularly for large tenants and senior housing operators facing occupancy and wage pressures.
- Debt levels, variable-rate exposure, covenant headroom and the effects of further interest-rate increases on financing costs and acquisition returns.
- Whether normalized AFFO and cash generation support the stated dividend-growth objective, taking account of equity issuance, investment commitments and the distinction between non-GAAP measures and cash available for distribution.