22Q3 GAAP loss was $0.34 per share and normalized FFO was –$0.06 per share, below my forecast of ‑$0.23 and +$0.01, respectively. The Office Portfolio met expectations, but Senior Housing Operating Portfolio (SHOP) results were disappointing as improved occupancy and higher rental rates were more than offset by significantly higher operating expenses. Non-Segment results were also below expectations.
SHOP operating expenses included an estimated $4.1 million of costs associated with damage caused by Hurricane Ian in Florida, but the main driver of the increase was inflation in wage, utility and food costs. Higher wage costs spring from efforts to fill open positions. The continuing shortage of labor requires a still heavy use of costly contract labor. Although DHC and its operators are making progress in hiring to reduce the use of contract labor, it expects that operating costs will remain elevated in 2023.
Based upon the disappointing 22Q3 results, I have reduced my normalized FFO estimates for the third consecutive quarter to ‑$0.23 for 2022 (from –$0.10) and +$0.04 for 2023 (from +$0.25). The decrease in projected 2023 FFO is due mostly to higher SHOP operating costs. Since most of this year’s occupancy gains are from needs-based residents, there may be a limit to how much occupancy will improve in 2023.
The Trust faces a bank debt payment in 2023 and a debt maturity in 2024 which combined with elevated capital spending will deplete its cash by mid-2024. With this quarter’s disappointing performance and guidance that SHOP operating costs will remain high in 2023, it is less likely that DHC will be able to show sufficient improvement in its financial performance to issue new debt to refinance the maturing bond issue (and some of the bank debt) by 23H2. In that case, it will likely face some form of debt restructuring, which will substantially dilute the interests of DHC’s existing shareholders.
DHC’s stock is down 34% since my last report vs. the 3% drop in the S&P Small Cap 600. The combination of poor stock performance, disappointing 22Q3 results, little sign of improved financial performance for 2023 and the approaching debt payment obligations point to a much less optimistic outlook for DHC shareholders. Accordingly I am reducing DHC’s performance rating to “4” (Underperform), the price target to $0.50 and the safety rating a notch to “D-”. The stock might rally periodically as it did in October; but without a meaningful and sustainable turnaround in 2023 financial performance, it will eventually head lower.
This is a summary of my recent update report on Diversified Healthcare Trust (DHC). To receive a copy of the full report, please reach out to my using the contact information provided below.
November 16, 2022
Stephen P. Percoco
Lark Research
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