Diversified Healthcare Trust reported 2020 third quarter normalized funds from operations (FFO) (according to my definition) of $11.0 million or $0.05 per share, well below results for 19Q3 and 20Q2 and also below my projection of $27.8 million or $0.12 per share. The decline reflects the impact of pandemic-related costs and occupancy declines on its senior housing operating portfolio (SHOP) business.
Of notable concern was the lack of clear signs of improvement in SHOP. Occupancy on all SHOP properties declined 350 basis points (bp) sequentially to 75.2%, despite a 31% increase in move-ins. Data from DHC’s operator, Five Star Senior Living (FVE), indicate that the declines in SHOP occupancy were consistent across three of its four property types: independent living (IL), assisted living (AL) and continuum of care retirement communities (CCRC).
Although the Trust’s disclosures on the incidence of COVID-19 within its resident population are sketchy, it does appear that the number of infections experienced by its patients increased in 20Q3 (vs. 20Q2) but the rate of infection decelerated during the quarter. I also infer that COVID-related deaths among DHC’s SHOP residents have been steady in number, but at a rate (as a percent of those infected) well below the averages published by the Center for Disease Control and Prevention (CDC) for the senior cohorts (i.e. 75-85 years of age and 85+).
After its primary goal of ensuring patient and employee safety, DHC is committed to optimizing revenue even if it delays a recovery in occupancy. This, it believes, will position it better for the future. DHC’s market approach apparently differs from competitors who are offering big rent discounts to build back occupancy quickly. This approach probably contributed to the 350 bp sequential decline in DHC’s SHOP occupancy, which was worse than the peer group average.
Management anticipates that the decline in SHOP occupancy will ease only slightly to 24-25 bp per week during 20Q4 from 27 bp in 20Q3. That equates to a 3.1% quarterly decline. Since SHOP profit margins will most likely continue to decline with occupancy, I have reduced my outlook for DHC’s 20Q4 adjusted FFO from $0.10 to ($0.01). Consequently, I now anticipate full year 2020 adjusted FFO of $0.54, down from $0.72 previously.
For 2021, I have reduced FFO projection from $0.54 to just $0.06. My revised projection now anticipates weak performance continuing for the first half of the year, but significant improvement in the second half. Since there is, at this point, no evidence of a bottoming out, let alone a rebound, in occupancy, my 2021 projection is clearly speculative and therefore has potential downside risk, if the bottom in occupancy is delayed beyond the first half of the year.
Management believes that occupancy will bottom out when an effective vaccine approved and begins to be distributed. It is not surprising, therefore, that the stock has rebounded sharply, closing at $4.24, up nearly 50% over the past eleven trading sessions, following the recent announcements by Pfizer and Moderna.
Despite the disappointing 20Q3 performance and 2021 FFO outlook, my investment thesis has not changed. With the issuance of $1.0 billion of 9.75% senior notes in April, the Trust has nearly eliminated the risk of financial default over the next couple years and given itself time to work through the pandemic to complete its turnaround.
When it is able to demonstrate progress in its turnaround efforts, DHC will refinance the 9.75% notes probably with proceeds of new debt and equity offerings. (The 9.75% are trading at a yield of 4.32% to the June 2022, so the market still anticipates a refinancing.) The savings of interest from repaying the 9.75% Notes should more than offset the additional dilution from the share issuance. Accordingly, my price target for DHC’s stock remains $7.30, but if the turnaround is slower than anticipated, achieving that target price will take more time.
November 18, 2020. (From a report originally published on November 17, 2020. Please contact me for a copy of the report.)
Stephen P. Percoco
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