In early April, Five Star announced a change in its strategy whereby it will transition out of the management of 108 smaller senior living communities (SLCs) with 7,500 living units (with an average of 69.4 units per community), close and reposition 27 skilled nursing facilities (SNFs) with 1,500 units located within its continuum of care retirement communities (CCRCs) and close 37 Ageility inpatient rehabilitation clinics that are located within the exited SLCs. The transition is expected to be completed by the end of 2021.
After the transition, Five Star will be left managing 120 communities with 17,906 units. The remaining communities are larger, with an average of 149.2 units per community. They have an average occupancy rate that is about 300 basis points (bp) higher than the company’s average occupancy on March 31 and about 10 full percentage points (1,000 bp) higher than the occupancy on the exited communities and SKFs. Thus, the strategic shift will allow Five Star to focus on managing larger communities where it believes it has a competitive advantage.
In the short run, however, the transition will reduce the management fee income that Five Star receives from the property owner, Diversified Healthcare Trust (DHC). Five Star will also lose the revenues and operating profit from the 37 Ageility rehabilitation clinics that are slated to close.
Prior to the announced strategic shift, I had expected that Five Star would produce earnings per share of $0.23 per share in 2021 and $0.38 per share share in 2022. Now with the loss of revenues and earnings from the transitioned communities and Ageility clinics, I anticipate that the company will report a loss of $0.18 per share in 2021 with earnings rebounding in 2022 to $0.24 per share.
On the day of the announcement, Five Star’s stock fell 13.7% to $5.49. It eventually found a bottom at $4.66 on April 23 and has since recovered some of the ground that it lost. It closed on Friday (May 21) at $5.99.
With the change in the earnings outlook, I have reduced my price target on Five Star’s stock to $7 from $8 previously. However, since the new lower price target represents a 16.9% return from the current quote, I am maintaining my outperform rating on the stock.
Although the transition will present certain challenges especially with the lingering impact of the pandemic, I believe that this is a good strategic step for Five Star, putting it in a better position to grow both the senior living business and Ageility over time. The company will have greater management capacity to pursue new management contracts presumably of larger communities. It also has the financial strength (with little debt and projected available cash of about $70 million by the end of 2022) to grow the business organically or even pursue acquisitions.
My full update report on Five Star Senior Living is available upon request.
May 22, 2021
Stephen P. Percoco
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