Diversified Healthcare Trust reported 2020 fourth quarter normalized funds from operations (FFO) (my definition) of $15.1 million or $0.06 per share, slightly better than 20Q3, but well below 19Q4. The results were modestly better than I anticipated with lower operating expenses, greater unrealized gains on its investment in Five Star Senior Living (FVE) and realized gains on property sales. Even so, occupancy in its senior housing operating portfolio continued to fall at about the same pace as in 20Q2 and 20Q3.
Despite the disappointing news on occupancy, DHC’s stock has recovered modestly since the beginning of the year on increasing optimism about a quicker end to the pandemic. Five Star reported earlier this month that 87% of its residents have received at least the first dose of the COVID vaccine. At about the same time, the CDC issued new guidelines opening up senior living communities to visitors once again, as long as vaccinations have reached the 70% threshold and there are no ongoing uncontrolled outbreaks.
With the vaccinations, resident move-outs should fall sharply. Five Star said that occupancy at managed communities decreased only 0.1% in February. But in order for occupancy to begin rising again, move-ins need to recover toward pre-pandemic levels. Although there should be considerable pent-up demand for needs-based senior housing, potential residents and their families may further postpone their decisions until they are confident that it is safe. Still, as life returns to normal, move-ins should too. Visibility to a bottom in occupancy has increased.
My projections anticipate that occupancy will bottom out in 21Q2 and then begin to rise slowly for the balance of the year. The pace of the rebound in occupancy should gather steam in 2022. With occupancy now at very low levels, DHC will continue to experience GAAP net losses for the next two years, but my projections show that normalized funds from operations (FFO) will bottom out at $0.20 per share in 2021, before rebounding to $0.38 in 2022.
DHC has also taken some steps recently to ensure its liquidity as it awaits the rebound in its business. In January, it amended its bank credit facility, gaining waivers on certain covenants through June 2022 in exchange for granting the banks a security interest in certain of its properties and reducing the size of the facility from $1.0 billion to $800 million.
In early February, in response to the changes in the bank agreement and the continued pressure on profitability, Moody’s and Standard & Poor’s each downgraded the Trust’s credit ratings on outstanding public debt securities by a notch to Ba3 and BB, respectively.
In February, DHC issued $500 million of 4.375% Senior Notes due March 1, 2031. Proceeds were used in part to repay a $200 million bank term loan. The remainder will be used to retire the $300 million of 6.75% Senior Notes due 2021 when they become callable at par on June 15.
With DHC’s profitability expected to remain challenged in 2021, the company has disclosed that it may draw down its revolving credit facility to build up its cash position in anticipation that it will breach a minimum debt service coverage covenant by mid-year.
Beyond 2021, a key objective for DHC is to retire the $1 billion of 9.75% Senior Notes due 2025 when they become callable on June 15, 2022. My analysis suggests that the interest savings from retiring the 9.75% Notes will more than offset the potential dilution from an equity offering as large as $500 million. Accordingly, my price target is $7.50 and I am maintaining my performance and safety ratings of “1” and “D”, respectively. The primary risk to my outlook and investment thesis is a longer-than-anticipated delay in the recovery of occupancy. This will sustain the pressure on the company’s financial performance, forcing it to carry its high debt burden for longer
March 31, 2021
Stephen P. Percoco
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