After Canadian Oil Sands Ltd. cut its dividend by 43% last week and Baytex Energy Corp. cut its dividend by 60% earlier this week, companies with stable and predictable dividends are looking all the more attractive. Companies like NorthWest Healthcare Properties REIT (TSX: NWH.UN), Canada’s largest non-government owner and manager of medical office buildings and healthcare real estate, which stands to benefit from positive macro fundamentals in its industry.
Northwest Healthcare REIT currently has a dividend yield of 9.09%. Here are the reasons why I believe that its dividend is sustainable and can be relied upon.
Payout ratio
While the payout ratio has risen somewhat recently, it currently stands at 96.5%, which means that it is still being covered by cash flow. In terms of liquidity, there is currently $465,000 in cash on the balance sheet and debt ratios are well below the upper thresholds. As of the third quarter of 2014, debt-to-gross book value ratio was 55.1%. Management’s target for this ratio is 55%-60%, and in the Declaration of Trust, the limit is 65%.
Non-core property dispositions
NorthWest’s initial goal was to dispose of $40 million in non-core assets this year, and as of the third quarter disposition for the year totaled approximately $18 million, way behind expectations. But management still aims to achieve the $40 million target, it will just take longer than initially anticipated. We should expect one or two more dispositions in the fourth quarter and possibly early next year. These dispositions will be used to fund the redevelopment of sites, such as increased parking and increased density, as well as other initiatives to create value (turnkey managed clinics).
Lower interest costs due to refinancings
In the latest quarter (the third quarter of 2014), Northwest Healthcare REIT refinanced approximately $22 million at lower mortgage rates, with $15 million being refinanced at 3.22% (versus the prior 5.76% rate), and a $7 million refinancing at 3.9% (a 117-basis-point reduction). NorthWest has reduced its weighted average interest rate to 4.63% from 4.8% at the beginning of the year. Management expects more reductions to come in 2015.
Short-term issues lead to attractive valuation and dividend yield
Some of the issues that the company is currently facing are lower than expected occupancy and a slowdown in new leases. Occupancy in the latest quarter was 91.8%, a slight decrease from the previous quarter (30bp lower), but up from 91.3% in December 2013. The rate at which the REIT has been able to secure new leases has also been disappointing, as only 50% of its plan materialized. Lastly, net operating income declined marginally in the first nine months of the year and in the third quarter, -.2% and -.8% respectively.
But these issues are certainly reflected in the REIT’s valuation. It currently trades at nine times 2014 funds from operations, which is below its peer group, and its dividend yield is 9.09%. While the company is experiencing some difficulties which would explain this valuation discrepancy, the long term fundamentals remain intact so I believe that this represents a buying opportunity and an opportunity to get exposure to a high dividend yield from a relatively stable and predictable REIT.
Initiative underway to create value
Management is working on initiatives to increase net operating income in the mid- to long-term, such as what they call “turnkey initiatives”. This refers to the newly introduced managed clinic concept whereby NorthWest would collect an administration fee as well as a percentage of physicians’ revenues in exchange for managing their practice.
The trend in the industry is toward third-party managed clinics and family health teams as opposed to physicians setting up their own practice, so NorthWest’s move is in line with this. This, in turn, would also drive traffic (higher parking revenues to the REIT) and result in increased synergies for tenants that serve patients. It is still in early stages but expect a bump in net operating income from these facilities versus the traditional facilities.
NorthWest Healthcare Properties REIT is benefiting from the demographic trend that is alive and well today and should continue to reward investors with a stable dividend.
