Investors bullish on Chartwell Retirement Residences (TSX: CSH.UN) have generally pointed toward long-term growth and profitability of seniors looking for retirement housing as reasons for why this trust remains a solid investment at current levels. Certainly, from a demographic standpoint, baby-boomer Canadians are now entering retirement age en masse, and many seniors will be looking for housing solutions that providers such as Chartwell offer, making this REIT seem to be an attractive long-term play.
As we know, demographic fundamentals supporting long-term growth trends are great; however, the implication is that the long-term growth Chartwell will be able to realize over time will be profitable. But when looking at the REIT’s numbers, this may not be the case.
What do the fundamentals say?
With many elderly retirees choosing seniors housing communities, assisted living, or long-term care solutions as primary options, real estate investment trusts (REITs) focusing on these housing segments have performed exceptionally well. Many REITs, including Chartwell, have exploded to ridiculous valuations given the lack of free cash flow generation, years of negative margins, and unrealistically high distributions.
While some analysts have pointed to the fact that Chartwell currently has one of the lower payout ratios among REITs in general, it should be noted that Chartwell is different than a traditional residential, commercial, or industrial REIT in that the company has much higher operating expenses related to the care aspect of the trust’s real estate portfolio. From 2012 to 2016, Chartwell has posted net operating income of -$139 million, $24 million, -$8 million, $12 million, and -$1 million respectively, on revenues that have hovered between $686 million and $884 million (trending downward).
Free cash flow has hovered between $11 million and $47 million over the past five years; however, dividend distributions have remained stable and growing within a range of $69-83 million per year. The fact that dividend distributions have averaged more than 230% of free cash flow over the past five years has resulted in a situation where the trust has been forced to raise debt each year, generally in an amount that covers both its debt repayments and dividend payments in excess of free cash flow.
Subtracting debt repayments and dividend payments from newly issued debt and free cash flow, investors get the picture that the REIT is essentially forced to raise debt each year and is likely to do so moving forward, irrespective of capital expenditures, due to the net deficit left by unsustainably high dividend distributions.
Bottom line
While in theory I like the long-term growth prospects of retirement-residence-focused REITs, I would look elsewhere for better-run, operationally sound options on the TSX.
Stay Foolish, my friends.
