What’s Ahead for Senior Living Stocks?

Because of the substantial selloff, senior living stocks could be good satellite positions for total investment over the next few years.

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Senior living stocks, particularly, Chartwell Retirement Residences (TSX:CSH.UN) and Sienna Senior Living (TSX:SIA) stocks, have declined substantially in the last 12 months. These two stocks are down approximately by 34% and 29%, respectively.

CSH.UN Chart

CSH.UN and SIA data by YCharts

It seems the market is pricing in dividend cuts for these high-yield stocks. At writing, Chartwell yields 7.15%, while Sienna yields 8.6%! However, they could still be nice opportunities for total returns on a turnaround.

First, here are some of the challenges the senior living businesses are experiencing.

Senior living business challenges

Higher operating expenses, which can be more or less traced down to inflation, is a general theme. For example, operating costs including labour, insurance, and utility costs have generally jumped higher. Similarly, interest expense has also increased due to higher interest rates.

Specifically, for Sienna Senior Living, which gets government funding for the long-term-care communities in British Columbia and Ontario, other than higher labour, insurance, and utility costs, it also witnessed an increase in government-funded direct-care expenses. Because expenses rose faster than revenue, ultimately, it experienced a drop of 7% in its same-property net operating income in 2022.

To increase investor concerns, the company also increased its share count by about 6.8% in 2022. As a result, its payout ratio (based on its operating funds from operations) was 97% last year. This leaves very little margin of safety to protect the 8.6% dividend.

The scenario is similar for Chartwell Retirement Residences as well with its direct property operating expense rising faster than its resident revenue. As did Sienna, Chartwell also increased its share count in 2022, but thankfully, not as much as Sienna. Chartwell increased its share count by roughly 1.5%. That said, ultimately, Chartwell’s 2022 funds from operations payout ratio was approximately 115%, making its dividend technically not sustainable.

In the short term, with sufficient liquidity, both companies could choose to maintain their dividends. For now, indeed, both are maintaining their dividends. However, given their high payout ratios, investors should not trust their high yields entirely.

The turnaround opportunity

The Bank of Canada has increased interest rates to curb high inflation. For now, the central bank is maintaining the policy interest rate at 4.50% to observe how the current interest rate affects the macro economy and inflation.

As inflation is put under better control, it should lead to the senior living businesses having a better handle on their operating costs. Ultimately, this could lead to a turnaround in the stocks of Chartwell and Sienna. In the meantime, shareholders should enjoy dividend income (even though a portion of the dividend might be cut). Currently, analysts believe they’re undervalued stocks. They’re calling for potential upside of 32% and 25%, respectively, over the next 12 months.

Investor takeaway

As you can tell by now, Chartwell and Sienna aren’t the safest of dividend stocks to own. Their dividends could be cut sometime over the next 12 months. However, because they earn income from their retirement and long-term-care portfolios, they should pay some sort of dividend income no matter what. Therefore, they could be good total-return investments on a turnaround over the next few years. Interested investors should size their positions accordingly.

This article represents the opinion of the writer, who may disagree with the “official” recommendation position of a Motley Fool premium service or advisor. We’re Motley! Questioning an investing thesis — even one of our own — helps us all think critically about investing and make decisions that help us become smarter, happier, and richer, so we sometimes publish articles that may not be in line with recommendations, rankings or other content.

Fool contributor Kay Ng has a position in Chartwell Retirement Residences. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.

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