CareTrust REIT

Moat: 2/5

Understandability: 2/5

Balance Sheet Health: 4/5

CareTrust REIT is a self-administered, publicly-traded REIT engaged in the ownership, acquisition, development and leasing of skilled nursing, assisted living, and other healthcare related properties across the United States.

Investor Relations Previous Earnings Calls

The moat, understandability, and balance sheet health scores reflect a conservative evaluation to ensure a margin of safety in any assessment.

CareTrust operates as a real estate investment trust (REIT), focusing on acquiring and managing healthcare facilities. This model creates recurring revenues for them through long-term leases.

Business Overview

CareTrust REIT operates in the healthcare real estate sector, primarily focusing on skilled nursing facilities (SNFs), but also including assisted living facilities (ALFs), and other healthcare related properties. Their business model is centered around acquiring and leasing these properties to healthcare operators under long-term, triple-net leases. This structure means that tenants, not CareTrust, are responsible for covering most operating expenses and property-related costs such as insurance, taxes and maintenance. The company is reliant on the performance of these operators, where rent and profitability is contingent on regulatory reimbursements and occupant census.

  • Revenue Distribution: CareTrust’s revenue primarily comes from rental income generated by leasing out healthcare properties. Their client base is diversified across geographic areas, consisting of 198 facilities in 28 states (as of December 2022). As per their 2022 annual report, senior housing accounted for 74% of total property revenue, skilled nursing 15%, and others 11% respectively. They have made a shift away from skilled nursing with an aim to become more diversified into higher revenue senior housing facilities.
  • Industry Trends: The healthcare real estate industry is undergoing transformation due to demographic shifts, regulatory changes, and technological advancements. Increasing life expectancies and the aging Baby Boomer generation are driving up demand for senior housing and healthcare services, which could be a tailwind for companies like CareTrust. At the same time, changes in reimbursement models and the potential impact of regulations can create uncertainty, making it important to understand how these factors impact different parts of the portfolio.
  • Margins: The company is highly sensitive to interest rates because it is a REIT and is leveraged, so its expenses are quite variable. A large portion of operating expenses, which are very stable and predictable, are passed through to tenants as per their lease agreements.
  • Competitive Landscape: The healthcare real estate market is relatively fragmented, with a large number of REITs and private investors. Competition to purchase facilities in attractive markets is very high. Key players include larger healthcare REITs such as Healthpeak Properties and Ventas, among several others. In the SNF space, large private operators like Genesis, HCR ManorCare and large government reimbursement providers also play a large role. Also, regional and local owners can exert competitive pressures in specific markets.
  • What Makes the Company Different: CareTrust REIT emphasizes long term relationships with strong operators in their segment. They also like doing sale-leaseback acquisitions directly with operators, thereby cutting out the middlemen and enabling them to acquire higher quality real estate assets at better rates. Their investment focus is primarily on facilities with the ability to generate strong returns. They also appear to focus on non-unionized and lower-labor-cost regions for their assets. This strategy appears to be differentiated enough from the competition, that are in more competitive markets or are willing to accept lower profits.

Key Drivers are demographics, regulations, and economic and market conditions. The management team sees the following tailwinds: aging populations, favorable regulatory changes that might lead to increase in occupancy rates, and growth in the value of real estate properties.

Financial Analysis

  • Revenue: CareTrust’s revenues primarily come from the lease agreements on the healthcare properties they own. Based on their full year 2022 report, total revenue was $191.9 million, driven by their diversified portfolio. During their full year 2022 report, the company saw strong operating results due to the acquisition of new properties during the year and improved occupancy rate and profitability across their existing properties. The annual rent of their existing operations increased by 10.2 percent in 2022 as compared to prior years.
  • Margins: The profit margins for CareTrust are quite stable. Due to their triple-net-lease model, most operating expenses are the responsibility of the lessees. Net income margin in 2022 was just below 11% although this could be misleading as the company is a REIT and thus does not seek high profits. Instead, it relies more on its ability to grow its asset portfolio. As such, operating income is high, and their income can be greatly affected by financial expenses which are quite volatile in the current economic environment.
  • Earnings: The company reported diluted earnings per share (EPS) of $0.40 in 2022, which is down compared to $0.71 in 2021, mainly due to their sale of properties and the write down on investments. Their funds from operations (FFO) was $1.47 per share down from $1.63 per share in the prior year. This indicates that there are concerns with their overall ability to generate profits for their shareholders. These numbers are further complicated by the nature of the REIT, and the volatility in the market.
  • Balance Sheet: The company has a relatively strong balance sheet with a debt-to-equity of 1.3, and it has a reasonably high debt to equity ratio that does raise some concerns, yet seems normal for REITs. However, they have taken steps to de-leverage their balance sheet, by selling off properties and using cash proceeds to pay down their debt. As a result, they have improved their interest coverage ratio over the past year. In terms of liquidity, their current ratio is 1, indicating a balance between current assets and current liabilities. The company had $30.8 million in cash as of December 31st, 2022.
  • Cash Flows: In terms of cash flows, the company had $89.3 million in cash from operations, and $459 million in cash from financing activities in 2022. These results are not surprising as REITs rely heavily on borrowed capital for acquisitions. But the company has negative $359 million cash flows from investing activities as it sells off existing properties. Thus it is critical for the company to ensure that it can raise capital at favorable rates to maintain growth.
  • Capital Structure: The company has a reasonably high debt load, with long term debt accounting for more than 80% of their total debt. Their debt is mostly fixed, which reduces volatility in terms of interest payments, but it is also difficult for them to improve their profitability by deleveraging. They have a substantial amount of convertible preferred stock which is convertible to common stock. As well, the company has a large portfolio of secured loans and mortgages, which are backed by their properties, and which also are a primary source of income.

The company’s cash flow projections, including a declining revenue growth in 2023, have not been changed and the company is maintaining its full-year guidance for adjusted FFO of $1.33 to $1.35 per diluted share. Their capital structure remains flexible, and they expect acquisitions to increase during 2023, which indicates they expect future returns to be high.

Moat Analysis: 2 / 5

CareTrust’s economic moat is relatively weak. While they do exhibit some characteristics of a moat, those may not be very sustainable.

  • Intangible Assets: The company does utilize brands to attract lessees and obtain a price premium in their leases. However, such brand power does not seem to make a large impact in this industry, making this a very weak moat.
  • Switching Costs: The companies that rent CareTrust’s properties are often locked in with long term triple net leases. These agreements require heavy investment on the tenant’s side, making it costly and difficult for them to switch to competing properties. These contracts should have some stickiness, but many lessees are small mom-and-pop healthcare facilities that may not have a lot of stability. This indicates a narrow moat.
  • Network Effect: There are no apparent direct network effects for this company. The amount of interconnected customers is not material to the value of the business.

  • Cost Advantage: The company is able to secure favorable terms by acquiring high quality real estate, and by cutting out the middlemen by dealing directly with the operators. Such advantages do help with increasing profits, but they are not something that cannot be quickly replicated by competitors. Also, many competitors are very large with established relationships, thus indicating this is a weak moat.

  • Overall Moat Rating: Given all the above factors, I would consider the company to have a narrow economic moat. Their competitive advantage is present, but may not be long-lasting or very wide. Thus they have a rating of 2/5 in terms of economic moat.

Risks to the Moat and Business Resilience

The most important risk is that the company is heavily reliant on continued government funding of healthcare through programs such as Medicare and Medicaid. Changes to those programs could significantly reduce reimbursements for clients, which would affect their profitability and potentially their ability to meet their lease obligations.

Additionally, the company faces operational risks from the quality of their tenants. If their tenants are unable to achieve occupancy requirements and are not profitable, then they may not be able to pay rent. Furthermore, competition in the healthcare industry may also have ripple effects on their tenants profitability, which can affect their long term agreements with CareTrust.

The company’s portfolio is also concentrated in a few areas. More than a third of their investments are in California and Texas, which puts the business at risk if anything were to affect real estate values in those particular geographies. Their portfolio consists mostly of senior housing and SNFs as they are transitioning from a mixed portfolio approach.

Interest rate increases have been a serious concern for the company, and could result in reduced acquisitions in the future, as capital is costly. As well, high interest rates could have adverse affects on the profitability of their existing portfolio. Any slowdown in the economy could affect the financial performance of their tenants and their future ability to grow. Inflation will further impact profitability by increasing operating expenses for their tenants.

The management team is confident in its long term profitability and sees many tailwinds in the coming years. They see the aging population and high demand for healthcare facilities as reasons for optimism. But as an investor it’s important to understand that the company is vulnerable to changes in regulations and economic fluctuations and the ability of tenants to pay rent, and is subject to significant economic risks.

Understandability: 2 / 5

The business model is relatively straightforward, but the nuances of triple-net leases and healthcare funding can make the valuation difficult. Also understanding their exposure to various aspects of the healthcare system requires additional due diligence. The company is exposed to market sentiment for real estate investments and REITs. The overall picture requires a fair amount of knowledge and experience in various areas, making it a relatively difficult business to understand.

Balance Sheet Health: 4 / 5

The company has a relatively strong balance sheet with a low debt to equity ratio. They have good liquidity metrics and a good track record of refinancing their debt. They have also taken steps to reduce their debt and increase their flexibility in the future. However, the company’s high debt levels make them vulnerable to interest rate increases and economic downturns. Although they seem to be doing all they can to alleviate these risks, it is critical that investors carefully monitor their performance and make informed decisions based on available facts.