Phiwath Jittamas
Shares of American Healthcare REIT (NYSE:AHR) have seen a successful public debut, as optimism about 2024 interest rate cuts provided some relieve among investors early into the year.
While there has been optimism on rate cuts moving down a bit in recent weeks, shares were priced on the lower end of the preliminary offering range. The long-term potential of healthcare REITs naturally exists, but the reality is that finances of American Healthcare REIT are rather complicated, providing few reasons for me to get really upbeat here.
A Broad Range Healthcare REIT
AHR describes itself as a self-managed REIT which acquires, owns and operates a broader range of healthcare real estate, such as medical office buildings, senior housing, hospitals and nursing facilities, among others.
Founded in 2015, the company has steadily grown its balance sheet, which is now valued at $4.6 billion, the vast majority comprised out of 298 properties, encompassing over 4 million square feet of medical office space, over 10,000 senior housing beds/units and nearly a similar 10,000 nursing beds. About 40% of healthcare rental revenues come from integrated senior health campus as well as medical office buildings, complemented by the so-called SHOP, senior housing, SNF and hospital properties.
Annual base rent on a consolidated basis runs at around $320 million, although this falls to $280 million on a pro rata business, taking into account that the company is only majority owner in a substantial number of properties in which it co-operates with JV partner Trilogy, although the company has obtained an option to buy out the shares held by its JV partners.
These assets comprise nearly 19 million square feet, with the vast majority of the real estate located in the US, although the company has a presence in the UK and Isle of Man as well. The vast majority of these solutions are located in the Midwest, with 27% of rent generated in Indiana, nearly 11% of sales in Ohio, as well as states like Michigan, Texas and Missouri.
The company is led by CEO Danny Prosky, a >30 year industry veteran which aided by M&A has grown the business to its current form, a diversified healthcare player with a reasonable WALT just in excess of 6 years.
Valuation & IPO Thoughts
American Healthcare REIT sold 56 million shares at $12 per share, that is ahead of the over allotment option, with net proceeds used to pay off debt. Pricing took place at the lower end of the preliminary $12-$15 offering range.
These 56 million shares represent a huge part of the business, with the post-IPO share count standing at 122 million shares, granting the REIT an equity value just shy of $1.5 billion.
The results are a bit hard to read as total revenues and grant income has risen from $1.24 billion in 2020 to $1.63 billion in 2022, as a small profit of $8 million reversed into a net loss of $73 million. These revenues are a multiple of the reported rental revenues above, due to the fact that many fees and associated costs run through the REIT as well, creating somewhat of an opaque financial statement. While revenues rose to $1.38 billion in the first nine months of 2023, the company still posted a $44 million GAAP loss for the corresponding period.
The lack of profitability is probably the reason why the equity valuation trails the pro forma shareholder equity position of $1.93 billion, as reported for the third quarter of 2023.
It is of course not uncommon for REITs to post net losses, after accounting for depreciation charges, but even if we focus on other metrics, the performance is lackluster. With pricing taking place on the lower end of the range, shares rose to $13 and change following the public offering. Despite these minimal gains, shares still trade at a discount compared to reported book values.
Concluding Remarks
The bottom line will improve a bit as the pro forma net debt position will fall from about $2.5 billion to $1.9 billion upon the public offering. With net proceeds earmarked to reduce debt, that approximately $600 million debt reduction (and associated interest expense forfeited) will provide a boost to the bottom line, to the tune of around $30 million assuming a 5% cost of debt.
Other than the lack of realistic earnings, there are many other risks; with the company facing stiff competition, it could be hit by Covid effects (in case of a resurgence), the company relying on a number of relatively large operators, lack of geographical diversification between regions, and potential impact of escalation in ground leases.
All these risks and lack of earnings might be offset by the long-term potential, which is clearly there and driven by favorable demographics in this regard, with the population aging, all while near term construction activity has been limited. Another driver is the potential provided by the option to buy out the remaining stake in Trilogy, as an estimated $1.00 per share dividend looks compelling as well, for a yield at 7% and change here.
The reality is that, despite the long term sound fundamentals and diversified healthcare portfolio, the REIT’s continued losses make me a bit cautious, although that a dollar per unit dividend looks quite compelling, with leverage ratios looking manageable.
That said, I look forward to seeing the real impact of the deleveraging and potential to buy out the remaining stake in the properties, which seem to carry an above-average take in income streams. These activities have potential here. For now, this remains a show-me first story, as I look forward to the release of the upcoming quarterly results from here.
