Real estate was one of the worst-performing sectors of 2017, and healthcare REIT HCP (NYSE: HCP) was no exception. While the S&P 500 is up by more than 19% for the year, HCP is down by 8.7%. Even when you factor in dividends, shareholders are still in the red for 2017.
Continue Reading Below
Despite the dismal stock performance, 2017 was a rather strong year for HCP. Here's a rundown of what happened with HCP in 2017, and why the stock is down despite a solid year.
Why is HCP stock down in 2017?
As I mentioned in the introduction, the real estate sector, as a whole, has been quite a laggard in 2017. Rising interest rates have been the main culprit, putting downward pressure on REIT prices.
There are also some negative factors specific to the healthcare sector, such as oversupply fears in the senior housing industry, which is HCP's largest property type. And the company's strategic deleveraging of its balance sheet has depressed the company's earnings power a bit more than investors had been expecting.
To be clear, HCP's business is doing just fine. Its senior-housing properties are performing well, and adjusting its balance sheet to an appropriate level of risk is a good reason to expect lower earnings. In fact, there are several good reasons for shareholders to be happy with the company's performance this year.
Continue Reading Below
HCP is less dependent on its largest tenant
As part of its transformation plan that began with the spinoff of its skilled nursing assets into QCP, HCP also decided to reduce its exposure to its largest tenant, Brookdale Senior Living. The company has set in motion a series of transactions designed to shed some of its Brookdale-run properties. In the near term, Brookdale is buying six properties from HCP and is acquiring HCP's interest in certain joint ventures. Throughout 2018, HCP has been granted the right to terminate its management agreements on 68 Brookdale-occupied properties.
Not only will these transactions reduce the share of HCP's net operating income that comes from Brookdale from 27% today to less than 16% -- the Brookdale concentration has been as high as 35% -- but it will result in $500 million in initial proceeds and another $600 million-$900 million throughout 2018, which can be used to invest in other assets, or to bolster the company's balance sheet.
The balance sheet has improved
Speaking of the balance sheet, HCP's financial condition has improved tremendously since 2016. Thanks to the QCP spinoff and other strategic asset sales, the company now has no significant debt maturities until 2019. HCP has repaid $3.7 billion of debt since the spinoff and has a far more attractive leverage ratio than it used to.
In addition, because the spinoff of QCP left the company with higher asset quality, HCP can borrow more cheaply. Since the spinoff was announced, HCP's debt spread -- the interest premium it pays to borrow -- has fallen by roughly 100 basis points.
In fact, S&P recently raised HCP's credit rating to BBB with a "positive outlook," an important step toward HCP's goal of regaining its former BBB+ rating.
A private-pay-dominated portfolio
Generally speaking, healthcare properties that derive their income from private-pay revenue sources have more predictable and stable income streams than those dependent on government-reimbursement programs like Medicare and Medicaid. Since the QCP spinoff was completed, HCP's private-pay revenue mix has gone from 78% to 96%, when announced transactions are considered. This should further help produce a stable, predictable revenue stream going forward.
Growth and development progress
Most of the attention focused on HCP in 2017 had to do with reductions -- the spin-off of QCP, the Brookdale asset sales, and so on. However, the company has begun to pursue attractive growth and development opportunities recently.
For example, HCP has agreed to acquire a $228 million life-science research campus in Boston, a high-growth market. And the company has $870 million in committed ground-up developments, mostly life-science properties.
Furthermore, the company's land holdings create a "shadow pipeline" of over $1 billion. In other words, HCP is starting to get serious about growth again in its core property types.
What to expect in 2018
2017 (and the latter half of 2016) was a transformational year for HCP. And while the company pursued some growth opportunities in 2017, the focus should shift more toward growth in 2018. As I've written before, there are some amazing long-term opportunities in healthcare real estate, and now that HCP is a well-capitalized, focused healthcare REIT, it can pursue the most attractive opportunities as they arise.
10 stocks we like better than HCP
When investing geniuses David and Tom Gardner have a stock tip, it can pay to listen. After all, the newsletter they have run for over a decade, Motley Fool Stock Advisor, has tripled the market.*
David and Tom just revealed what they believe are the 10 best stocks for investors to buy right now... and HCP wasn't one of them! That's right -- they think these 10 stocks are even better buys.
Click here to learn about these picks!
*Stock Advisor returns as of December 4, 2017