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After the recent spin-off of its least-stable assets, healthcare REIT HCP, Inc. (NYSE: HCP) reduced the amount of its quarterly dividend payment for the first time in over 25 years. Normally, an uncharacteristic dividend reduction like this would be a cause for alarm, but this is a unique case. Here's why shareholders should be happy with HCP's lower dividend, and why the payment is likely to increase again in 2017.
A dividend reduction... but not really
HCP slashed its quarterly dividend payment from $0.575 to $0.37, a 36% reduction. However, if you haven't been following the company too closely, you may not be aware that HCP recently spun off a portion of its assets into a newly created REIT known as Quality Care Properties (NYSE: QCP), or QCP.
Think of this as a similar situation to a stock split. If a company that pays a $2 annual dividend per share splits two-for-one, the per-share dividend can be expected to be cut to $1 per share. It wouldn't really be a dividend reduction -- there are simply twice as many shares that are now paying a dividend.
In HCP's spin-off, the same logic applies. The collection of properties that generated HCP's income is now represented by all of HCP's shares and all of QCP's shares. There are more shares representing the same income-generating properties, so a dividend reduction makes perfect sense.
Furthermore, while we don't know QCP's dividend policy yet, I'd be surprised if the combined dividend that shareholders end up receiving from both companies isn't comparable to HCP's pre-spinoff dividend.
A good move for consistent dividend growth
The purpose of creating QCP was to remove the skilled nursing and assisted living properties from HCP's portfolio, in order to create a stable collection of senior housing, life science, and medical office properties.
There were a few reasons for wanting to do this, but a major factor is that the vast majority of HCP's remaining properties are dependent on private-pay revenue sources, as opposed to being reliant on government reimbursement programs such as Medicare. Generally speaking, private-pay healthcare assets are more stable and predictable.
The idea is that the spin-off will increase the overall quality of HCP's assets, and the "sale" of the spun-off properties to QCP will improve the company's financial flexibility. HCP's stated goal is to regain its investment-grade credit rating, which would lead to lower borrowing costs and higher profit margins.
Stability and higher margins are a great combination for future dividend growth, so although shareholders aren't receiving quite as much income as they were before, this move should be applauded.
As far as dividend growth goes, along with its third-quarter earnings, HCP announced 2017 adjusted FFO guidance in a range of $1.89-$1.95 per share. The current quarterly dividend translates to $1.48 per year, which leaves plenty of cushion to boost the payment next year.
The bottom line
Despite the appearance, HCP's recent dividend cut wasn't really a cut at all. Rather, this is a similar situation to a stock split -- some of the income stayed with HCP, while some went with QCP. Regardless of the dollar amount of post-spinoff HCP's dividend, the important thing for shareholders to take note of is that HCP now has a portfolio full of stable, high-quality properties that should allow the company to raise its dividend in 2017 and consistently increase the payment in subsequent years.
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Matthew Frankel owns shares of HCP and Quality Care Properties, Inc. The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.