CareTrust REIT, Inc. (CTRE) Earnings Call Transcript & Summary

Thank you, everyone, for joining. We're at the top of the hour. We are now in the CareTrust REIT meeting. My name is Farrell Granath, and I'm co-lead with Jeff Spector for healthcare REITs and the BofA REIT team. I'm joined today by David Sedgwick, who is the CEO and President of CareTrust. And I will pass it over to you, Dave, for opening remarks and if you want to introduce any of your team members who I see are sitting on sides.

Great. Well, hello, everybody. Thanks for your interest. Bill Wagner, our CFO, is right over there; and Derek Bunker, SVP of Strategy and Finance is over there. And my name is Dave. Happy to be with you and CareTrust. So if you're new to the story, I'll just give you 45 seconds on us. We -- the story really started back in 1999 when a little nursing home company got started in California called the Ensign Group. We started leasing properties from REITs and the engine got started and got moving faster and faster. And then next thing you know, we are starting to acquire real estate of our own and went public in 2007. By about '13, '14, we realized that all this real estate that we owned -- we were not getting credit for it by the Street. And we saw a window of opportunity to spin off that real estate and form CareTrust REIT, which is what we did in June of 2014. For some reason, the Street didn't like the fact that we had one tenant. And so we decided to grow that concentration down, which we have over the years. We averaged about $225 million of investment activity per year for the first 9 years or so, adding operators, primarily all triple net skilled nursing, some triple net seniors housing along the way. I became CEO in 2022, although I've been with the company since our days -- early days at the Ensign Group. I'm a recovering nursing home administrator, so I come to this seat in a little bit of a different way than other REIT CEOs. But that kind of makes sense because the skilled nursing asset class is hypersensitive to the quality of the operator, much more so than your traditional real estate metrics. Last year was bananas. That's a technical term for what happened. After going $225 million a year, last year, we did $1.5 billion of acquisitions. And in the midst of that, we were faced with an opportunity to consider an acquisition in the U.K., which would be our first M&A deal, not to mention our first international deal. After some internal debate, we decided to -- even though it didn't broke, why fix it? Because it didn't broke, let's add another engine of growth to the ship from a position of strength, which is what we did. We closed on that in May and internalized that team in July and are working on integrating that company into ours now. We were in London all of last week, and I haven't seen my kids now for too long, so can we wrap this up? Now in the midst of this year, another year of explosive growth, we're on pace to exceed last year. We had an overnight -- a very successful overnight offering that maybe some of you participated in a few weeks ago as we announced a $600 million pipeline of deals that we think we're going to be able to execute on here in short order. And in the midst -- just like last year, in the midst of a very big year, this year, we're also thinking about next year and how we can build now a third engine of growth as we are looking at going into the shop space in earnest. About 18 months ago, we were about a $2.5 billion market cap company. Today, we're around $7.5 billion. And it seems like quite by accident, but it's been a lot of fun.

Thank you for that. And as a reminder, this is an open dialogue. Please jump in if you have any questions while we kick things off. But I think maybe the biggest highlight acquisitions. So I think can we break into a little bit more about why you made that decision to enter into the U.K.? How long did that take you to maybe make that decision in closing? And what has that done now to your portfolio more meeting the asset classes that you're touching?

Yes, a little inside baseball on it. The deal came to us last summer. We had looked at the U.K. a few times over the previous 3 or 4 years, always deal related. And each time we get to know the market a little bit better, get a little bit more comfortable with it. We really did struggle with the decision of whether or not to do it because it didn't broke, and we didn't want to distract from the momentum that was building on our core business. What we liked about it was a lot of the same things that we love about the business here, the seniors and skilled nursing business here are prevalent there. You've got a supply-demand imbalance. You've got the Silver Tsunami wave coming. You've got a mix of private and public funding that we're very familiar with. You have a fragmented market that is ripe for roll-up like here. And you have the ability finally for a very concentrated SNF REIT like us, skilled nursing facility REIT like us to diversify a little bit. And if there's a little bit of an elevation to the floor of our multiple because of that diversification, we'll take that, too. But ultimately, all of those boxes get checked, the biggest box that we really wanted to check was having another engine of growth because, as you all know, real estate is cyclical. And if for whatever reason, things chilled on the skilled nursing front from an external growth perspective, we wanted another avenue to continue that to go. We killed that deal once because of other big opportunities that we were pursuing and then we decided to reengage. And as we were entering into it in earnest, we brought on Derek Bunker because -- and he joined us, he quarterback the deal and now we just can't get rid of him. He just sticks around -- he stays around. And he led that whole deal, and that enabled us to do it while not slowing down elsewhere.

And what potential synergies could you see with this acquisition? And as you've closed it in '25 and now looking into '26 as you're just saying the internalization of the team back in July, what could we expect?

Well, there was about a $10 million G&A at Care REIT, and we think that we can capture about $5 million of savings. That will probably fully get realized going into next year. The internalization of the team has been great. There are some cultural differences for sure. There's some stereotypical differences between the pace of play and risk appetite between the U.K. and the United States, and that's certainly been on display, since we've taken over, but they are traveling up the culture curve pretty quickly. We got them some running shoes to not so subtly say it's time to run. They're custom kicks, coral color. They're very -- they're hot. I'll show you a picture later if you want to see them. And then we also discontinued PowerPoint because they haven't had a lot of access to capital to do much. So they've gotten exceptionally talented with PowerPoint. So we don't use that much. And so just a couple of little anecdotes of how we are getting them on our pace of play. What's fun is, like I said, we were just there last week, and we spent a lot of time looking at the pipe. The pipe in the U.K. is growing exponentially, like there wasn't really anything there when we took over because they -- while they didn't have any capital, they tried to stay relevant, the best they could with PowerPoint. And now there's actual deal flow and excitement crossing their desk and they're pretty fired up. There's a couple of -- in the $600 million pipeline that we announced, about 60-ish percent of that is U.S. skilled nursing, about 20-ish percent is SHOP here in the States. And then the rest is a U.K. deal that we -- surprised that it's already in the [indiscernible] and should close this year. But I'm getting more excited about what that could mean for next year.

[indiscernible].

Yes. A couple of thoughts on that. One decision that we had to make out of the gate was are we going to keep the team in London? Or are we going to do this all on our own and capture $10 million of synergies, right, instead of $5 million. And our thought there was that we'll be better off long term if we keep the team intact. So we've got 2 seasoned investment professionals. We've got a handful of seasoned asset management professionals and a long time of relationships, not just with the existing operators, but with twice as many that are not already operators of ours. What we've seen so far is that there's been a dearth of capital in the U.K. for quite some time, and they are hungry for it, and they're bringing us deals on their own. It's all relative. Our size is still relatively small compared to the big guys. And so if we did $100 million, $200 million, $300 million, $500 million a year of acquisitions there, that will move the needle for us. That will be fantastic. Right now, I think it represents about 16% of our revenue out of the gate. Can we hold on to that? Can we grow it? It depends on what we do with SHOP, depends on what we do here. But I think it's going to be meaningful, especially because we have the team on the ground with relationships that now we're going to throw some gasoline on to really grow that. The other thing is how we compete for deals may be a little bit different in that historically, the lease coverage there has been very, very high and lower yields. But because of the lack of capital, there have been some entrants that have really pushed on yields and -- but the cost is the coverage might be a little bit tighter, right? So there might be a middle ground there for us to really capture quite a bit of interest from operators wanting to have a little bit better coverage with us. And because of our cost of capital advantage, we can still get a nice spread and do some damage.

And I think also when you were just mentioning this potential U.K. deal, back on the earnings call, it didn't seem as much of the U.K. was a part of the conversation. I've seen among peers, U.S. SNFs has been kind of dominating the conversation. I guess from the last time we spoke on your earnings call, have you seen an acceleration in their willingness or ability to have these transactions and deals over in the U.K.?

Yes, for sure. The -- like I said, when we took over, there really wasn't a pipeline at all that we acquired. We really acquired the assets, the relationships and the team. And the momentum is really snowballing right now as operators inside and outside of the portfolio are bringing us relationships and deals off market and some stuff that's hitting the market. And there's deals kind of all sizes percolating out there. So yes, we think there's some meaningful work to do there.

And then I guess if we then shift over to the SHOP opportunity that you had mentioned.

SHOP opportunity?

SHOP opportunity...

Don't get me started with the puns. You guys -- I don't do a lot really well. Metaphors I do. I do puns, SHOP opportunitSHOP opportunity, okay? SHOP operational...

So make sure to get you a shirt, but I'll have it all on there. Yes. So with the Shop opportunities?

You want to say SHOP opportunity, don't you?

With the conversations we've been having, I know that you've been doing things in the back end of potentially building out, there's the thoughts of building out a platform, if transitions were ever a possibility, if not, how is that -- how are those conversations going? Has that also picked up? Or has now this U.K. opportunity maybe be taking more of a forward step in the conversations?

Yes. So we're sort of experiencing a repeat of last year, right? Because last year, we had this crazy year of growth and yet we were -- we wanted to figure out how to add another engine of growth in the midst of that. And now we're doing that same thing again with SHOP. In December of last year, we hired a new SVP of Investments over SHOP. Basically, all he does spends all of his time curating operators and deals for the SHOP vertical. In June, we added -- we hired somebody as an associate for him. So we're definitely investing in that space. Right now, we have 2 deals in our pipeline of $600 million pipeline that are SHOP. And so the shot clock is ticking, if you will, to be ready. And we are investing time and energy into getting ready for that -- those deals to close. We've hired a data engineer at a USC, who's brilliant, making us very efficient and fixing the IT kind of piping and plumbing problem with SHOP because the way you asset manage triple net assets is certainly different than how you do a SHOP asset. And so all of that plumbing is getting worked on right now so that by the time we do close that first and then second deal, we'll be ready. And we can do that without really adding much of G&A at all because it's built to suit. It's small enough. Having said that, the opportunity set in front of us is massive with respect to SHOP is 40,000 properties compared to 15,000 SNFs and 15,000, give or take, care homes in the U.K. So there's a huge opportunity set there from onesie-twosies like we have right now to big portfolios. And the beauty of our situation is we don't have to do it. If we're managing this thing for the next few years, you don't do it, in fact, because there's too much brain damage for just the next few years. But we're really thinking about forever. And if you kind of think about the S-curve of a business, we're certainly on the upswing. I don't know how far that S-curve up we are. But what we're trying to do is adding new S-curves to it. And the U.K. is one and then SHOP is another so that we can maintain this pace of growth as we go from 2.5% to 7.5% to 10.5% to whatever. So we're currently building the infrastructure to suit the pipeline while feeling really opportunistic about a larger deal if one presents. Now if there's a large portfolio that comes with the platform, we would need to rethink how we organize ourselves. But it's -- we have this cost of capital and balance sheet to continue on the gas.

I was hoping you could dive into that a little bit more. My next question about your balance sheet right now sits well below where peers are and has been consistently as well as you just raised overnight, you have a large amount of cash available to you. How do you think about your cost of capital and being able to execute now going forward on these growth objectives?

This hyper low leverage era of ours really started, I don't know, Bill, what would you say, end of '22, early '23, right? That's when the windows of opportunity really started because the interest rates spiked our portfolio -- we had just kind of re-shored up the portfolio coming out of COVID. And because we had done that so quickly, I think we got some credit for that from the Street and said, okay, maybe these guys can start growing again. And we started to see the pipe really take shape as we started executing that other strategy of lending and creating those strategic partnerships. And so we just started working at preparing the balance sheet to take advantage of what could be a 6-month window of opportunity, who really knows. And having that balance sheet as low as it is, we wanted to just have all the optionality that we could to take advantage of whatever crossed our desk and not be restricted by moves in the market because I don't know if you've noticed, but it's a crazy equity market last few years. And so if we could derisk that, we would do that. And this rhythm that took place of quoting a pipe closing and/or issuing equity on the ATM generally to match fund, rents repeat, reload. And because we had some view as to the funnel of deals coming into the pipe, we were over-equitizing that and just got it down to where it's become -- we kind of really love it. We love having that flexibility. And when the U.K. deal then crossed our desk, for example, you give us a $1 billion opportunity in front of us and put it all on the line and still be underneath our 4x net debt to EBITDA -- 4x to 5x net debt to EBITDA, are you kidding? And for a company of our size, that just -- it's a huge advantage that we have.

And I guess also then now turning back over to SNFs and we're thinking about -- I'm now also looking at the U.S. market and how those conversations and potentially if you're still seeing transactions pick up, are you seeing greater competition in those conversations? And are you seeing any differences in cap rates? And if you can put it relative to the U.K. cap rates for SNFs?

Yes. The competition for U.S. SNFs is pretty steady. There's always a bid. And if there's more than 2, there's -- it feels like there's good competition for it. The beauty of our situation today as opposed to 2022 is that we've developed these relationships that have essentially created an off-market pipe of deals where we get first crack at it. And it's not so much competition for it. These are deals that we would have never seen. The market hasn't seen them. These guys tie them up and bring it to us to help them close. And so that's just a really clear advantage that we never enjoyed before the last couple of years. On the stuff that's marketed, yes, there's competition. There always is. And I think we have a cost of capital and relationship and reputation strengths there that help us get our fair share of the marketed stuff as well. You would expect to see skilled nursing acquisitions for us be in the 9s, somewhere in the 9s. Could we go below a 9 to get a big portfolio deal and maybe pay a premium there? We could do that. In the U.K., for the care homes, those are much more like assisted living memory care type facilities than skilled nursing. So keep that in mind when I say that the cap rates there are going to be probably for us in the 8s, maybe into the 9s, if we can, but it's just this push and pull with the yield and the coverage. Back in the day here in the states when triple net seniors housing was a thing, you would see lease coverages in the [ 1.1, 1.2x]. Whereas there, it's always been about 2x on an EBITDARM basis, so maybe 175, 180 on a DAR basis. But because of the market there has been a little bit disrupted because of lack of capital, lack of competition. And so I think we'll probably be somewhere in the 8s, like I said, maybe a 9 if we're lucky. But there's the tax leakage component there where we're losing somewhere around 100 bps, maybe even more on it, which is real. So we've got to factor that in as we decide between different asset classes.

And I guess also on the coverage that you were just mentioning, we've seen your coverage continue to go up. And across your whole portfolio, now it's above 2.5x, about 2.68x for EBITDARM coverage. I'm curious your thoughts, have we reached a new normal? Are we always going to be sitting in a type of coverage where we're above the 2x? Or was this a result of the environment?

It's tough to say. I think the challenge with keeping it perpetually rising is that when -- so just to clarify, when we quote our pipe -- I'm sorry, when we quote our coverage, that's not 100% of the assets we own, right? Because when you're acquiring like we do, we want to give the new acquisitions and the new operator some time to season before we reflect that coverage. If you acquire something at, call it, a 1x coverage kind of aggressive investment, knowing that you believe this is going to go to a 1.75 in the course of the next 18 months. At what point do you start quoting that? Probably not right out of the gate because you don't -- the new operator doesn't even have his own -- his or her own financials to go off of, right? So you do give it some time to season. And by the time you bring it in, you're not going to wait until it goes to 2x to bring it in. You're probably going to bring it in as soon as it's stabilized at a 1.4. So that should naturally kind of -- all the new investments kind of bring it down a little bit. But over time, if it continues to perform it, there's going to be that push-pull between it. So I wouldn't expect it to skyrocket as we layer in the newer investments as they've seasoned. Yes. And then you're going to diversify by asset class or stratify it that way. And if you're talking just about skilled nursing, we're absolutely thrilled with anything north of 1.4, 1.5x. So whether it continues on from here or not remains to be seen. But just on that point, one thing about us that might be a little bit unique is that we happily and consistently as we underwrite, sacrifice a little bit of the yield in exchange for coverage for our operators. We want all of our energy to be on growth and not on recycling capital, which is a euphemism for a failed investment. So if we give up a little bit of yield there, just a tiny bit of accretion on that front out of the gate, then all of our energy can be on just growing the business. And all of our energy can be on growing the business instead and being able to absorb the headlines because if you're going to invest in skilled nursing, you better have a strong stomach. For headlines, for Idaho saying you're going to cut Medicaid by 4%. You're ready for that. If not, don't buy CareTrust or buy CareTrust because you know that our coverage is such that we can absorb these shocks, especially when skilled nursing is a necessary required piece of the infrastructure of health care in the country. So if it is required and you've got the best operators with great coverage and don't hyperventilate when you see a headline, there's a reason why we get the highest cap rates of all asset classes. I'll get off my soapbox.

[indiscernible].

I've personally spent my entire career in skilled nursing and seniors housing. I was -- I'm a recovering nursing home administrator. For the last 25 years, we have seen it all. We've seen times where Republicans are better for skilled nursing and Democrats are better for skilled nursing. We've even seen a pandemic. We've seen economic crisis. We've seen state budgets and disarray. We've seen monumental changes to the way Medicare pays skilled nursing providers. We've seen a year with a 10% cut to the Medicare rate. And yet the best operators year in and year out, cycle after cycle, find a way to adapt and thrive. And so as we look at this, there's a lot of handwringing around the big beautiful bill. And we got countless inquiries from investors and research analysts about, hey, we heard this is where -- what -- this is how they're going to cut Medicaid. And we went down all these rabbit holes with them while telling them, look, we really don't think that all Medicaid beneficiaries and providers are created equally and that there is a sacred cow here, and that is nursing homes with respect to Medicaid. And that proved out to be the case for the big beautiful bill. That doesn't mean that for the next few years, there won't be some changes, changes inevitable with respect to the regulations and reimbursement approaches. But like I said, if skilled nursing hasn't been killed by now, it never will, particularly with the demographic wave that is on its way.

And I'll bring you back to the headline. And I think maybe a few people who know about CareTrust know about -- have heard the tax exposure. So I was wondering if you could add any commentary around that. I know there was a forbearance agreement over OHI that came to the news. There's another operator that was gone after by the DOJ. Where you sit today? How are they performing? And how do you view them as an operator?

So -- man, I could -- I'm not going to, but I could go on for a long time that ...

You say, we have nice time limits...

We continue to receive information from PACs about the facilities that we own, and they're performing very well. So one comment I'll make on the Hindenburg piece that came out against PACs is that it's the first nursing home hit piece in the history of man that didn't have even one sentence about patient care. That was maybe the most shocking thing. The quality of care, the customer service, the quality measures, the star ratings, the fundamental business of caring for people in nursing homes. If that was suspected, that would certainly have been highlighted in that piece. And the fact that they continued and continue to this day to have superior occupancy and skilled mix is a testament to that because every single day in every market that they're in, a vote is cast with every discharge from a hospital about where they want to send their patient to get care. So it seems to us that those fundamentals are still very much in place. There's been several announcements about PACs about their Part B revenue that they are reversing that. If you strip out all of the Part B revenue with PACs from our portfolio, they're still north of 2x coverage. So their CFO, you saw the news yesterday, was let go or resigned. The silver lining, if any, on that news is that maybe that means that, that clears the path for an auditor to sign off on an audit. Pretty difficult, I think, to do that while a CFO is under investigation. So hopefully, they'll be able to give us some news and give you all news around their KPIs and their timing on filing. But from what we can see, they continue to deliver good care, take good care of these facilities, and they're performing very well.

Great. And to wrap it up, we have 3 rapid fire questions. So...

Okay. As you can tell, it's hard for me to be rapid fire.

When the Fed starts to cut, do you expect borrowing rates for long-term debt to decline, stay flat or potentially rise? This is in context of like the 10-year, obviously.

I don't know what do you think?

This is you -- on you.

I don't know.

Okay. No worries. Last year, the majority of companies stated that they are ramping up spending on AI initiatives. How would you characterize your plans over the next year, higher, flat or lower?

Higher.

And do you believe same-store NOI for your sector will be higher, lower or the same next year?

Higher.

Wonderful. Well, thank you so much for joining us.

Thank you.

Thank you.