Sabra (SBRA) Stock: Low Occupancy Threatens 8.9% ‘Sucker Yield’

Thesis

According to the US Census Bureau by 2030 all Baby Boomers will be at least 65 years old. With Baby Boomers being the largest generation in US history, this means that any industry that caters to this demographic could potentially see significant growth over the rest of the decade and beyond. The first industry that comes to mind is without a doubt healthcare and healthcare related facilities such as hospitals, clinics, skilled nursing facilities (SNF) and senior housing.

The broad healthcare sector has been hit hard during the Covid pandemic but has rebounded nicely since. The healthcare index rebound has mostly been fuelled by pharmaceutical companies such as Amgen (AMGN), AbbVie (ABBV) and Johnson & Johnson (JNJ), all of which are near their respective all-time highs. Healthcare REITs however, have not seen such a steep recovery. This is likely due to the fact that they have faced some extreme headwinds, including:

• rising costs and labor shortages
• decreasing occupancy caused by patient reluctancy to be in their facilities (mainly due to Covid)
• difficult macroeconomic environment with rising interest rates
• decreasing federal subsidies that helped these companies out during the pandemic + generally low insurance (Medicaid) reimbursements

Today, I analyse Sabra Health Care REIT (NASDAQ:SBRA) as I believe it might be well positioned going forward. My reasoning is as follows:

• Sabra operates within a sector that could grow significantly.
• President Biden announced recently that the public health emergency will end on May 11, this will allow SBRA to operate more normally going forward.
• Sabra recently managed to sell a sizeable part of their SNF portfolio at a very good price (source). This confirms their focus on moving away from a heavily weighted concentration in SNF and more towards senior housing.
• Based on relative valuation SABRA currently seems undervalued trading at 9.12x FFO compared to its historical average of 10.9x.
• With the Federal Reserve likely close to the end of their hiking cycle, I expect well positioned REITs to outperform going forward.

Let’s analyse Sabra together and see if it makes for a good investment.

Operations

Sabra Health Care is a real estate investment trust or REIT that specializes in owning and managing healthcare facilities. It is dedicated to providing high-quality, patient-centered care to seniors and people with chronic conditions.

SBRA announced the following in their Q3 2022 Investor Presentation:

Sabra will transition the 24-property portfolio previously leased to North American to two of Sabra’s existing tenants, Ensign and Avamere, for a combined initial annual rent of $34.5 million. As a result, Ensign will become one of Sabra’s largest relationships, representing approximately 8% of Annualized Cash NOI, while Avamere will remain one of Sabra’s largest relationships, also accounting for roughly 8% of Annualized Cash NOI.

This transition has made the portfolio quite heavily weighted towards their five biggest tenants (with The Ensign Group and Avamere Family being the largest tenants, with around an 8% share each). This wouldn’t be an issue if these were all A-rated strong entities, but unfortunately that is not the case. Below you can see the tenant’s coverage ratios – while all tenants generate enough to pay SBRA, I would like to see these ratios move closer towards 2.0x in the future to have more confidence, especially given the not so diversified tenant mix.

What I am also not thrilled about is the asset concentration into Skilled Nursing Facilities representing 60% of their portfolio, followed by Senior Housing at only 21.9%. I view senior housing as a superior asset to SNF as it provides a more predictable and stable cashflow. I would therefore like them to decrease their dependance on Skilled Nursing or at least find better balance between the two.

Thankfully SBRA has recently mentioned their focus on building a “balanced portfolio” which should include diversifying further into senior housing. Recently they managed to sell a sizeable part of their SNF portfolio ($185 Million worth) at a very good price of $200,000 per bed – almost double the national average for cost per bed (see chart below). Net proceeds from the sale were used to repay the revolving credit facility and thus reduce debt. I consider this to be great news, but frankly the stock has barely noticed.

Another problem for Sabra which we’ve already touched on is very low occupancy for Skilled Nursing of 72.9%. Senior Housing is doing better at 81.8% but still has lots room to grow. I expect these numbers to increase in 2023, as the public health emergency ends and Covid becomes a thing of the past, but I will be watching them closely in the upcoming earnings releases.

Financials

With Q4 earning expected on February 21, 2023 management has guided towards a full year FFO of $1.48 per share for 2022. Going forward analysts are not expecting much growth. FFO is actually expected to decrease slightly in 2023 as a result of the aforementioned disposal and then come back to today’s levels in 2024.

The company may appeal at first glance to income oriented investors because of its 8.9% dividend yield. But I am not very confident that the company can actually sustain this dividend going forward. Dividends in 2022 totalled $1.20 which represents a high payout ratio of 81% (vs FFO). Moreover, with an expected drop in income in 2023, finances will inevitably get tight for SBRA and management may be forced to cut the dividend later this year.

To get a full picture of what the company will face over the next two years, let’s have a look at the balance sheet.

As of Q3 2022 the company had $2.44 Billion of debt. Since then, the credit facility has been repaid from disposal proceeds so currently debt stands around $2.3 Billion. Sabra indicates in the table below that 73% of this is fixed, but a further look reveals that all of debt is actually fixed. This is because $436 Million of the Term loans are subject to interest rate swaps and collars that effectively fix LIBOR at 1.14% and the rest of Terms loans is effectively fixed by swaps at 1.1%. This brings the overall effective interest rate to 3.86% which is very good with fed funds rate now at 4.5%.

Sabra also highlights in their presentation that they have no debt maturities until Q3 2024 (note that the credit line in grey below has already been repaid). In Q3 2024 they will face $527 Million of debt due, which they will try to refinance. This is great and is actually a strong argument for them to do well over the next year to two because they won’t be burdened by debt repayment.

Valuation

As far as valuation, Sabra’s price currently trades at 9.08x FFO, compared to the long-term historical average of 10.92x FFO. This represents a potential upside potential of 20% if/when things normalize. This is decent and if it materialised, investors would an earn an annual return of 9.1% on top of the dividend (which now stands at 8.9%) over the next three years. Personally, I don’t think the dividend is sustainable though and the 9% annual return doesn’t justify the risk for me.

NAV paints a similar picture. SBRA keep its properties on the books for $5 Billion, with debt of $2.3 Billion, NAV stands at $2.7 Billion. At $13.50 per share the stock has a market cap of $3.1 Billion and therefore actually trades above net asset value. And sure, the asset value reported might be conservative, but I am not willing to overpay for an asset that has some pretty substantial risks, especially not when there are opportunities on the market today, that have similar risk characteristics, but trade at discounts to NAV as high as 50-60%. If you’re interested in such opportunities, check out my previous articles on Vonovia (OTCPK:VONOY) and Brandywine (BDN).

Summary and takeaway

In summary, Sabra operates in an industry that has faced severe headwinds lately, but over the long term could face tailwinds as Baby Boomers age. The company desperately needs to increase its occupancy. As is, I don’t think the 8.9% dividend yield is sustainable (payout ratio of 80%+ and likely to worsen in 2023) and we could see a dividend cut later in 2023 as the company tries to preserve liquidity.

Although the balance sheet is in a good shape, with 100% of fixed interest and no debt maturities until Q3 2024, I think the company will struggle to really take-off from here until some of the issues are resolved. I rate SBRA stock as a HOLD here and would only consider buying it if the company can prove its business model over the next year or so and manages to increase occupancy or if the stock price falls much lower thus reflecting some of the risks described in this article. Until then, I will stay on the sidelines and watch.