Sabra Health Care REIT, Inc. Q2 FY2023 Earnings Call

Good day, everyone. My name is Mandeep, and I will be your conference operator today. I would like to welcome everyone to the Sabra Second Quarter 2023 Earnings Call. All lines have been muted to avoid background noise. After the speakers' remarks, there will be a question-and-answer session. I now turn the call over to Lukas Hartwich, Senior Vice President of Finance. Please proceed, Mr. Hartwich.

Thank you, and good morning. Before we begin, I want to remind you that we will be making forward-looking statements in our comments and in response to your questions concerning our expectations regarding our future financial position and results of operations, including our expectations regarding our tenants and operators and our expectations regarding our acquisition, disposition, and investment plans. These forward-looking statements are based on management's current expectations and are subject to risks and uncertainties that could cause actual results to differ materially, including the risks listed in our Form 10-K for the year ended December 31, 2022, as well as in our earnings press release included as Exhibit 99.1 to the Form 8-K we furnished to the SEC yesterday. We undertake no obligation to update our forward-looking statements to reflect subsequent events or circumstances, and you should not assume later in the quarter that the comments we make today are still valid. In addition, references will be made during this call to non-GAAP financial results. Investors are encouraged to review these non-GAAP financial measures as well as the explanation and reconciliation of these measures to the comparable GAAP results included on the financials page of the Investors section of our website at sabrahealth.com. Our Form 10-Q earnings release and supplement can also be accessed in the Investors section of our website. And with that, let me turn the call over to Rick Matros, CEO, President, and Chair of Sabra Health Care REIT.

Thanks, Lukas, and good day, everyone. We start off with reimbursement. As everybody knows, the final Medicare market basket was 4%, up from 3.7% in the proposed rule. Importantly, though, this is the second and last year of the parity adjustment. Without the parity adjustment, the increase would have been 6.4%, indicating that the formula is capturing increased operating costs, which bodes well for next year's market basket. On the Medicaid side of the business, we're seeing increases well above historical averages. You may recall that for probably 10 years or more before the pandemic, Medicaid in the aggregate was averaging about a 0.5% increase a year. We're anticipating now that, in the aggregate, increases for this year will be over 5%. We've gotten a number of the rates already in place, and some more are on the way. So, over 5% we think is a good number, and I'd also remind everybody because of the lag time in the cost report process, as we look forward to next year's rates, we expect them to be even stronger. So some really nice tailwinds on the reimbursement side there. Moving on to operations, our coverages continue to improve broadly, with occupancies increasing in our skilled and in our assisted living portfolios. Labor is slowly getting better, all leading to margin improvement in our primary asset classes. None of this is happening quickly, but it is happening. As much as the coverage improved and what we reported, our trailing three EBITDARM coverage for skilled has improved three quarters in a row and now is at 1.68 excluding PRF, so actually quite a bit higher than even with a trailing 12 shows. On occupancy, occupancy continues to move up beyond the quarter and that along with the declining labor expenses have contributed to that coverage. We have significant upside with the transition of what were the 11 wholly-owned and live-in assisted living and memory care buildings to Inspirit. The transition happened more quickly than we anticipated. It was very cooperative. It went really well, with no frictional costs and that portfolio has underperformed the space for reasons that I think everybody is aware of. And I would remind everybody that prior to the pandemic, that portfolio was in the mid-90s from an occupancy perspective. So at 76% or so occupancy today, there's really pretty dramatic upside there. Given the size of our managed portfolio, it will have a disproportionate impact as we look at earnings going forward. While we do not provide guidance given the specificity, we're looking for relative to timing on the recovery of the managed portfolio on facility transitions, we now have enough visibility to provide a bridge back to earnings growth that we provided in the supplemental and in the investor deck that we released yesterday. Although there is no timeframe associated with that, it is a reasonable timeframe and serves as a blueprint that will help us as we get closer to 2024 and put out 2024 guidance. Our current acquisition pipeline has lightened as we've said, given our current cost of capital. We wouldn't expect to do much at this time. But that earnings upside demonstrates that there is an opportunity for us to get very active again as we move into 2024. That said, all the factors I've cited that are strengthening the portfolio and providing earnings growth as we look forward to 2024, we do believe just to emphasize the point that it will result in the cost of our equity improving.

Thank you, Rick. I will first address the results of our managed senior housing portfolio and then provide a brief update on our behavioral health investments. Our wholly-owned managed senior housing portfolio continues to recover with cash net operating income and margin, as well as REVPOR, trending up over the past five quarters. The headline numbers for the wholly-owned managed portfolio on a same-store basis, excluding non-stabilized assets and government stimulus, are as follows: Occupancy for the second quarter of 2023 was 79.9%, a 50 basis point decrease over the second quarter of 2022. Quarterly occupancy in our assisted living portfolio continues to increase, improving 120 basis points over the prior quarter and 250 basis points over the second quarter of 2022. REVPOR in the second quarter of 2023 increased by 7% over the second quarter of 2022 driven by continued rate increases achieved in our larger portfolios, which have targeted 10% for anniversary increases. Strong rate growth persists among all of Sabra operators, although realized increases were 5% to 7% in the quarter, rather than the 9% to 10% we saw in the prior quarter. Excluding government stimulus funds, cash net operating income for the quarter was slightly off of the prior quarter but 20.4% higher than in the second quarter of 2022 driven by continued margin recovery, particularly in our wholly-owned Enlivant portfolio, which benefited from strong operating leverage. That portfolio was transitioned to Inspirit Senior Living shortly after the start of the third quarter. Excluding three communities that were impacted by specific events such as leadership turnover and renovation, Sabra's same-store holiday communities posted year-over-year cash NOI growth of 17% in the second quarter of 2023, following 22% year-over-year cash NOI growth in the prior quarter. Excluding those three properties, Sabra's wholly-owned managed portfolio would have achieved nearly 31% year-over-year NOI growth this past quarter. Our net-leased stabilized senior housing portfolio has seen a full recovery to pre-pandemic occupancy and improving EBITDARM coverage. Occupancy growth has outpaced our managed portfolio, largely because the net-leased portfolio is mostly assisted living and memory care communities. In addition, we have transitioned a few lesser-performing leased-out communities to the managed portfolio, which allows us to participate in their financial recovery. Beginning this past June, the holiday portfolio has had two consecutive months of positive net occupancy growth, with July being exceptionally strong and momentum carrying over into August. Sabra has implemented a renovation program across the holiday portfolio in line with what other owners are doing, while only two projects have been completed so far. We expect that these improvements, once completed, will support accelerated occupancy growth, continued strong leasing results, and ongoing positive leasing spreads that should boost operating results across the holiday portfolio. Comparing the second quarter of 2023 to the second quarter of 2022, excluding government stimulus, our U.S. communities have outperformed our Canadian assets on cash NOI and margin REVPOR and expense growth. Although our Canadian communities have had significant growth in revenue and occupancy, the factors impacting expense growth, in particular labor, have lagged their recovery trends in the U.S., but are now moving in the right direction. We continue to invest in our behavioral health portfolio primarily through the conversion of existing owned properties. This is a granular process and takes time. At the end of the second quarter, Sabra's investment in behavioral health included 17 properties and two mortgages with a total investment of just over $800 million. And with that, I will turn the call over to Michael Costa, Sabra's Chief Financial Officer.

Thanks, Talya. For the second quarter of 2023, we recognized normalized FFO per share of $0.33 and normalized AFFO per share of $0.34. These results are consistent with the expected normalized FFO and normalized AFFO run rate of between $0.33 and $0.34 per share that we have shared over the last several quarters. Also, as of June 30, 2023, our annualized cash NOI was $458.5 million, and our SNF exposure represented 55.7% of our annualized cash NOI, down 100 basis points from the first quarter and down 500 basis points from a year ago. Our portfolio is the most diversified it's ever been, with our SNF concentration reaching its lowest point in our history. Additionally, our SNF concentration will decrease further as we realize the embedded upside opportunities in our portfolio. In both our supplement and in our investor presentation that we released yesterday, we have included a table that illustrates the upside opportunity in our portfolio from the recovery in our managed senior housing portfolio, as well as the stabilization of our previously disclosed property transitions and behavioral conversions. Once realized, this increased NOI will not only provide meaningful further future earnings growth but also naturally diversify our portfolio further and de-lever our balance sheet. During a time where accretive external growth is challenging due to our elevated cost of capital, proactive management of our existing portfolio has been and will continue to be the best source of earnings growth. Now, turning to the balance sheet. Our net debt to adjusted EBITDA ratio was 5.61x as of June 30, 2023. As we have noted in the last several quarters, there had been some notable decreases in our earnings run rates, namely the burning off of the Genesis excess rents, the transitioning of the portfolio formerly operated by North American to Ensign and Avamere, and the impact of transitioning facilities to new operators and new operating models. These items have created a drag on near-term earnings and likewise increased our net debt to adjusted EBITDA ratio. Accordingly, the increases we have seen in this ratio over the last few quarters were expected as a result of these factors, and we expect leverage to continue increasing slightly over the next several quarters as the full impact of these changes make their way into our trailing 12 months EBITDA. Importantly, however, this leverage impact is short-term in nature, and the upside opportunities I discussed earlier will have a positive impact on our leverage, up to a half turn of improvement in leverage once realized. We remain committed to a long-term average leverage target of 5x, and because of the embedded upsides in our portfolio, together with the proceeds from any potential future disposition activity, we are confident that we can achieve that target over time without needing to access the capital markets. As of June 30, 2023, we are in compliance with all of our debt covenants and have ample liquidity of over $926 million, consisting of unrestricted cash and cash equivalents of $27 million and available borrowings of $899 million under our revolving credit facilities. We have no material near-term debt maturities. Our next material debt maturity is in the second half of 2026, and our weighted average debt maturity is currently at six years. Excluding our revolving credit facility, which makes up just 4.1% of our total debt, we have no floating rate debt exposure, and our cost of permanent debt is 3.94% as of June 30, 2023. Finally, on August 7, 2023, our Board of Directors declared a quarterly cash dividend of $0.30 per share of common stock. The dividend will be paid on August 31, 2023, to common stockholders of record as of the close of business on August 17, 2023. The dividend represents a payout of 88% of our normalized AFFO per share. And with that, we'll open the lines for Q&A.

Your first question comes from the line of Juan Sanabria from BMO Capital Markets. Your line is open.

Hi, good morning. I was hoping you could talk a little bit about the SHOP portfolio and what you're seeing on AL versus IL, expectations for what cash flow should do now that with these transitions going on in Enlivant. Should we expect further degradation from Enlivant with the transition or is this the next step up rather than going down?

Yes, Enlivant, as I said in my opening remarks, we don't expect any downside there at all. The transitions happened. It's been a month, and everything is going really well there. We expect only upside, Juan; it's just a matter of how quickly it gets there. But that's why I put out the pre-pandemic occupancy as a benchmark in terms of what we're looking forward to over time.

Could you just comment on the relative performance of AL versus IL in that same-store pool?

Sure. So, it's Talya. We've talked about how in the past, for every quarter for quite a while, how they've performed differently. IL didn't go down as far and hasn't come up; hasn't bounced back as quickly. It's just the amplitude of the change has been different. I'd say, on the bulk, a lot of our IL in Canada has performed also sort of similar dampened amplitude in terms of how it went down in occupancy and therefore the rebound. That's driven by the whole aspect of being needs-based. I think the other piece of the equation really goes to some of the opportunities for renovation to the extent that we haven't been able to get in and renovate holiday assets during the pandemic. We're in catch-up mode as are all together, I think, landlords and owners at this time, and that's a meaningful factor because those assets are not five years old. They are older, and there is an opportunity there to really improve them.

And the only other thing I'd add, Juan, just to remind everybody, IL is a very different operating model. It's optional, even though there has been some acuity creep, it's not needs-based. It doesn't have the same labor needs or issues that have affected the other asset classes through the pandemic. It started out pre-pandemic; the margins at holiday in our portfolio were 40% or better. It started out with much higher margins to begin with. I really think that business, I know it's hard for folks, and we have a lot of things to pay attention to, but I really think that business is different enough that it really needs to be assessed kind of on its own and not always compared to AL.

And just going forward, should we expect further transitions or do you think at this point and what you know now, we're kind of through that part of the equation either on the SHOP or the triple-net side, I guess, for that matter?

It was pretty close through. I mean, other than the occasional ordinary course of business that probably no one would even notice.

Great, thank you. First off, are there any known additional offsets to the $42 million of NOI upside that you highlighted this quarter and what are the remaining capital requirements to achieve that $42 million?

Yes, so in terms of offset, nothing notable comes to mind on that. Those are just going to naturally occur over a period of time as those facilities stabilize as the senior housing managed portfolio continues to recover as it has been, so nothing notable offsetting that to point out. In terms of additional capital, the capital for those specific items on the conversion side, as we've talked on the past, there is capital that would need to be invested in those, but it's really small dollars in the grand scheme of things, far smaller than buying something in the market to renovate a wing or to put some dollars into a property. So again, nothing material that we foresee in terms of capital needs that would be needed to realize that.

And then just absent any significant improvement in the senior housing sector, I understand you are not providing guidance, but is $0.33 to $0.34 still considered an appropriate quarterly run rate? Additionally, could a portion of the $42 million potentially represent incremental upside from this point?

Yeah. I mean the $0.33 to $0.34 run rate is still a good run rate to use, I would say, for the next quarter, and then we'll have to reassess it at that point once we see how performance is shaping up. In terms of the timing of getting to that upside, it's going to depend on when you believe the senior housing space is going to return to pre-pandemic performance, that's really the largest driver of that number. We don't think it's three years away necessarily, but we don't think it's going to be by the end of this year either.

That's fair. I have one last question. You mentioned that you did approximately $20 million in dispositions. I believe you indicated $50 million through year-end. Is that still the accurate figure? Is some of that amount focused on the less core assets leased to Signature? That's all from me.

That's not related to Signature. And in terms of what we expect to dispose of, yes, we have some more that we're looking at. Again, it's not going to be of the size of what we completed earlier this year or anything like that. There's always going to be some sales in the normal course of business. But in terms of our larger dollar disposition activity, most of that is behind us.

Thank you for taking the questions. To clarify your comments about the long-term goal of $42 million, some of your competitors have outlined similar pathways. Given the targets for occupancy and margins, could you provide some insights? I know you mentioned the 90% occupancy upside, but specifically regarding reaching the $42 million, what are the expected SHOP occupancy levels and margins?

Yes, we've noted that in the table provided. What we've highlighted is the current occupancy and margin, and our assumption is that the upside merely returns to pre-COVID levels, which were around 87% occupancy and a 33% margin. We are not projecting anything beyond that at this stage. However, considering the demographics, we believe there is an opportunity to surpass those figures over time. For now, we're focused on modeling a return to those pre-COVID levels without aiming higher.

And just to clarify your comment about not one year and not three years. So let's just say two years. Is that assuming the current occupancy gain you've seen this year just continues? It would seem like that, but I just want to clarify if that's what you're assuming in terms of getting back to the pre-COVID metrics.

Yes, I think that's a fair assumption, Vikram.

Hey, good morning. Rick, or Talya, could you provide some color on Enlivant transition to Inspirit? It sounds like it was down faster than expected. I think you also transitioned the 2.0 senior housing assets to the same operator and I think both are in SHOP now. How did the conversation come about and why did you pick that particular operator? And could you also talk about any meaningful changes to the management contract there?

Sure. So we have known the CEO of Inspirit since we bought those two leased assets because he was basically head of that company that operated those. He ended up going out on his own. When the existing tenant decided they wanted to exit the business, and actually put their other assets up for sale, we decided to transition as well. Since we knew Dave and we knew his knowledge base of those assets and ran them for years, it made complete sense. The Enlivant assets, we looked at several operators. We focused on Inspirit because this fit incredibly well with our geography, and we had a very good sense of their level of focus and ability to execute within that geography. So we went with them, and that's how that came to be. It's kind of fortuitous they happened sequentially in that way. In terms of the management agreement, the terms are not materially different than what we have in place, or slightly different from what we have with Enlivant but not anything material.

Yes, I was talking about Medicare and Medicaid. That's why I gave the example this year's rate market basket for Medicare. Last year's was suppressed because of the parity adjustment from a couple of years ago. So that goes away next year, and that was actually a pretty big hit. It's the difference between a 4% market basket this year and a 6.4% market basket next year. Medicare is a little bit more current on capturing inflation than a lot of the State Medicaid systems. So we would anticipate next year's rate being quite strong as well, both because it will be capturing inflation and the fact that we won't have a parity adjustment. On Medicaid, there's just always a lag in the cost reports systems and by the time we get to next year's rates, it will fully capture, in most every state, 2022 which was the highest point of inflation that we've had. Obviously, it's come down since 2022. One of the reasons that the rates are so strong for this year is there are a number of states that decided to sort of override the formula because it wasn't reflecting more current inflation and so some of those states received better rates. We saw that in Ohio, Washington, Oregon, and Kentucky. We saw that in a number of places. I think one of the takeaways from what happened during COVID is a newfound awareness on the part of a lot of states that Medicaid has been underfunded. That’s why we anticipate rates being even stronger next year than they are this year. It's formulaic.

I think I mentioned that our results this quarter are slightly lower than before, particularly regarding the Enlivant portfolio. We are anticipating that the increases in October will take place, though I don't yet know what the specific rate increase will be. I expect it to be around 5% or higher. This remains on the elevated side due to the current inflationary environment, although it may not reach the 10% increases we observed a few months back. We will keep you updated.

Great, thanks. Just on the sales this quarter, could you quantify maybe a cap rate perspective or valuation kind of where assets are trading in the market these days?

Yes, in terms of those sales, the cap rate on those and I guess defining cap rate, I mean if we look at the yield comparing the rent that we were getting on those assets comparing that to the proceeds you receive, it's in that high single-digit range that we've been talking about the last several quarters; it's pretty consistent with that.

Great. Sorry. And then just kind of thoughts about the minimum staffing requirement. I'm curious if any conversations you've had with industry participants. I think it's no secret how this might end up shaking out. But any thoughts you have on minimum staffing and expectations for the back half of the year?

Yes. So pretty much the same as you've heard from our peers during this earnings season, and that is the implementation has been delayed again. A couple of things: One, the fact that this keeps getting delayed we view as a positive because CMS is really listening to all the concerns the industry has and the need to give the industry time to recover more. Just the plain fact that if required, everyone is required. But if people don’t exist, they don’t exist to be hired. I think that this is going to be phased in over some period of time, and the phase-in won't start for quite some time, so that's about as much as I think I know at this point. So certainly nothing that would reflect the concerns we had when this first came up.

Thank you for the question. I’d like to follow up on the earlier discussion regarding the independent living performance. You noted that there has been a slower recovery in independent living for some time, and it appears this is the first quarter where several REITs and operators in the industry are reporting unexpected softness in this area. From your perspective, should investors assume this suggests increased price sensitivity among independent living residents, since it’s less needs-based as you mentioned, or are there other factors that might be contributing to the overall softness in independent living, especially in the second quarter?

Yes, I don't think that there's anything specific. I think we've got certain things in our portfolio some renovations that had been delayed because of the pandemic that are happening now that has impacted occupancy, but that's all going to bode well for the future. Our holiday portfolio is a little bit different than some of the others because it's about one-third of the assets in it are assets that Holiday had acquired and are not sort of the blueprint holiday assets. There are some different markets. We actually feel good about the portfolio, but the fact that it isn't need-based, we think certainly has had the biggest impact. Pricing is pretty reasonable for the most part; it's nothing like AL pricing with all the various levels of care and all that. So I just think people want to stay home.

Thanks, Talya. I have a follow-up question on new transaction market commentary. On the SNF side, what yields do you think you could sell and buy out today if a substantial volume of properties traded hands?

We would be interested in making purchases at yields of 9.5% or higher. If yields are at 9% or below, we would consider selling. Other REITs have mentioned a preference for buying at yields above 9%, which aligns with the opportunities we are looking at. We want to ensure that any actions we take are beneficial. Additionally, buyers acquiring from us often purchase real estate along with operations, which differs from our situation. They might be looking at yields around 12% or even lower, whereas for us, that could translate to yields in the 5% to 8% range for real estate alone.

Yes. And the only other thing I'd add is pre-pandemic we saw a much higher cap rate on skilled when it was really high-quality stuff or larger portfolios where there was sort of a premium that went along with larger portfolio. Our thinking is that really it's nine handle, as Talya said, or higher; it's hard to rationalize at this point where the industry is, and there are still improvements to be had to start doing acquisitions with an eight handle on skilled space.

Hi. Thanks for the time on the follow-up. Just a couple of questions. I guess just on SHOP in general, are you seeing any creator price competition, whether it's because of distress or other factors across any of the businesses, AL, IL, either discounting or rent concessions and such?

I haven't heard any operator talk about that actually.

Thank you. With that, let me turn the call to Talya.

Thanks, everybody, for your time today. We appreciate it. As always, we're available for any follow-up. Look forward to talking to you and look forward to seeing you at some of the conferences after Labor Day. Take care.

This concludes today's conference call. You may now disconnect.