Sabra Health Care REIT, Inc. Q2 FY2024 Earnings Call

Good day, everyone. My name is Christina, and I will be your conference operator today. At this time, I would like to welcome everyone to the Sabra Second Quarter 2024 Earnings Call. All lines have been muted to minimize background noise. After the speakers' remarks, there will be a question-and-answer session. I will now turn the call over to Lukas Hartwich, SVP of Finance. Please go ahead, 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 earnings guidance for 2024 and 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, 2023, 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 that 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. Good day, everybody. Thanks for joining us. We appreciate it. As noted in our press release, the quarter demonstrated progress in all key areas. Guidance was increased. Our shop cash NOI growth was 17.7%. Our senior housing and skilled nursing occupancy increased, our EBITDAR rent coverage increased for both senior housing leased assets and our skilled nursing portfolio. Our skilled nursing portfolio continues to surpass pre-pandemic levels. In fact, coverage is higher than we hit our occupancy high in 2019, which was approximately 200 basis points higher than it is today, all of which bodes really well for the future. Nine of our top 10 operators had improved rent coverage, with McGuire being the only one that didn't, but came in at a strong 1.79 EBITDARM coverage with no concerning trends. Leverage ticked down. We announced approximately $136 million in new investments. Medicaid rate increases on a weighted basis are estimated to be roughly 7%, which is 200 basis points higher than last year's increases. 71% of Sabra's states have new effective Medicaid rates on July 1 of every year. The other six states are spread throughout different months of the year. The Medicaid rate increase for our top 5 SNF tenants was actually 10.6%. Additionally, Medicare has finalized its market basket increase of 4.2%. Our skilled nursing mix was up 110 basis points. Our labor costs, including contract labor for that asset class, are now at their lowest level since March of 2021. Agency is now down 50% from a year ago. Our skilled nursing EBITDA margins are now higher than pre-pandemic margins. We fully expect to see margins and coverage continue to improve. One comment I want to make on our behavioral segment. Our rent coverage was down, but if you look at the last five quarters, it's always up and down in the behavioral segment. You have to think about it a little differently than skilled nursing and senior housing, which are predictable businesses. The behavioral business is dynamic, much shorter length of stay, but has a breakeven point at much lower occupancy. And the coverage was still quite strong at 3.69. So there's a lot of breathing room there. We have no concerns about that, and you should expect it to move up and down a little bit more than you would in our skilled nursing or senior housing asset classes. In terms of our investment pipeline, we're starting to finally see some skilled nursing opportunities in the pipeline, and expect to increase over the coming months. We're also seeing an uptick in the behavioral space. At this point of the year, we continue to execute on the course we set before the year began and create a much stronger base from which to grow in 2025. And with that, I'll turn the call over to Talya.

Thank you, Rick. Sabra's 82 property managed senior housing portfolio, including joint ventures at share, had a very strong quarter. On a sequential quarter basis, the managed portfolio in total, including non-stabilized communities, had 9.3% quarterly cash NOI growth and a 1.7% in cash NOI margin increase, and that's sequential. This is a product of flattening expenses and continued occupancy and RevPOR gains. Sabra's same-store managed senior housing portfolio, including joint ventures, has 70 properties, 46 of which are in the US and 24 in Canada. Excluding non-stabilized assets, the headline numbers are same-store revenue for the quarter grew 6.8% year-over-year, with our Canadian communities growing revenue by 9.6%. Cash NOI for the quarter grew 17.7% year-over-year and 9.9% sequentially. In our Canadian communities, cash NOI for the quarter increased 23.9% over the second quarter of 2023 and 20.1% sequentially. REVPOR in the second quarter of 2024 increased by 3.1% year-over-year, while ex-Par decreased by 70 basis points, a function of stabilizing expenses and growing occupancy in both the US and Canada. Canada's senior housing recovery has accelerated with occupancy exceeding 91% this past quarter and cash NOI margin at nearly 32%. While occupancy has been strong for several quarters, expense control has moved into focus as the path to gaining margin and growing cash NOI. Domestically, the story is similar but the opportunity to reap the benefits of operating leverage is even greater given the potential of occupancy growth. As Rick mentioned, our not leased stabilized senior housing portfolio continues to thrive with consistently rising rent coverage, reflecting the underlying operational recovery. Sabra's total investment in behavioral health remains relatively static this quarter, we've begun to see more interest in this asset class, as Rick mentioned. Investors and operators are increasingly interested in the segment, and brokers have committed focus and our accelerating activity. And with that, I will turn the call over to Michael Costa, Sabra's Chief Financial Officer.

Thanks Talya. For the second quarter of 2024, we recognized normalized FFO per share of $0.35 and normalized AFFO per share of $0.36, both up $0.01 from our first quarter results. The sequential increase was driven by higher cash rents collected of $4.5 million, primarily related to first-quarter cash basis rents collected in the second quarter and $1.8 million of improved NOI from our managed senior housing portfolio. This was partially offset by a $2 million increase in cash G&A due to true-up of performance-based compensation expense estimates and a $900,000 increase in cash interest expense due to higher outstanding borrowings under our revolving credit facility during the period. Additionally, last quarter, we recognized $900,000 of nonrecurring business interruption insurance income. While there were various moving parts in our numbers this quarter, many of which are nonrecurring, what shines through is that the earnings growth we have experienced over the last two quarters was driven by the continued improvement in our managed senior housing performance, which translates to 6% year-over-year growth in both normalized FFO and normalized AFFO per share. Because of this improvement, the continued stability in our triple-net portfolio, our outlook for the remainder of the year has improved, resulting in an increase to our 2024 normalized FFO and normalized AFFO per share guidance. Our updated full year 2024 guidance ranges on a diluted per share basis are as follows: net income $0.52 to $0.55, FFO $1.33 to $1.36, and normalized FFO $1.36 to $1.39, adjusted FFO of $1.39 to $1.42, and normalized adjusted FFO of $1.41 to $1.44. I would like to highlight a few data points that are embedded in our updated guidance. First, our triple-net cash NOI run rate for the second half of the year is approximately $90 million per quarter, which is consistent with the actual results of the first half of 2024. Secondly, our recurring cash G&A run rate for the second half of the year is $10.4 million per quarter, which is also consistent with the actual results for the first half of 2024. Excluded from recurring cash G&A is stock compensation expense, which we expect to be approximately $2.5 million per quarter in the second half of 2024. Lastly, our guidance assumes year-over-year same-store cash NOI growth for our managed portfolio to be in the mid to high teens. Our guidance incorporates all announced investment and disposition activity as well as the announced activity under the at-the-market equity offering program and does not assume additional investment, disposition, or capital transactions beyond those already disclosed. Briefly turning to the balance sheet, our net debt to adjusted EBITDA ratio was 5.45 times as of June 30th, 2024, a decrease of 0.10 from March 31st, 2024. As of June 30th, 2024, we are in compliance with all our debt covenants and have ample liquidity of $906 million consisting of unrestricted cash and cash equivalents of $36 million and available borrowings of $870 million under our revolving credit facility. With the recent improvements in the cost of our equity capital, we utilized our ATM during and subsequent to the quarter to source capital to fund our announced investing activity. Year-to-date, we utilized the forward future under our ATM program to allow for the sale of up to 4.7 million shares at an initial weighted average price of $14.72 per share net of commissions and currently have 2 million shares with an initial weighted average price of $15.11 per share net of commissions that are available to use to match fund our investment activity. Finally, on August 7, 2024, Sabra's Board of Directors declared a quarterly cash dividend of $0.30 per share of common stock. The dividend will be paid on August 30, 2024, to common stockholders of record as of the close of business on August 19, 2024. The dividend is adequately covered and represents the payout of 83% of our second quarter normalized AFFO per share. And with that, we'll open up the lines for Q&A.

Thank you. Your first question comes from the line of Nick Yulico from Scotiabank. Your line is open.

Hi. Thanks for the question. This is Elmer Chang on with Nick. We appreciate more exclusivity communicating your seniors housing, managed same-store NOI growth expectations. You mentioned in your remarks that operating leverage seems to be improving. But is there any more color you can provide around the occupancy ramp expectations you have for the segment in the second half of this year and how that might impact expense growth at operators?

I can tell you that we're continuing to see some consistent growth in both AL and IL across the portfolio. In fact, together, they are currently around the same occupancy. I know our holiday portfolio hit 83% at the end of July, and that puts them 200 basis points below where they were at the end of 2019 right before the pandemic when we were all worried about increasing supply and what we were going to do with all that supply. So I think the momentum is there. We're seeing similar momentum on occupancy in Canada, where I think our Canadian portfolio is about 90% occupancy, ahead of the number I gave you for the second quarter, and we're seeing it also in our leased portfolio where just under three-quarters of our operators in our lease portfolio are 85% or higher occupancy. So it's really looking good. It just seems to be growing. The additional supply that I alluded to, which is substantial, that came on the market going into the pandemic and throughout it, is being absorbed, and that's in excess of a 10% increase in supply in senior housing in total. So it's a big number, and yet these occupancy numbers are going up.

Thank you for the information. Regarding the managed segment, could you provide any high-level figures on the investment pipeline and its implications for transaction activity? You mentioned that there is increased activity across all segments. In terms of pricing, does the 8% initial cash yield reflect the current deals you are encountering?

Okay. I'll take the second question first. In the market today, cap rates are going to start at a seven. If you're looking at active adult, it's going to be lower than that. My guess is it's in the sixes, but we are not pursuing active adults. So seven, 7.5 on senior housing going to eight. The assets that we've been able to acquire for an 8% yield initially or 8% cap rate going in are relatively new, about five years old or younger. They're modern and well leased up and in good locations. I think that's where the market is because that's where the debt markets are, frankly. The competition that used to outprice us drove pricing down based on debt and availability of debt. In terms of our pipeline, we are seeing a significant amount of deal flow. I would tell you right now, there's probably $0.75 billion of deals under review. That does not mean we're committed to them or have LOIs out on them. It just means that's what we're looking at. A small portion of that will proceed to LOI submitted, and we are being very selective of where we're placing our capital because our intent is to make those investments in a way that really enhances and improves Sabra's portfolio.

The only other comment I'd make on the SHOP cap rates is that those are going in yields, and the business is still recovering from the pandemic. So we're looking forward to really nice growth in all those investments that we've announced.

Got it. Okay. Thank you.

Next question comes from the line of Austin Wurschmidt from KeyBanc Capital Markets. Your line is open.

Great. Thank you. I think you alluded to the SHOP segment kind of instability and triple net overall driving the guidance increase. But just curious if SHOP was the sole driver of the guidance increase, or did any of the investment activity have a positive impact on this year's outlook as well?

Yes. I would say the investment impact is probably pretty muted for this year, given that most of it is in the second half of the year. So you're not going to see a lot of uplift in our 2024 full year numbers as a result of that. You'd expect to see more of that impact going into 2025 and beyond. Yes, I would say the performance in our core portfolio, our same-store portfolio, combined with the stability in our triple-net portfolio is really what's driving our optimism for the back half of the year.

Got it. And then you guys were previously a little reluctant to provide the same-store NOI growth guidance for the senior housing managed assets. You discussed this mid-teens growth. I guess, what's giving you the confidence to incorporate that into your assumptions more formally? And how should we think about that mid- to high teens growth versus whatever was in the initial outlook?

I'll take the first shot at it. I think that more time has passed as we've recovered from the pandemic. It's really as simple as that. This is a business that, as I mentioned in my opening, pre-pandemic was an extremely predictable business. That predictability, as we all know, disappeared, but it's starting to come back now. It's really just a function of time giving us more confidence.

So should we expect going forward that you'll be willing to give out the outlook on an annual basis for the SHOP portfolio, given things have stabilized a bit?

To the extent the portfolio has stabilized when we put out our next guidance for 2025 or anywhere beyond that, if the portfolio stabilizes, it becomes a lot easier to predict that. We could consider it.

I'm going to add one more thing to the response. Operating leverage in our Senior Housing managed portfolio is particularly relevant, and that's why it's a little tough for us to give you a great, very detailed, and specific answer because we're at the cusp of hitting operating leverage in many of the assets in the SHOP portfolio. In some, we've already passed it, which is why you're seeing the incredibly strong numbers in the Canadian portfolio that I outlined. In the US, we're on the cusp of that as well. That will be the driver of the significant EBITDA contribution from incremental occupancy growth.

That's helpful. Just last one, kind of along the similar lines for the operating leverage. These assets that you're seeing at 8% cap rates on the senior housing managed side, are those assets similarly where the in-place portfolio is from an occupancy and margin perspective? Or do you see outsized opportunity? Just trying to understand where they are in the life cycle of recovery to where you're stepping in. Thank you.

They're in line. Some of them are doing somewhat better than others, but there is, as Rick mentioned before, a significant growth opportunity there as well over the next couple of years. So we're not underwriting to an 8% stabilized, we're underwriting to an 8% going in with upside.

The other thing I'd point out is that the investments we announced post-quarter with Leo Brownies are one of our strongest operators. We've been doing business with them for years, both from a development and an operating perspective. To enter into these new investments with an operator that is familiar to us and has had success bodes well for the growth going forward as well.

Great. Thanks, everybody.

And your next question comes from the line of Juan Sanabria from BMO Capital Markets. Your line is open.

Hi. This is Robin Adlan sitting in for Juan. Just curious what would make you more inclined to pursue portfolio acquisitions?

At this point, we're just not seeing quality portfolios out there. We're not willing to take on anything that's going to create a lot of work or noise. We've made a commitment to our shareholders that we are going to be predictable and disciplined and rigorous in everything that we do. We prefer small, digestible deals and do as many as possible rather than take on a portfolio that tends to require a lot of work.

Okay. And on Medicaid, what's the expectation for increases next year now with inflation coming down significantly? I guess asked differently, is there any catch-up left in inflation?

I think we may have hit a high point this year. I think next year, we'll still be capturing inflation, and we will still have outsized Medicaid rates next year. But certainly, over the next few years, assuming inflation moderates, those rates will moderate as well. We still have some outsized rates ahead of us.

And just the last one on the pipeline. How should we think about funding investment growth? And what can we expect from a debt-to-equity split?

As I mentioned in prepared remarks, given the strength we've been seeing in our cost of equity capital, that is a viable source of funding where we could go out, use the ATM, use our revolver to match fund investments on a leverage-neutral basis and still make accretive investments to Sabra no matter how you define accretion, whether that's from earnings or NAV. It's a limited source of capital, but it is one we plan to use to combine with other sources. As long as we have the cost of capital to find investments we like, there isn't a cap on it.

Got it. Thank you.

Your next question comes from the line of Joshua Dennerlein from Bank of America. Your line is open.

Hey, guys. Thanks for the time. I wanted to go back. I think in the opening remarks, there was a comment on the behavioral space EBITDAR coverage or EBITDARM coverage at 1.79. Could you confirm what that is today? And then what was it prior quarter?

I said 3.79. It's actually 3.69. If you look at the last five quarters, it does move around some. As I stated, it's not as predictable a business because you have a much shorter length of stay with residents in these facilities than in senior housing or skilled nursing. You have a breakeven point on occupancy at about 50% to 60%. It's a much different economic model, and we are accustomed to it. We conduct deep dives to ensure there aren't any concerning trends, and we are not seeing that. The lumpiness is more normal than in our other business lines.

Okay. And that 3.79, that's stripping out the specialty hospitals and others?

No, it's included in there. It's what we disclose in our supplement.

Okay. Is there a big variability between those three categories?

Yes. Specialty hospitals have much higher coverage, but we underwrite the additional treatment investments at two times or more. We underwrite them at a much higher level than we do with skilled nursing or senior housing. There will always be some leeway there, particularly given occupancy breakeven points.

Okay. Interesting. Thank you.

I'm happy to spend more time with you offline, if you'd like.

Thank you. And your next question comes from the line of Michael Griffin from Citigroup. Your line is open.

Yes. Thanks. I want to go back to acquisition opportunities. Could you give a sense of what the accretion spread is between your acquisitions and your weighted average cost of capital? Are lenders open for lending again on both seniors and skilled nursing?

Yes, there are loans available. The agencies are somewhat open. It still is a challenge to get people to refinance existing debt. The single biggest challenge with debt service coverage is that loan-to-value and cap rates moving up mean that values today are not what they were five years ago. No one is going to buy at a 6% cap rate when their borrowing rates are 6.5% to 7.5%. There's not a lot of equity pickup and positive leverage from the debt.

Yes. In terms of accretion based on the funding sources disclosed in our filings with the ATM, which we did that at a lower price than we're trading at today, the sales proceeds... These investments that we've announced are over 100 basis points accretive. I expect that spread to be better as we are able to use the ATM at more attractive prices.

As businesses continue to improve post-pandemic.

That sounds good, guys. Really appreciate the color there. Lastly, I'd just be curious to get your thoughts on the skilled mix increasing. Is this a deliberate action taken by our operators, or are there other factors impacting this? Would you expect it to continue to increase in the future?

We still haven't hit our high on skilled mix. I would expect it to increase. Seasonality may affect it a little bit. Operators can be more selective in who they admit as occupancy continues to improve. When occupancy is low, everyone wants to get their beds filled, so you may see a bigger increase in Medicaid census than Medicare. The operators in our portfolio focus on the high acuity model, positioning them well for the future, particularly when you think about value-based reimbursement.

The skilled mix statistic we provided is based on revenue. For this quarter, you have six months' worth of the Medicare increase that went into effect last October, benefiting that statistic as well.

Great. That’s it for me. Thanks for the time.

Thank you.

Your next question comes from the line of Vikram Malhotra from Mizuho Securities. Your line is open.

Good afternoon. Thanks for taking the question. I just wanted to clarify the 100 basis point spread you mentioned. Would that imply your cost of capital is 7%? How do you determine cost of capital? Can you give us some context for that 100 bps compared to what you've achieved historically on deals?

The over 100 basis point number is based on looking at the AFFO expectation baked in consensus, and we look at our guidance with the various moving pieces incorporated including our investment's impact. We do it on a leverage-neutral basis versus market expectations for our earnings. Historically, we executed on transactions at a similar point in time with that same spread.

Got it. And just maybe a high-level question for you or for Rick. Now that we're clearly past COVID and starting to grow again, how might the AFFO growth trajectory differ from history over the next 1 to 5 years? In the past, we've talked about a 5% AFFO growth trajectory over multiple years. Does anything change that allowing for higher or lower over time?

Once our managed portfolio fully stabilizes and becomes more predictable in terms of growth prospects, that AFFO per share growth absent additional investments is estimated to be around 5%. However, we are always looking for opportunities to increase that figure. So, while it's a reasonable assumption, it's not set in stone.

Remember, we're at a different inflection point with these property classes. There's no new supply, occupancy will exceed pre-pandemic levels, and margins should exceed pre-pandemic levels. We've already seen that on the skilled nursing side. In addition to skilled nursing investments, we're continuing to invest in SHOP. That component of our portfolio will significantly impact our earnings growth moving forward.

Great. Thank you.

And your next question comes from the line of John Pawlowski from Wells Fargo. Your line is open.

Hi. Thank you. Could you give us the cap rate on the purchase option for the loan you made this quarter? Of the $750 million you mentioned under review, what percentage of those are under the loan-to-own structure? I know recently, there hasn't been much strategy, but I'm curious if those deals are starting to look more attractive.

The only purchase option we currently have is the one we closed that you referenced. We are not in the business of making these loans. That was an off-market situation with an operator we've had great success with. The cap rate is hard to say because it will be upwards of 9%, based on the lease structure we anticipate having.

To reiterate, we understand why some peers are putting so much capital to work on loans, but we are in a different place. All our investments are focused on contributing to earnings growth. Loans at this point for us are essentially short-term money with no growth potential, presenting risk without benefits.

Got it. And then regarding G&A, I think originally in Q4, you guided cash G&A to be near $37 million for the year based on the stock compensation numbers you provided. It seems to imply a $40 million number for cash G&A this year. What's causing the acceleration?

This quarter, we had a true-up of performance-based compensation expense, resulting from our improved expectations. The increased guidance is why cash G&A has risen. It will blend out to around $90 million per quarter in the back half of the year, consistent with first-half results.

Got it. Thank you.

Thank you. And finally, on the minimum staffing, with the Chevron ruling, is this essentially over with? Can we say that officially almost?

You'll recall that I said this was over.

So I guess that's the answer to that. Lastly, regarding investing in SHOP, do you need more people if you get meaningfully larger on that side? Or do you have enough scale to execute on SHOP without needing to hire more?

We're in pretty good shape from an infrastructure perspective, allowing us to scale up nicely. Any necessary additions would be incremental since our basic infrastructure, people, and systems are already in place.

Okay. Thanks very much.

Thank you all for your time again. We appreciate the support. As always, we're available for offline conversations. Have a great day. Thanks.

Thank you. This does conclude today's conference call. You may now disconnect. Have a great day.