When the Yield Is Just Icing On The Cake

by Investing Daily
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Submitted by Investing Daily as part of our contributors program.

What could be better than a 5% yield not tied to a particular pace of economic development, particular price of a commodity or level of dovishness from the Federal Reserve?

How about a 5% yield that’s been an afterthought over the last year after capital gains of 50-80% ? Throw in a strong secular tailwind, and no wonder the securities in question refused to budge during this week’s correction.

No other holdings in the family portfolios I manage combine such attractive fundamentals with anything approaching the same technical strength. Take my Citigroup (NYSE: C) and my Michael Kors (NasdaqGS: KORS), please. Leave me the Sabra Healthcare (NasdaqGS: SBRA) and Medical Properties Trust (NYSE: MPW).

As the names suggest, both are real-estate investment trusts (REITs) catering to the health care industry. Sabra, a two-year-old spinoff from the former Sun Healthcare nursing-home operator, leases out skilled nursing and retirement facilities, while MPW finances hospitals of every stripe.

Those are the early 21-st century growth industries given the aging of the Baby Boomers, and both companies’ ballooning balance sheets and rising distributions are proof of that.

Sabra and MPW are essentially specialized health-care lenders, and they’ve profited from the banks’ stinginess with credit, even as their own funding costs have dropped in the increasingly yield-starved capital markets.

While both momentum investing stocks have staged impressive rallies, they’ve done so from levels deeply depressed by existential concerns that proved unfounded.

At the time of its split-off in late 2010, Sabra was the real-estate arm of a struggling and deeply indebted nursing care provider facing steep Medicare cuts.

But the 11 percent cut ultimately enforced proved more bracing than catastrophic and, freed from Sun’s orbit, Sabra has in fact capitalized on the nursing-home industry’s cash cravings. The company’s funds from operations (FFO) per share, the common measure of REIT performance, are forecast to rise to at least $1.85 a share in 2013, an increase of 41 percent in just two years.

MPW was in the bargain bin as recently as June ahead of the Supreme Court decision on the Affordable Healthcare Act, a topic of understandable interest to hospitals in line for millions of additional paying customers under the legislation. Once the Supreme Court upheld the law, MPW’s share price healed rapidly, hurt not at all by last year’s 27 percent increase in normalized FFO to 90 cents per share.

Near-term prospects look bright as more Republican governors sign up for the Medicaid expansion pushed by Obamacare. The extra patients should give hospitals additional incentives to invest it the newest and most expensive equipment, and MPW stands ready to provide the cash in exchange for triple-net-leased property. (Triple-net leases make all taxes and maintenance costs the responsibility of the tenant.)

The growing acceptance of the Medicaid expansion suggests that broader access to health care remains a populist issue; so does the popularity of the Obamacare provisions mandating coverage for patients with prior conditions and for young adult students (by their parents’ insurers.)

Of course, MPW would be hurt badly if access to hospital care were drastically curtailed, just as Sabra would wither and die if, in our collective wisdom, we opt to throw grandma from a train instead of bankrolling skilled nursing facilities.

But in the far more likely prospect of growth fueled by inescapable demographics (the government expects spending on nursing-home care to increase by 6 percent annually through 2019), Sabra and MPW are poised to continue to do well, and to gain extra leverage with their clients should budget-cutting pinch providers’ cash flow.

A more liley danger lurks in the potential for a medium-term rise in funding costs. But both companies have the bulk of their borrowing costs fixed for years to come, while future acquisitions will presumably price in the additional interest-rate risk.

To this point, neither company has had trouble finding deals immediately accretive to the bottom line, and neither is expected to hit that wall this year. Neither stock is expensive on a cash flow basis relative to other REITs, which compete for investor dollars with low-yielding bonds as much as stocks.

Over the last two decades REITS have handily outperformed every category of stock and debt, returning 13 percent a year, on average versus 12 percent for the Nasdaq Composite, 10 percent for the S&P 500 and 7 percent for an index of government and corporate debt, according to the National Association of Real Estate Investment Trusts (NAREIT). Health care trusts as a whole delivered a 20 percent return last year, trailing even headier gains in the industrial and retail REIT sectors, according to NAREIT.

One day, this party will come to an end as yields spike; in fact the only year in which REITS have meaningfully underperformed stocks in the last decade was 2007, at the peak of the last interest-rate cycle. But there’s very little evidence that the next such point will be reached in a year or two. And that means Sabra and MPW have plenty of room to keep growing.

This article by Igor Greenwald originally appeared on Investing Daily.

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