HCP Earnings Call Insights: Lease-Up Progress and Robust Deal Pipeline

HCP Inc (NYSE:HCP) recently reported its fourth quarter earnings and discussed the following topics in its earnings conference call.

Lease-Up Progress

Jeff Theiler – Green Street Advisors: Just a couple of quick ones. Given the update on the Sunwest portfolio in terms of how their lease-up is progressing, how much of their CapEx program they’ve gone through since you last gave us update I guess back in October?

James F. (‘Jay’) Flaherty III – Chairman and CEO: Well, when we last gave the update, we hadn’t closed the transaction yet, Jeff. We’ve now closed 129 of the 133. We still have four properties that we’re weighing to come in once we clear some consents. So, it’s early days yet, but based on two months of actual data EBITDAR is up relative to both where it was at the time of closing, but more importantly up relative to our underwriting which obviously is accretive to the coverage ratio.

Jeff Theiler – Green Street Advisors: And any update on the lease-up in particular? Are they getting those properties leased up at the rate that you expected?

Paul F. Gallagher – EVP and CIO: They are up just a little bit over where we have underwritten. So, their performance has a schedule.

Jeff Theiler – Green Street Advisors: And then, just moving to HCR ManorCare, continued drop in coverage as we expected as the cuts worked through the system. Just wondering what your thoughts were on the facility level coverage as we look out a year? I mean HCR ManorCare has spent a tremendous amount of capital on these facilities. The coverage has been overwhelmed by the Medicare impact. But as you look out over the next year, how do you see those rebounding?

James F. (‘Jay’) Flaherty III – Chairman and CEO: Well, let me make a couple of comments here. First of all, looking backwards, HCR has come through a very challenging 18 months. You’ve had the triple-whammy, if you will, of the RUGs-IV cuts changes to therapy reimbursement which made it difficult for HCR to affect some of the cost reductions that they otherwise would have hoped to achieve. And then you’ve got the (GLPL) litigation environment which resulted in the reassessment by third-party actuaries of the Company’s potential liabilities for services provided in the prior six years. So, that’s kind of the context of the environment they have been operating in. We really like to look forward and Jeff you’ll recall that about 18 months ago on our November 11 call when we were reporting the June 30, ’11 coverage results I’d indicated that notwithstanding the fact that you would see the next couple of quarters reported by HCP, HCR coverage continue to go up. In fact, that was going to be a delayed reaction to the August 2011 CMS cuts where that in fact has occurred and now we are at the next inflection point which is you are now going to see these coverages rebound. So, I’ll take you through the fourth quarter results which were quite strong for HCR. Admissions, 90% of which come from hospital discharges and that’s very significant for another reason which we’ll discuss in a minute were up 3.2% in Q4 2012 versus Q4 2011. In 2012, HCR had best year ever for patient quality and outcomes and the Q4 census for each of HCR’s three lines of business skilled nursing, assisted-living recall that 20% of our investment is in the assisted-living – specifically, the (dementia) memory care sector. Then the third line of business home, health and hospice were all quite strong. The Company finished the year with $120 million of cash on hand that’s projected to be $145 million of cash on hand at the end of 2013 that we’ve got $100 million of availability on the line of credit, and in 2012 after the rent to HCP after interest expense and after CapEx, they were positive cash flow to the tune of $50 million, so you’re starting to see the lift that we had anticipated on the prior call. I think in fact on the prior call, I’d indicated that I expected Q3 2012 results to be at trough quarter, where you two look at solely just the fourth quarter results for HCR, so not the trailing 12 months ending 12/31/12 which Paul just cited, but specifically the fourth quarter on a normalized basis, you would see that fixed charge coverage ratio as having increased versus the third quarter fixed charge coverage, so again as we had indicated. Bringing that back to the overall headline, Jeff, we would expect in 2013 that fix charge coverage ratio to be in excess of what the 1.29 that was achieved in 2012. So, that’s a little bit about how we look at a portion of our HCR investment.

Jeff Theiler – Green Street Advisors: Just any sense of the magnitude of how much it would be in excess of that? Just trying to gauge whether we’re looking at 0.1 turns or 0.2 turns there, just that?

James F. (‘Jay’) Flaherty III – Chairman and CEO: I think we’ve got perfect information for the first quarter of fiscal 2013 which is the fourth quarter of calendar 2012. I think we’re going to want to see another quarter or two before we get definitive on that, but not surprisingly the trends directionally are going the way we anticipated them. Perhaps much more importantly, because we’ve also got our OpCo Investment that we watch and I want to bring you back to the comment about 90% of the admissions rates here come out of hospitals. With what’s going on in health care reform, at least as it relates to health care reform being taking place in the marketplace, you’ve got some very, very positive developments here. You’ve got increasing acceptance on the part of both the hospitals and the payors towards risk sharing, reimbursement and when you’ve got a company like HCR that’s got a fully built out model with market concentrations, you take those cluster markets and they are the beneficiary right now of several CMS sponsored pilot concepts which are teaming and partnering HCR with large managed care companies to create new reimbursement paradigms that are risk-sharing in nature. You’ll start to hear more, later this year, but perhaps probably more importantly 2014, you will start to hear concepts like site neutral, reimbursement and bundling and all these become your wind at the back of the HCR platform that generates best outcomes for the lowest cost.

Robust Deal Pipeline

Robert Mains – Stifel Nicolaus: Discussion of HCR ManorCare, one question, it’s just a number. Tim, I didn’t – I want to make sure I got it right. The total accrual for the prior period reserve adjustments?

Paul F. Gallagher – EVP and CIO: For the prior 12 months?

Robert Mains – Stifel Nicolaus: Yeah.

Paul F. Gallagher – EVP and CIO: $95 million.

James F. (‘Jay’) Flaherty III – Chairman and CEO: For the prior 12 months ending.

Paul F. Gallagher – EVP and CIO: That’s for the prior 12 months ending December 31.

James F. (‘Jay’) Flaherty III – Chairman and CEO: In Paul’s remarks, consistent with Paul’s remarks.

Robert Mains – Stifel Nicolaus: And maybe 59 was in the fourth quarter. Do you have that 12…

James F. (‘Jay’) Flaherty III – Chairman and CEO: 69.

Robert Mains – Stifel Nicolaus: 69, okay. Then do you have the 12 for the period ending 9/30?

James F. (‘Jay’) Flaherty III – Chairman and CEO: It was in the $38 million.

Robert Mains – Stifel Nicolaus: Jay, you spoke about feeling positive about the pipeline when you look out at what’s available if we have kind of seen continue to see cap rate compression or the assets you have been looking at sort of in the range of, I’ll stop the question there?

James F. (‘Jay’) Flaherty III – Chairman and CEO: What’s the question?

Robert Mains – Stifel Nicolaus: Question is what do you see, when you look at your pipeline are valuations stabilizing continuing to go up, what how would you kind of characterize things overall?

James F. (‘Jay’) Flaherty III – Chairman and CEO: I stand by my comments the deal pipeline is quite robust. Good news for HCP it cuts from left to right through our 5 by 5 mile and from up to down to our 5 by 5 model so we’ve got number of opportunities that we are currently either diligence or in dialog on I would say the following. I would say relative to a couple of years ago. There are more opportunities presenting themselves and more in the case in the sense of A, absolute dollar value more in the sense of B, just absolute number of transactions and interestingly enough C, more in the sense of different types of transactions. So that – again, I think that augers well given, we’ve got our (five-by-five) model that cuts across a number of different property types and ways that HCP can in fact deploy our shareholders’ capital.

Robert Mains – Stifel Nicolaus: Then just focusing in a little bit on life science, it seem that you’re doing some new construction. Are you seeing a pickup in demand there?

James F. (‘Jay’) Flaherty III – Chairman and CEO: I would say, we’re seeing – we’re very good leasing results witnessed our all-time high occupancy at 12/31, which obviously is expected to going forward 12 months be at an higher occupancy by the end of ’13. I would say, the demand is not intensity or fever pitch demand that we saw kind of back in ’06 and ’07. I think a lot of these corporations are being a little more measured in terms of A, how much space they want and B, where they want that space. So, I would say it’s muted. It’s positive but it’s muted, would be the way I would describe it.

Robert Mains – Stifel Nicolaus: Your development in Cambridge, would you kind of view that as planting a flag on the East Coast from which you can expand or is it kind of more opportunistic?

James F. (‘Jay’) Flaherty III – Chairman and CEO: Well, it’s clearly opportunistic, and I guess you could say it’s playing a flag, but I’d (hesitant) to make the point that it’s a quite a small flag. The total building is how may square feet?

Paul F. Gallagher – EVP and CIO: It’s 70,000 or so.

James F. (‘Jay’) Flaherty III – Chairman and CEO: Yeah, so, we’ll see. We are pleased with – that opportunity was very opportunity. But in the context of a platform or a flag or a stake in the ground, I think people ought to understand the overall size of it.

Timothy M. Schoen – EVP and CFO: Yeah, it’s more of the lateral, it’s more an opportunistic opportunity.

A Closer Look: HCP Earnings Cheat Sheet>>