Diversified health care REIT HCP (HCP) released its first-quarter earnings this morning, and the results were broadly good.
Adjusted funds from operations (“FFO”) came in at 79 cents per share, beating the consensus estimate by a penny. (Adjusted FFO is a non-GAAP measure of earnings often used for REITs that strips out depreciation and gains or losses from property sales.)
Adjusted FFO per share increased by 5% year-over-year, and HCP expects adjusted FFO per share of between $3.09 and $3.15 for the full year 2015, in line with analyst estimates. Same-property net operating income was up 3.5% year-over-year. Overall, it was a solid if characteristically boring quarter for HCP.
Still, HCP stock dropped this morning after the opening bell and is down nearly 3% at time of writing.
What gives?
HCP Stock Down, But Not Out
We should remember that HCP is a sleepy healthcare REIT, not a high-flying tech stock. HCP stock is never going to see wild price moves centered around an earnings release dates. Its business model is too conservative and predictable for that. As with most other high-yield REITs, HCP stock is primarily driven by interest rate expectations. And on that front, the news has not been particularly good.
The 10-year Treasury yield has been rocketing higher since mid-April and is now sitting just below the highs for the year set in early March. As of this writing, the 10-year Treasury note yielded 2.12%. It has traded as low as 1.6% this year. As bond yields have risen, REIT stock prices have taken a beating. HCP stock is down about 19% from its 52-week highs, and much of the rest of the sector is down by a comparable amount.
Higher yields hit REITs in two ways. First, operationally, they raise borrowing costs and cut into profitability. But secondly — and more importantly — they affect the pricing of the REITs themselves by raising the discount rate. Basically, why would you accept business risk and equity volatility that come with REIT dividends if you could get a competitive payout from safe, guaranteed bonds?
So, with that in mind, let’s take a look at HCP’s dividend. At current prices, HCP yields a very attractive 5.7%. I would consider that an attractive yield even in a world of 3%-4% Treasury yields.
I should be clear that I do not expect bond yields to drift that high any time soon; I expect the 10-year yield to bounce around in a range of about 2% to 3% over the next five years. But even if I am wrong and yields go higher, HCP would be competitive as an income payer. And current income is only part of the equation. Unlike bond coupon payments, REIT dividends actually grow over time.
HCP’s dividend growth has been somewhat modest, growing at a 4% annual clip over the past 10 years. But it has been unflinchingly consistent. HCP has raised its dividend for 30 consecutive years.
Between the current dividend yield of 5.6% and a dividend growth rate of 4%, investors in HCP can expect something in the ballpark of 9%-10% annual returns going forward. That’s not amazing … but it certainly isn’t bad in this market.
So, is HCP a buy?
In my view, the entire REIT sector is attractive right now, and HCP is no exception. If you’re assembling a diversified income portfolio to see you through retirement, HCP is a solid candidate to include.
Charles Lewis Sizemore, CFA, is the chief investment officer of investment firm Sizemore Capital Management. As of this writing, he did not hold a position in any of the aforementioned securities. Click here to receive his FREE weekly e-letter covering top market insights, trends, and the best stocks and ETFs to profit from today’s best global value plays.
