Potential Impacts from Coronavirus on Occupancy Rates Puts Ventas' Dividend at Higher Risk

Ventas (VTR) has paid uninterrupted dividends for twenty years, including during the 2007-2009 financial crisis, a time which tested the financial strength of most businesses and forced one-third of dividend-paying S&P 500 companies to cut their payouts.

However, Ventas is now facing an unprecedented and unforeseen risk: that the REIT's already weak-performing senior living portfolio, which accounted for 53% of net operating income in 2019, may be impacted by the emerging coronavirus and the virus' ramifications on the senior housing market.

In recognition of this new risk, we are downgrading Ventas' Dividend Safety Score from Safe to Borderline Safe.

The challenge facing the senior housing industry is two-fold. First, residents are often more vulnerable to illness due to age and underlying medical conditions. No one knows yet quite how severe the coronavirus is or how widely it will spread, but there's a chance that the virus takes a toll on occupancy rates.

Regardless, what's more certain is that many elderly will likely defer their decision of whether to move into senior housing for at least the next several months, if not the next year or two. In fact, California's governor called yesterday on all senior citizens to isolate themselves, and it wouldn't be surprising to see other states follow suit soon.

The timing is especially poor for operators of senior housing. Oversupply in the industry has eroded profits, and Ventas reported that the rent coverage (i.e. ratio of cash flow to rent expense) of its senior housing operators is just 1.1x.

In other words, operators are already barely able to cover their rent payments with cash flow, so any hit to revenue or added expenses to protect residents may require operators to renegotiate their leases with Ventas or defer rent payments.

Furthermore, Ventas operates many of its own senior living properties, exposing the REIT to the ups and downs of the industry more than if the firm solely collected rent from outside operators. 31% of Ventas' net operating income is from self-operated senior living properties.

That said, 43% of Ventas' net operating income is generated by properties other than senior housing, including medical offices, hospitals, research centers, and long-term acute care facilities, none of which appear likely be negatively impacted by the spread of coronavirus and the public's response.

Nevertheless, analysts were already projecting that Ventas' payout ratio would hover around 100% before news of the coronavirus broke. Now, it would be unsurprising if Ventas' payout ratio were to meaningfully exceed 100% this year.

Management's response to any fall in cash flow will depend on the magnitude of the decline. Unfortunately, given the lack of precedent to this situation, it's difficult to know how much of Ventas' cash flow could be at risk.

Let's say, however, that Ventas' cash flow from its senior living portfolio drops 50%, a potentially extreme but conservative estimate of what might happen as a result of rent defaults, deferrals, and/or renegotiations. (About 13% of Ventas' profits are already generated by senior living operators with rent coverage ratios below 1.0x.)

If this were to happen, Ventas' overall cash flow would in turn fall 25% (senior living makes up roughly half of Ventas' total cash flow). Since Ventas' payout ratio would exceed 100%, the REIT would likely need to take on additional debt to maintain the dividend, and the question would then become how much borrowing capacity Ventas has and how temporary management views the situation.

Ventas' leverage (as measured by the firm's net debt to capital ratio) sits at 53% right now and has never risen above 55% over the last decade. If management were comfortable bringing leverage up to 55%, Ventas could borrow another $1 billion. (Ventas' net debt and total capital are currently $12.3 billion and $23.2 billion, respectively.)

The REIT's dividend costs $1.2 billion annually, which is roughly equal to the firm's expected cash flow in 2020. A 25% decline in cash flow would thus entail a $300 million deficit (25% of $1.2 billion) in the funding of the dividend.

So with an additional $1 billion in capital on hand from borrowing, Ventas could theoretically afford to cover its dividend for 3 to 4 years while waiting for the senior housing market to rebound.

Viewed in this light, it's not out of the question that management could maintain the dividend even if senior housing experiences a significant but temporary decline in occupancy.

At the same time, it's unclear how willing management would be — or how prudent it would be — to maintain the dividend at the expense of the firm's balance sheet, future financial flexibility, and new property acquisitions in fast-growing markets outside of senior housing.

After all, Ventas' elevated payout ratio and leverage don't leave much margin for surprises, which is why the market has punished the stock amidst uncertainty.

The bottom line is that Ventas' dividend is now at higher risk. It's too early to say, though, that the dividend is clearly unsafe. There are still a lot of unknowns: how lethal the virus is, how much it will spread, what the government's response will be, how resilient the senior housing industry is, and much more.

For now, we are downgrading Ventas' Dividend Safety Score to Borderline Safe given the very non-zero risk of a dividend cut. We will continue to monitor this unprecedented situation and provide updates as new information arrives.

Current shareholders should weigh whether they are comfortable owning a stock with this much uncertainty while also recognizing that Ventas' stock price likely already reflects at least some of the growing risk of a dividend cut.