Description

Overview

Brookdale was last written up by Althea in July of 2021 in a well done and highly rated write-up that focused on BKD as a favorite Covid recovery play. The stock has been disappointing since that time though a lot of progress has been made. The mgmt team has executed well, occupancy is rising, rent rate increases have been impressive, industry supply/demand is now favorable and the labor situation is improving. At the same time, lease restructurings are finally happening and BKD is now in a position of strength to walk away from or renegotiate the terms of any remaining bad leases. BKD has long been rumored as a takeout candidate in a consolidating space and its likely that BKD will be acquired in the next couple of years. Certain pockets of real estate will remain challenging and I believe you will see significant pools of capital in the asset class shift focus to senior living assets. These dynamics set the stage for BKD to be a strong performing stock over the next few years.

BKD is the US leader in senior living units operated at 672 communities/57K units across 41 states. BKD owns 31K units with 21K leased and the rest managed.

Thesis

Senior Care is a Needs Based Product / Attractive Care Option

• Senior living is largely a need-based product. If anyone has a parent or grandparent that is compromised, it is easy to see the value proposition that the senior living industry provides. Assisted living elder care is less expensive than at home care, when considering the cost to maintain a home. Having a parent or grandparent move in with you is also challenging. I can speak from personal experience that the financial resources, time, energy, space, patience and safety precautions required to appropriately care for a failing elderly person are shocking. Finding a safe and healthy environment is key and BKD provides that. JD Power ranked BKD as #1 in customer satisfaction among Assisted Living and Memory Care communities.
• In addition to a safer environment, better and more reliable level of care and a healthier social environment, senior living is also a better decision financially. 24/7 Home Health Aide costs can average $236K a year (this excludes home costs and taxes and food). Say you want just 8 hours a day of care for your mom instead of 24/7… the hourly rate for non 24/7 home health care is $30-$40 and would still get these annual costs well above $100K (this also excludes home costs and taxes and food). Further, you would have to care for an adult for the rest of the day somehow. Incontinence is not isolated to 8 hours a day! Senior living costs ~$65K annually and includes all food, housing, laundry and care costs with many services such as a hair stylist brought right into the facility. The more care you need as a resident, the more services are available. The additional focused level of care can flex this cost higher – typically another 5 hours of dedicated care per week in a senior living facility can add ~$6K a year. The 5 hours of additional help per week can handle incontinence or prescription help, bathing help, or dressing assistance. Many options are available and typically 20-25 hours a week can be added to the base level of care before a more intensive memory care type floor is recommended. Memory care (patients with dementia or Alzheimer’s or residents with substantial needs) can run $100K to $140K a year for everything they need. Importantly, BKD’s mix is skewed towards higher acuity residents in Assisted Living and Memory Care, which at 70%, compares to the industry average of 50%. This value proposition for professional care is important as 94% of senior housing resident fees are private pay and the alternatives make less financial sense.

Leases will be Renewed at Favorable Terms or Terminated

• The leased portfolio has caused a lot of problems in the past. Onerous lease terms caused painful financings and restricted the company’s ability to sell assets. Critically, the portfolio has also been responsible for the poor FCF performance. Without a doubt, the leased portfolio has destroyed significant value for shareholders. These dynamics have been corrected and the value destruction should be in the past for BKD. Management is finally in a position of power here as can be seen in their recent decision to walk away from a lease renewal for 35 communities and then executed a new lease for ten of those communities in a more favorable structure. A major lease will mature in 2025 and will likely be favorably dealt with well ahead of schedule.

Favorable Supply / Demand

• Supply is now favorable as increasing material, labor, and financing costs have led to a slowdown in new construction. New starts are 93% below the peak with inventory growth at multi-year lows. BKD’s latest investor presentation has some helpful slides detailing some of the construction cost trends and new starts/opening data. At the same time, demand from BKD’s target population is set to explode. 1.0MM new seniors will enter the target market age cohort every year through 2030.

Occupancy, Revenue and EBIT Growth Ahead

• BKD’s occupancy peaked in Q4 of 2013 at 89.0% and was in the mid-80s right before Covid hit and threw the industry into a complete tailspin. BKD hit an occupancy low of 69.4% in March of 2021. As of August month end, occupancy has recovered to a weighted average of 77.6% and month end level of 79.3%. August saw the highest number of move-ins over the past five years. The supply/demand dynamics should drive occupancy higher over the coming years. As occupancy recovers, Revenue and EBIT will materially inflect. Mgmt provided a new and helpful slide in its recent investor presentation which highlights some of the earnings potential at various levels of occupancy (see below).

• The owned portfolio, which is the main value driver to the BKD story, once had operating income margins in the low/mid 30s. Operating income margins were almost half that in 2022 due to low levels of occupancy and elevated labor and opex costs from covid. The margin recovery is underway as they have recovered to the low 20s in the first half of this year but there is significant growth ahead. This owned portfolio margin recovery is worth roughly a couple billion of value to BKD which would mean multiples of the current stock price, even at conservative cap rates. Importantly, the owned portfolio is poised to generate significant cash flow going forward.

Attractive Valuation

• Senior living is not an easy business – patients are fragile, good labor is often challenging to retain, operational costs are difficult to manage and of course you have a litany of random extreme events that can pop up and make the business temporarily impaired (wildfires, hurricanes, covid and excessive flu as examples). Brookdale handles a lot of these issues the right way, putting its resident’s safety and care ahead of anything else. Brookdale did a lot of things right during Covid, it was costly and painful for shareholders to endure but the management team did handle the crisis as well as one could given the vulnerability of their resident base. Brookdale’s business is not an easy one but it is an important and critical collection of assets. Assets that are significantly undervalued relative to their potential earnings power and strategic value. The company is well positioned to create shareholder value. Liquidity (nearly all cash and equivalents) is around $450MM and FCF should be materially improved from here and positive. The maturity ladder is favorable and while leverage is optically high with debt of $3.8B, 92% of BKD’s debt is non-recourse property level mortgage debt. Off 2023, BKD is trading at an ~8.0% cap rate with no value ascribed to the lease portfolio. Off my 2025 numbers, BKD is trading at a ~10.0% cap rate with no value ascribed to the lease portfolio and very reasonable recovery assumptions (some occupancy recovery to the low 80s which is below pre-covid levels and owned margins in the 26% zone, also below pre-covid levels). The stock has more than 100% upside even on these conservative assumptions.  

BKD’s significant earnings power should materialize over the coming years as the industry normalizes post covid’s occupancy and labor shock and favorable supply/demand dynamics drive growth. BKD has multi-bagger potential from here with excellent execution. Without excellent execution, the strategic value of the asset, combined with industry tailwinds should still result in stock prices decently higher than current levels.

Catalyst

Occupancy Improvement

Owned Margin Recovery

Takeout