Description

Elder Trust (ETT)

Elder Trust is a leveraged healthcare REIT that is well-along in the process of healing from the bankruptcy and subsequent re-organization of its major tenant, Genesis Health Ventures. Other healthcare REITs such as Senior Housing Properties and Omega have rallied substantially as the industry has recovered from Medicare reimbursement problems, and ETT is not an exception. However, while up sharply from its lows of 2000 and 2001, the current share price reflects only a portion of ETT’s true value.

ETT’s assets consist of 23 healthcare properties: 10 assisted living facilities, 8 skilled nursing facilities, 4 medical office buildings, and 1 independent living facility. Leases are NNN for the most part. In addition, ETT has investments of $24 million in four unconsolidated entities which include 7 skilled nursing facilities and 2 assisted living facilities. The facilities of the unconsolidated entities are operated by Genesis and the lease payments thereof are obligations of Genesis.

Balance sheet @ 03/31/02:

Dil. Share out: 7,680
Mkt Cap @ $8.00: $61,440

Bank Debt: $4,548
Mortgage Debt: $106,376
Book Equity: $81,674

Equity/Share: $10.63
Price/Book: 76%
Debt/Equity Ratio: 1.36

Proj. ’02 FFO: $12.4 million
Proj. ’02 FFO per share: $1.60
Price/Proj. ’02 FFO: 5.1x

ETT’s major tenant, Genesis Health Ventures, filed for chapter 11 in mid-2000 in the wake of cuts in Medicare reimbursement for nursing care. The Genesis bankruptcy did violence to ETT’s financial position, placing it in technical default and forcing ETT to stop paying dividends. The stock got below $1 before recovering as Genesis emerged from bankruptcy in October 2001. Although ETT is current on all its debt and has cleared the income statement of special one-time charges, the balance sheet shows $50 million of current debt and a dividend has yet to be reinstated.

Due to the technical default status and suspended dividend, not to mention ETT’s $50 million market capitalization and total lack of analyst coverage, ETT trades at only 5.1x this years projected FFO of $1.60 per share, versus 9x to 10x FFO for other healthcare REITS. If ETT were to adopt an 80% FFO payout ratio in line with industry standards, the shares would yield 15.6% at the current price, versus yields of 7% to 10% for other healthcare REITS (lowly Omega Health Investors, which was posted on VIC last year and has been a major success, is an exception). A P/FFO multiple of 7.5x would place ETT at $12, and an 80% FFO payout ratio with a 11% yield would place the shares at $12.50, approximately 50% above the current price.

Management has stated that the dividend policy will be addressed in the latter part of 2002, and the balance sheet issues, as well as the future of Medicare reimbursement for Genesis, should be resolved in the next four to five quarters. ETT’s current debt is comprised of:

1) Bank debt of $4.5 million which matures 08/31/02. An estimated $3 million should be outstanding at that time. Management expects to get an extension on decent terms. The balance is being reduced by $450k/month, and management has indicated that the balance can be reduced to $0 by the end of November.
2) Three J.P. Morgan mortgage loans totaling $30 million due 12/1/02. ETT has the right to extend the mortgages for an additional 2 years with the payment of a $150k fee. Payments are current.
3) Technical default on $14.8 million in mortgage debt. These notes were sold to a pooled vehicle, and the default status, which resulted from Genesis’ bankruptcy, can not be corrected even though ETT is current on the debt.

Risks:
ETT’s major tenant, Genesis Health Ventures, may be adversely effected by the discontinuation of relief granted to nursing home operators which is set to expire in September of this year. Negotiations (i.e., industry lobbying) are ongoing in Congress, and most analysts expect the final version to be a compromise that will allow the industry to survive as opposed to sending the whole group back into chapter 11. Genesis is in decent shape in my opinion and should be able to withstand an adverse Medicare outcome. The VIC write-up of Kindred Healthcare addresses this issue and I encourage anyone who’s interested to read it. My worst case scenario is that the outcome from Congress is perceived as a negative for the industry, and valuations are brought down. This would likely spill over to ETT to some degree, although I do not think it would impact ETT’s revenue or cash flow.

Catalyst

Dividend reinstatement. REIT investors like dividends, which is why they don’t like ETT. As ETT’s balance sheet issues are resolved and cash flow is applied toward debt reduction (Cash flow after principal payments is $1.20 per share), a dividend can be reinstated and the shares should properly reflect their intrinsic value.