QUIC RESEARCH REPORT. Cash Yield. Chartwell Retirement Residences Pitch (TSX: CSH.UN) Canada s Aging Population Needs to Live Somewhere

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1 QUIC RESEARCH REPORT Cash Yield Adam Cotterill Simon Rezene Brendan Blaikie Chartwell Retirement Residences Pitch (TSX: CSH.UN) Canada s Aging Population Needs to Live Somewhere Introduction Chartwell Retirement Residences REIT (TSX:CSH.UN) is an open-ended real estate investment trust that operates within the senior living subsector. The REIT owns, manages, and operates a portfolio of various senior housing communities, ranging from independent through assisted living to long-term care. The purchase of CSH would provide the QUIC portfolio an opportunity to capitalize on changing demographic trends in Canada. As the Canadian population ages, there will be a greater number of citizens who will opt to move into retirement residences and drive demand for senior care. Investment Theses Thesis I: Market Position Thesis II: Focus on Operational Efficiency Thesis III: Strong Development Pipeline Valuation Using a blended valuation of Net Asset Value and Comparable analysis, we arrived at a price target of $ This represents an implied twelve month share price return of 4.98%, and a total return of 8.81%. QUIC Research Reports focus on emerging investment themes that affect current portfolio companies and companies under coverage. The information in this document is for EDUCATIONAL and NON-COMMERCIAL use only and is not intended to constitute specific legal, accounting, financial or tax advice for any individual. In no event will QUIC, its members or directors, or Queen s University be liable to you or anyone else for any loss or damages whatsoever (including direct, indirect, special, incidental, consequential, exemplary or punitive damages) resulting from the use of this document, or reliance on the information or content found within this document. The information may not be reproduced or republished in any part without the prior written consent of QUIC and Queen s University. QUIC is not in the business of advising or holding themselves out as being in the business of advising. Many factors may affect the applicability of any statement or comment that appear in our documents to an individual's particular circumstances. Queen s University 2014

2 Table of Contents Canadian Demographic Outlook 3 Canadian Senior Housing REITs 4 Chartwell Retirement Residences: Company Overview 5 Investment Theses 6,7 Catalysts & Risks 8 Valuation 9,10,11 References 12

3 Exploiting Canada s Aging Demographic The aging of the Baby Boomer generation has had an effect on economic activity in practically every stage of their lives, and the impending retirement of this demographic is not likely to break the trend. The population of seniors age 75 years and older in Canada is expected to grow by 111.2% between 2014 and 2034 (Statistics Canada), while the population of Canada is only expected to increase by 19.1% during that time period. Canada s population is aging and many baby boomers are entering the prime age where they consume the most healthcare services. One such health care service is senior housing, and Canada s demographic transition is expected to create a surge in demand for senior housing, especially in Canada s major markets. Seniors will begin to look to transition from their family homes into a home which more accurately meets their needs. Coupled with the current unaffordability of residential housing in some of Canada s major cities, senior citizens in Canada who will represent more and more of the population will begin to look more seriously at senior housing. With there being a clear, foreseeable increase in demand for healthcare services in Canada, investors have started to take notice. The interest in Senior Housing properties served to push cap rates down, and while cap rate compression is expected on high quality property, the sector experiences a remarkable bps drop in cap rates for the highest quality assets. Furthermore, in 2015, vacancy rates for senior housing came down in virtually every market in Canada. The increase in the activity of Canada s Senior Housing Market is also indicative of the public s awareness that Canada s population is aging quickly. The entry of US REITs into the Canadian senior housing market has only served to put further downward pressure on cap rates. Ultimately, this wave of activity culminated with the OTPP s purchase of Amica in 2015 but the increase in activity within the sector is dramatic beginning in EXHIBIT I: CDN Senior Housing Deal Activity $0.4 $0.4 $1.2 $0.8 $2.4 $2.3 $ EXHIBIT II: Canadian Population Over 75 Years of Age 5.46 MM 4.61 MM 2.50 MM 2.56 MM 3.02 MM 3.77 MM Source: Capital IQ

4 Extendicare (TSX:EXE) Business Overview Extendicare is a leading provider of care and services for seniors in Canada, with a network of 118 senior care and living centres, 64 of which are owned and 54 of which are managed by the REIT. Extendicare s properties are comprised of longterm care, retirement living, and home health care spaces, with the majority of these properties located in Ontario. EXE focuses on long-term and home health care, as these two property segments make up ~85% of the REIT s NOI. EXE is geographically exposed to Ontario, with 60% of the portfolio concentrated in the province. Over the past year, EXE has performed very well, posting year-over-year gains of 12% for total revenue and NOI, a 19% increase in EBITDA, and a 69% increase in AFFO. In EXE s most recent quarter, the REIT beat analysts AFFO/Unit estimates by ~53%, coming in at $0.21/Unit Investment Thesis 1, Long-Term Care Focus As long-term care is primarily needs-driven, demand should remain stable throughout weak economic periods as Canada s population continues to age. With 60% of the REIT s properties located in a strong Ontario senior care market, EXE is positioned well to continue to deliver strong longterm SPNOI growth. will continue to decrease throughout the next few years, settling at 66% in This low payout ratio will allow the REIT to use the excess FFO to finance acquisitions and developments; an integral part of management s plan to increase NOI over the next five years. 3. Clear-Cut Plan For Growth Management has strictly outlined a plan to grow NOI by ~30% over the next five years through development. The plan involves the redevelopment of 21 Class C long-term care facilities, planning to spend ~C$350MM over the next five years, as well as four retirement housing Greenfield development projects, expected to bring in an additional ~C$8MM in NOI//year. With D/GBV currently standing at 40% (14% lower than its closest peer), EXE s balance sheet is ready to be levered to finance these developments. Together, these developments are expected to bring in an additional C$36MM in NOI each year. EXHIBIT III: NOI Breakdown by Property Type 7.0% 5.0% 3.0% 55.0% 2. Strong Distribution Yield/Payout Ratio Combination EXE s management has been able to guide the REIT well over the past few years, simultaneously maintaining an attractive yield of 5.6% while lowering its payout ratio to just 76%, down from 84% in It is estimated that EXE s payout ratio Source: Capital IQ, Company Reports 30.0% Long-Term Care Other Canadian US Ops Home Health Care Retirement 4

5 Sienna Senior Living (TSX:SIA) Business Overview Sienna Senior Living (TSX: SIA) owns and operates 54 high-quality seniors living residences in key markets in Ontario and British Columbia, comprising 7,923 beds/suites serving the continuum of independent living, assisted living, long-term care and specialized seniors programs and services. The Company is one of Canada's largest owners of seniors living and the largest licensed long-term care provider in Ontario, with approximately 8,800 employees dedicated to helping residents live fully, every day. Investment Thesis 1. Retirement Residences Driving Growth SIA has reaped the benefits of the aging Baby Boomer population in Canada as the REIT s retirement residences (~27% of NOI) generated 19.3% SPNOI growth year-over-year in 2Q16. This increase can be attributed largely to occupancy growth of 530bps year-over-year. Rental rate increases will begin to take over as the key driver for growth, as demand for retirement residences is increasing steadily, and so should retirement residence occupancy. 2. Portfolio Repositioning SIA is currently repositioning its portfolio to increase exposure to private-pay tenants. The REIT s management has outlined a pro-forma portfolio of 20% private-pay properties and 80% government funded properties, while the current portfolio is 17.4% and 82.6% respectively. This increase in exposure should provide strong rental rate growth in the long-term, as well as cash flow stability, as government funded properties are highly regulated and leave less room for organic growth. 3. Strong Cash Retention and Growth Initiatives During 2Q/16, SIA retained ~C$23MM of funds from operations to fund strategic growth initiatives, such as the redevelopment of long-term care homes, as well as strategic acquisition opportunities. SIA s management is exploring the possibility of redeveloping Class B and Class C long-term care properties, as well as leasing up four non-stabilized retirement communities. These retained funds are expected to be used to help fund these growth initiatives, as well as any acquisition opportunities, and will be a key growth driver when retirement residences become stabilized. EXHIBIT IV: Post-Acquisition Pro Forma Portfolio Portfolio as at Q2/ % Pro Forma Portfolio 20.0% 82.6% 80.0% Source: Capital IQ, RBC Capital Markets Government Funded Private-Pay 5

6 Chartwell Retirement Residences (TSX:CSH.UN) Business Overview Chartwell Retirement Residences (TSX:CSH.UN) owns, manages, and operates a portfolio of various senior housing communities, ranging from independent through assisted living to long-term care. These communities include meal service, twenty-four hour supervision, and general household services, with more patient-specific care options available for assisted living tenants. EXHIBIT VI: Q2/16 YoY Growth/Decline 53.7% 40.0% The REIT s portfolio consists of 24,619 suites across 170 facilities, with just under 90% of its properties located in Ontario and Quebec 1.7% 8.5% (2.0%) EXHIBIT V: Market Statistics C$MM except per share amounts or otherwise noted Share Price (September 16, 2016) $ Week High $ Week Low $11.74 F.D. Shares Outstanding F.D. Market Capitalization $2,824 Add: Net Debt $1,722 Enterprise Value $4,575 CSH s management has outlined a strategy comprised of five key strategic priorities of: growing core property portfolio contribution, maintaining a Average Occupancy SPNOI Total AFFO AFFO/Unit Debt/GBV strong financial position, improving the quality and efficiency of corporate support services, building real estate portfolio value, and providing exceptional services and care Year-to-date, CSH has done well to increase occupancy by 1.7% and increased revenue by 4.6% for the six months ended June 30 th, This has resulted in an SPNOI increase of 8.6% during the same period. However, Chartwell still has occupancy gains to make as they currently sit just above 92% occupancy. EXHIBIT VII: Year-to-Date Share Price Performance Versus Benchmark Sep Dec Mar Jun Sep-16 TSX:CSH.UN S&P/TSX Capped REIT Index Source: Capital IQ, Company Reports 6

7 Investments Theses Thesis I: Market Position CSH is the largest provider of senior housing in Canada by a wide margin. The REIT has ~38% market share of the Retirement Care (RC) market which makes up 73% of its portfolio. In its Long Term Care (LTC) segment, CSH is the 4 th largest operator behind players such as Extendicare who dominate the LTC space. Given the REIT nearly doubles its next closest competitor within the RC market, it is best positioned to capitalize on a demographic shift where there will be a growing population of senior citizens. By 2020, the number of Canadians over the age of 75 is expected to increase to 7.7% from 6.7%, and eventually hit 9.1% by According to RBC Capital Markets, there could be nation-wide demand for an additional 4,000 5,000 private-pay seniors housing suites annually for the next 15 years. CSH s leading market position implies that longterm demographic trends are in the REITs favour. EXHIBIT VIII: Suite Count Among Dominant Players in Canadian Senior Housing 24,619 With little supply risk expected to disrupt CSH s market share, the REIT is comfortably able to maintain 93.4% same property occupancy with room for some upside. With significant non-core divestments in 2014, the Ontario portfolio has been repositioned toward more competitive properties which should help drive ongoing occupancy improvements. The REITs scale in Canada ensures its development pipeline and acquisition activity will protect its market share as major players look to ramp up supply over the next 10+ years. Thesis II: Focus on Operational Efficiency The REIT has been able to create an economic moat through a focus on developing and acquiring operationally efficient residences. Management has continually invested in branding, marketing and sales initiatives to continue to increase awareness of Chartwell s name and drive traffic to its residences. From a cost control standpoint, the REIT is able to manage its controllable costs through annual efficiency reviews, a centralized purchasing system, and energy management programs. Historically, the REIT has boasted industry leading NOI margins at ~30%, while competitors margin fall in the low to high teens. 12,175 8,694 8,550 7,603 7,579 EXHIBIT IX: Industry Leading NOI Margins 40% 30% 20% 10% 0% Chartwell Extendicare Sienna Senior Living Source: Company Reports Source: Company Reports 7

8 Investment Theses Thesis II: Focus on Operational Efficiency (Cont d) Due to the elasticity of demand with private pay residences, CSH is able to charge higher rates to its customers and thus sustainably increase rental rates 2-3% annually. The REITs focus on its Ontario market which makes up ~45% of NOI is a testament to management s commitment on maintaining strong operating margins. Market rent in Ontario is higher than any other province by nearly 30%, and CSH s growth prospects in Ontario ensure the REIT will be able to maintain NOI margins in the 30-35% range over the long term. In addition to margin expansion from an increased presence in Ontario, CSH s brand and scale as the largest player in Canada has allowed the REIT to grow revenues from additional care and services. EXHIBIT X: Geographic Breakdown by # of Suites 60% 40% 53% 34% $4,000 $3,000 Thesis III. Strong Development Pipeline CSH s scale and entrepreneurial management team has enabled the REIT to maintain a strong development pipeline and consistently pursue strategic acquisitions in its core markets. Year to date, Chartwell has completed 5 acquisitions, with 4 of them in Ontario. As previously mentioned, a focus on acquisitions in its highest margin province reflects management s focus on growing the business in the right areas. In 2015, the REIT acquired just under C$600MM of 13 new properties in core markets at a weighted-average cap rate of 6.2%. CSH s development pipeline includes 12 projects encompassing 2,129 suites. Management has sought to develop modern, market-specific, and operationally efficient senior home communities. These projects are estimated to have a total cost of C$235MM, with completion dates ranging from the beginning of 2017 through Due to the sale of its entire U.S. portfolio at U.S. $847MM, the REIT has been able to improve its balance sheet position. D/GBV has decreased from 57% to 49% since 2013, giving management the option to raise funds through debt to continue acquiring and developing properties. EXHIBIT XI: Development and Acquisition Activity in % 10% 3% $2, % Ontario Quebec British Columbia Alberta $1,000 Source: Company Reports Breakdown by Number of Suites Assisted Living Monthly Rates Under Development Joint Ventures Acquisitions Source: Company Reports 8

9 Catalysts & Risks Catalysts 1. Development Opportunities A large component of CSH s strategy is to develop modern, market-specific senior housing communities, using these developments as a means to grow NAV/unit and earnings. As Canada s population ages, demand for new supply of both retirement housing and long-term care properties is projected to increase sharply. By 2021, it is expected that ~17,000 new suites will need to be developed each year. CSH s ability to capitalize on this increase in demand will be key to long-term growth.. 2. Mortgage Debt Restructuring CSH currently has a large portion of mortgage debt maturing in , totalling 41% of total debt. CSH s management intends to refinance at least ~C$297.0MM of the mortgage debt with long-term, CMHC insured mortgages, bringing annual mortgage maturities below the REIT s targeted maximum of C$175MM of expiries per year. This possible restructuring will decrease the REIT s debt exposure during those three years, freeing up funds to continue developing and acquiring new properties. 3. Ontario Occupancy Gains The Ontario senior housing market is expected to EXHIBIT XII: Stable Development Pipeline continue to benefit from an aging Baby Boomer population, resulting in increased demand for senior housing, and therefore increasing CSH s portfolio occupancy. With ~2.5% contractual rental rate increases yearly, increased occupancy will continue to bolster SPNOI growth, exemplified by CSH s 11.3% increase in Ontario SPNOI year-overyear. Risks 1. Government Intervention Long-term care and senior housing facilities are subject to much government regulation and intervention, with legal limits on rental rate increases, thereby decreasing CSH s growth prospects. Though the majority of the REIT s properties are non-government funded, private-pay properties, government regulation, especially in Ontario (53% of Suites) will remain a key factor driving rental rate growth going forward. 2. Canadian Retirement Exposure With 89% of CSH s portfolio comprised of retirement housing suites, any material change in regulations or a wealth of new supply brought online in retirement housing markets may decrease demand for retirement housing suites, thus decreasing CSH s ability to keep rental rate growth at the current ~2.5% level. $250 $234 $200 $150 $100 $62 $44 $28 $38 $50 $17 $45 $0 Q2/17 Q3/17 Q4/17 Q1/18 Q2/18 Q3/18 Total Cost ($MM) Unlevered Yield Source: Capital IQ, BMO Capital Markets 10.0% 7.5% 5.0% 2.5% 0.0% 9

10 Comparable Companies Analysis Canadian Senior Housing Comparables Market Enterprise Prem (Disc) Debt / Net Debt / Price / FFO Price / AFFO Dividend Company Price Cap Value to NAV EV EBITDA 2016E 2017E 2016E 2017E Yield Chartwell Retirement Residences $15.10 $2,907 $4, % 0.4x 7.3x 16.7x 15.7x 17.8x 16.9x 3.7% Mainstreet Health Investments $10.76 $3,432 $3, % 0.1x 9.1x 12.1x 7.6x 15.8x 10.0x 9.0% NorthWest Healthcare Properties REIT $10.44 $921 $2, % 0.6x 9.1x 11.6x 10.9x 12.4x 11.6x 7.7% Sienna Senior Living $16.98 $781 $1, % 0.5x 7.3x 13.9x 13.2x 12.5x 12.2x 5.3% Extendicare $8.68 $768 $1,176 (5.1%) 0.4x 3.7x 15.9x 13.9x 13.5x 13.0x 5.5% Average 4.3% 0.4x 7.3x 14.0x 12.3x 14.4x 12.7x 6.2% Median 7.2% 0.4x 7.3x 13.9x 13.2x 13.5x 12.2x 5.5% Multiple Valuation P / FFO Implied Target Metric (C$) Multiple (x) Price FY x $15.68 FY x $15.84 P / AFFO FY x $15.58 FY x $15.64 Analysis Chartwell Retirement Residences trades at a premium to Senior Housing peers on a P / FFO and P / AFFO basis. We believe this premium is justified as a result of a number of factors, including Chartwell s dominant market-leader position and relatively superior development pipeline. While other names in the peer set may seem more attractive, no other REIT has a similar market share profile as Chartwell and the ability to consistently achieve NOI margins in the ~30% range. While intuitively Chartwell should be trading above peers, the significant premium at which they trade is a concern as we look at potentially adding the name to our holdings. Source: Capital IQ 10

11 Net Asset Value Model NAV Build Blended Capitalization Rate NAV Summary FTM NOI $285 Blended Cap Rate 6.94% Value of Capitalized Income $4,106 Non-Real Estate Assets $200 CIBC Canaccord Genuity Consensus $13.25 $ Total Assets $4,306 Less: Liabilities $1,870 Less: Claims on Equity 0 Net Asset Value: $2,436 Dilluted Shares Outstanding 179 Net Asset Value Per Share $13.62 Assigned Prem / (Disc) to NAV 10% Implied Share Price $14.98 GMP TD BMO $14.50 $14.75 $15.00 Blended Capitalization Rate Capitalization Rate Formula Geography Properties Size (beds) % of Total Cap Rate Ontario, CAD 108 7, % 6.84% Quebec, CAD 44 7, % 7.13% British Columbia, CAD 18 1, % 6.56% Alberta, CAD % 7.02% Total , % 6.94% Cap Rate = Net Operating Income Property Value Analysis Chartwell Retirement Residence s Net Asset Value is ~$ The capitalization used was a geographically blended cap rate, taking into account Chartwell s exposure to four separate senior housing markets in Canada. After attributing a 10% Premium to Chartwell s Net Asset Value, we arrive at an implied share price of $14.98 or $ We took a conservative approach in assigning a premium to Chartwell s Net Asset Value as we wanted to consider current valuation levels and investor expectations for the REIT reflected in its current share price. With that being said, we believe this Premium is justified given Chartwell s ability to consistently drive successful developments to market and dominate the Retirement Care market in Canada. Source: Capital IQ 11

12 Valuation Blended QUIC Valuation Analyst Price Targets Method Weighting Target Price TD Securities $17.50 NAV Target Price 50% $15.00 BMO Capital Markets $16.50 Comps Target Price 50% $15.75 Implied Target Price $15.40 Canaccord Genuity RBC Capital Markets $16.00 $16.00 Share Price (September 16, 2016) $14.67 Scotia Capital $16.00 Implied Share Price Return 4.98% Dividend Yield 3.83% Implied Total Return 8.81% Implied Prem / (Disc) to NAV 13.07% QUIC CIBC World Markets $15.00 $15.50 Conclusion Chartwell Retirement Residences would be a great addition to the Cash Yield portfolio, and would allow for exposure to the Specialty sub-sector and to take advantage of Canada s impending demographic transition. From a valuation standpoint, Chartwell s currently trades at a significant premium to peers on a comparable basis, and at a significant premium to NAV on an intrinsic value basis. Occupancy levels for Chartwell s Quebec (~94%) and Western (~95%) occupancy are likely approaching their peaks which should plateau NAV/unit growth until development projects come online. While we continue to favour management s strategy of upgrading the quality of their portfolio through the acquisition/development of new properties, we believe the market has captured its growth prospects in its current share price. Chartwell is a fundamentally sound business, but is currently too expensive. We believe the senior housing market in Canada as a whole is overlooked, and a more attractive entry point into Chartwell would be a great way to gain exposure to an industry exhibiting favorable trends through a growing population of seniors. Source: Capital IQ 12

13 References 1. Company Reports 2. Capital IQ 3. Forbes 4. Bloomberg 5. SEDAR 6. The Globe & Mail 7. RBC Capital Markets 8. BMO Capital Markets 13