Health Care REIT Inc.

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1 January 05, 2015 Health Care REIT Inc. Current Recommendation SUMMARY DATA NEUTRAL Prior Recommendation Underperform Date of Last Change 07/20/2004 Current Price (01/02/15) $76.95 Target Price $ Week High $ Week Low $53.05 One-Year Return (%) Beta 0.55 Average Daily Volume (sh) 1,964,202 Shares Outstanding (mil) 328 Market Capitalization ($mil) $25,240 Short Interest Ratio (days) 7.02 Institutional Ownership (%) 88 Insider Ownership (%) 0 (HCN-NYSE) SUMMARY Health Care REIT s third-quarter 2014 normalized FFO per share beat both the Zacks Consensus Estimate and the prior-year quarter figure. Results reflected higher same-store net operating income (NOI) growth and notable investments in premium assets. In the quarter, the company completed $757 million of gross investments including $653 million in acquisitions, and $76 million in development funding. We believe that such strategic portfolio investments would serve as growth drivers for Health Care REIT. Moreover, the company s better-than-expected third-quarter results, on the back of notable operating portfolio performance, are encouraging. In addition, a rise in senior citizen spending for healthcare reasons promises strong future prospects. However, an anticipated rise in interest rate in the medium to long term and intense competition remain the pressing concerns. Risk Level * Low, Type of Stock Large-Blend Industry Reit-Eqty Trust Zacks Industry Rank * 69 out of 267 ZACKS CONSENSUS ESTIMATES Revenue Estimates (In millions of $) Q1 Q2 Q3 Q4 Year (Mar) (Jun) (Sep) (Dec) (Dec) Annual Cash Dividend $3.18 Dividend Yield (%) Yr. Historical Growth Rates Sales (%) 51.2 Earnings Per Share (%) 6.2 Dividend (%) 3.7 using TTM FFO/Share 18.8 using 2014 Estimate 18.7 using 2015 Estimate 17.6 Zacks Rank *: Short Term 1 3 months outlook 3 - Hold * Definition / Disclosure on last page A 439 A 462 A 497 A 1,816 A A 679 A 784 A 789 A 2,882 A A 826 A 848 A 865 E 3,341 E ,623 E Funds from Operations (FFO) per Share (FFO is operating earnings before non-recurring items) Q1 Q2 Q3 Q4 Year (Mar) (Jun) (Sep) (Dec) (Dec) 2012 $0.87 A $0.89 A $0.91 A $0.85 A $3.52 A 2013 $0.91 A $0.93 A $0.97 A $0.99 A $3.80 A 2014 $1.00 A $1.06 A $1.04 A $1.02 E $4.12 E 2015 $4.36 E Projected FFO/share growth - Next 5 Years % Zacks Investment Research, All Rights reserved S. Riverside Plaza, Chicago IL 60606

2 OVERVIEW Toledo, OH-based, Health Care REIT Inc. is one of the major healthcare real estate investment trusts (REITs) in the U.S. Founded in 1970, this company was the first REIT to invest exclusively in healthcare facilities. The company invests in a broad range of healthcare real estate properties such as senior housing communities, skilled nursing/post-acute facilities, medical office buildings, inpatient and outpatient medical centers as well as life-science facilities. It also provides a wide array of property management and development services. As of Sep 30, 2014, the company s portfolio comprised 1,246 properties located across 46 states in the U.S. as well as in the U.K. and Canada. REASONS TO BUY Health Care REIT s diversified portfolio allows it to explore opportunities in different markets based on individual market dynamics. The company usually leases its healthcare facilities under "triple net" leases, where the tenant pays all taxes, insurance and maintenance for the properties, in addition to rent. Moreover, the company establishes business relationships with experienced healthcare management companies or operators who lease these properties on a long-term basis. These activities insulate the company from short-term market swings and drive steady top-line growth. Notably, the company s revenue grew at a compound annual growth rate of 33.7% from Moreover, in the first nine months of 2014, its revenues climbed 18.3% year over year to $2.5 billion. Health Care REIT is strengthening its focus on high-barrier-to-entry affluent markets around the world through strategic investments. The company s major buyouts, like that of Gracewell Health Care business with Sunrise Senior Living and HealthLease Properties REIT enhanced its portfolio quality. Also, in the third quarter, the company completed $757 million of gross investments including $653 million in acquisitions, and $76 million in development funding, mainly targeted toward the highquality properties. We expect such opportunistic investments to facilitate a steady source of rental income going forward, and provide the company with a competitive edge. In addition, the healthcare sector is comparatively immune to the macroeconomic problems faced by office, retail and apartment REITs. It offers stability to the company amid a volatile market, as even in tough economic conditions customers need to spend on healthcare services, while reducing their discretionary buyouts. Moreover, according to the Centers for Medicare and Medicaid Services (CMS), national health expenditures are expected to rise by 5.8% in In fact, the healthcare sector provides ample opportunity for the real estate companies and supporting healthcare facilities, to grow and enhance their profitability. Also, the 75+ age cohort is growing 6 times faster than the rest of the population and 75+ households with $50K+ income are projected to increase by 33% from 2012 to Further, the 79 million baby boomers Medicare eligibility boosts the company s medical office buildings business. Hence, given these factors, we believe that Health Care REIT has strong growth potential as it is well poised to capitalize on this trend. Health Care REIT, with a healthy balance sheet position, disclosed in September the successful completion of its $1.1 billion common stock offering. As of Sep 30, the company declared $2.5 billion in line of credit, $1 billion in cash and $152 million of in the form of pending disposition accruals. The company has also raised its annual disposition guidance to $625 million from $450 million. Further, the company is generating $60 million of equity per quarter through dividend reinvestment programs. This offers it the wherewithal to invest in its growth needs. Equity Research HCN Page 2

3 REASONS TO SELL Health Care REIT operates in an intensely competitive market and contests with national and local healthcare operators regarding factors such as quality, price and range of services provided, and reputation, location and demographics of the population in the surrounding area, along with the financial condition of its tenants and operators. This limits the company s power to significantly raise its top line and ink deals at attractive rates. Though acquisitions and developments are a strategic fit, such moves involve considerable upfront costs. This remains a drag as new properties usually take time to generate revenues. In fact, overall expenses showed a rising trend in the past few years (up 72% in 2013, 34% in 2012 and more than double in 2011). This upward tendency continued in the first nine months of 2014 too, as expenses were up 8.5% to $2.2 billion. Hence, rising expenses remain a concern. A considerable amount of Health Care REIT s income is determined by government reimbursement rates. If the government cuts reimbursement rates through Medicare or Medicaid, revenues could fall in the future and negatively affect its long-term growth potential. Additionally, a significant portion of Health Care REIT s revenues originates from a few tenants, which exposes it to concentration risks. If one of the company s larger tenants runs into a financial difficulty, earnings could be adversely affected. A rise in interest rates in the medium-to-long term can be a challenge for Health Care REIT as the company has substantial exposure to long-term leased assets. The properties under long-term triplenet leases generally have fixed rental rates, which are subject to annual increases. On the other hand, many of the company s debt obligations bear floating rates with interest and related payments rates varying with the movement of LIBOR, Bankers Acceptance or other indexes. Now, with the fixed-rate nature of a substantial part of the company s revenues on one hand and the rise in cost of debt on the other (when interest rate would rise), the company s profitability would get adversely affected. In addition, any rise in rates would increase the cost of financing acquisitions, and investment and development activity expenses, and lower the amount that third parties would be ready to pay for the company s assets at disposal. RECENT NEWS Health Care REIT Q3 FFO Beats by a Penny, View Narrowed Nov 4, 2014 Health Care REIT reported third-quarter 2014 normalized FFO of $1.04 per share, a penny ahead of the Zacks Consensus Estimate and up $0.07 year over year. The 7% year-over-year increase in normalized FFO per share is primarily driven by same-store net operating income (NOI) growth and notable investments in premium assets. Moreover, normalized funds available for distribution (FAD) came in at $0.91 per share, up from $0.86 per share in the year-ago period. Total revenue rose 8.1% year over year to $847.5 million and exceeded the Zacks Consensus Estimate of $835 million. Inside the Headlines In the third quarter, same-store NOI increased 4.3% from the year-ago period, driven by a 7.6% yearover-year rise in the seniors housing operating portfolio. Equity Research HCN Page 3

4 Health Care REIT concluded gross investments worth $757 million in the quarter under review. This comprised $653 million in acquisitions, $76 million in development funding, $25 million in loan advances and $4 million in capital improvements. Notably, the third-quarter acquisitions comprised 16 medical office buildings, 11 U.K-based seniors housing operating assets (managed by Sunrise), a post-acute asset (operated by Genesis) and 3 U.K.- based seniors housing triple-net assets (operated by Avery). Health Care REIT exited the third quarter with cash and cash equivalents of $998.7 million, up significantly from $207.4 million as of Jun 30, Outlook Narrowed Health Care REIT narrowed its full-year 2014 normalized FFO per share guidance range to $4.07 $4.13 from $4.05 $4.15 guided earlier, denoting a 7 8% increase from Notably, the company raised its 2014 disposition guidance to $625 million from $450 million. Also, the company narrowed its normalized FAD per share outlook range to $3.59 $3.65 from the previous range of $3.57 $3.67. Dividend Update On Oct 30, 2014, the board of directors at Health Care REIT declared a quarterly cash dividend of $0.795 per share, reflecting a rise of 4% over the year-ago dividend of $ This marked the company s 174 th consecutive quarterly dividend payment. It was paid on Nov 20, 2014, to stockholders of record as on Nov 11. Recent Developments Health Care REIT to Sell Entrance-Fee Portfolio & Gain $95M Dec 1, 2014 Health Care REIT declared that it expects to reap a gain of around $95 million by selling seven entrance fee communities and one rental community for $435 million. The company has inked a deal in this regard and the purchase price depicts a 5.6% cash yield on sale. This move comes as part of the company s effort to trim its non-strategic assets and reuse the proceeds in accretive measures. Following this disposition, only one entrance fee community will be left under Health Care REIT s ownership. Health Care REIT Acquires HealthLease Nov 19, 2014 Health Care REIT has completed the acquisition of HealthLease Properties REIT for a purchase price that denotes a 7% initial cash yield. The acquisition enriches the company s portfolio with high-quality seniors housing, post-acute care and long-term care communities. Further, Health Care REIT has formed a partnership with Mainstreet Property Group. This includes a deal under which Health Care REIT would shell out around $369 million, reflecting a 7.5% initial cash yield, for acquiring 17 communities under the Next Generation brand. The purchase is expected to close in phases after construction is accomplished, starting in fourth quarter of the current year through the first quarter of Equity Research HCN Page 4

5 In addition, HCN struck a deal with Mainstreet to offer mezzanine financing at favorable mid-teen interest rates and gain purchase option rights for another 45 Next Generation development projects, upon accomplishment of each project. This represents an acquisition pipeline worth $1.0 billion, expected to be delivered in phases from 2016 through first-quarter Managed under long-term triple-net lease agreements by reputed operators, the portfolio acquisition is expected to facilitate a steady source of rental income in the long term, thus providing Health Care REIT with a competitive edge. Health Care REIT Issues Senior Notes to Pay Off Debt Nov 14, 2014 Health Care REIT disclosed notes offering to reduce its debt level. In particular, the company priced 4.50% senior unsecured notes worth 500 million at % of the principal amount. The notes, due 2034, have a yield-to-maturity of 4.538%. The offering of the notes is expected to close on Nov 25, Health Care REIT plans to utilize the reaped proceeds from this offering to pay off the advances under its chief unsecured credit facility and meet other corporate needs such as acquisitions. For Health Care REIT, the aforementioned offering is a strategic fit as it will help in managing interest expenses efficiently. Also, the increased financial flexibility will enable the company to pursue its portfolio enhancement activity that will strengthen its top line, going forward. Note: 1. FFO, a widely accepted and reported measure of the performance of REITs, is derived by adding depreciation, amortization and other non-cash expenses to net income. 2. FAD, a measure to ascertain the ability of REITs to generate cash, is derived by subtracting straightline rent and non-recurring real estate expenses from funds from operations. Equity Research HCN Page 5

6 VALUATION Shares of Health Care REIT currently trade at 18.7x the Zacks Consensus Estimate for 2014 FFO per share, a 19.1% premium to the industry average. On a price-to-book basis, the shares trade at 1.9x, a 13.6% discount to the industry average. Therefore, the valuation looks attractive on price-to-book basis. Our 6-month target price of $81.00 equates to 19.7x the Zacks Consensus Estimate for 2014 FFO per share. Combined with a quarterly dividend of $0.795 per share, this price target implies an expected total return of 7.3% over that period. This is consistent with our Neutral recommendation on the shares. The stock currently has a Zacks Rank #3 (Hold). Key Indicators F1 F2 Est. 5-Yr FFO Gr% P/CF 5-Yr High 5-Yr Low Health Care REIT Inc. (HCN) Industry Average S&P Crown Castle International Corp. (CCI) NA NA American Tower Corporation (AMT) NA NA NA Ventas, Inc. (VTR) Vornado Realty Trust (VNO) TTM is trailing 12 months; F1 is 2014 and F2 is 2015, CF is operating cash flow P/B Last Qtr. P/B 5-Yr High P/B 5-Yr Low ROE D/E Last Qtr. Div Yield Last Qtr. EV/EBITDA Health Care REIT Inc. (HCN) Industry Average NA S&P NA 1.9 NA Equity Research HCN Page 6

7 Earnings Surprise and Estimate Revision History Equity Research HCN Page 7

8 DISCLOSURES & DEFINITIONS The analysts contributing to this report do not hold any shares of HCN. The EPS and revenue forecasts are the Zacks Consensus estimates. Additionally, the analysts contributing to this report certify that the views expressed herein accurately reflect the analysts personal views as to the subject securities and issuers. Zacks certifies that no part of the analysts compensation was, is, or will be, directly or indirectly, related to the specific recommendation or views expressed by the analyst in the report. Additional information on the securities mentioned in this report is available upon request. This report is based on data obtained from sources we believe to be reliable, but is not guaranteed as to accuracy and does not purport to be complete. Because of individual objectives, the report should not be construed as advice designed to meet the particular investment needs of any investor. Any opinions expressed herein are subject to change. This report is not to be construed as an offer or the solicitation of an offer to buy or sell the securities herein mentioned. Zacks or its officers, employees or customers may have a position long or short in the securities mentioned and buy or sell the securities from time to time. Zacks uses the following rating system for the securities it covers. Outperform- Zacks expects that the subject company will outperform the broader U.S. equity market over the next six to twelve months. Neutral- Zacks expects that the company will perform in line with the broader U.S. equity market over the next six to twelve months. Underperform- Zacks expects the company will under perform the broader U.S. Equity market over the next six to twelve months. The current distribution of Zacks Ratings is as follows on the 1141 companies covered: Outperform %, Neutral %, Underperform 5.7%. Data is as of midnight on the business day immediately prior to this publication. Our recommendation for each stock is closely linked to the Zacks Rank, which results from a proprietary quantitative model using trends in earnings estimate revisions. This model is proven most effective for judging the timeliness of a stock over the next 1 to 3 months. The model assigns each stock a rank from 1 through 5. Zacks Rank 1 = Strong Buy. Zacks Rank 2 = Buy. Zacks Rank 3 = Hold. Zacks Rank 4 = Sell. Zacks Rank 5 = Strong Sell. We also provide a Zacks Industry Rank for each company which provides an idea of the near-term attractiveness of a company s industry group. We have 264 industry groups in total. Thus, the Zacks Industry Rank is a number between 1 and 264. In terms of investment attractiveness, the higher the rank the better. Historically, the top half of the industries has outperformed the general market. In determining Risk Level, we rely on a proprietary quantitative model that divides the entire universe of stocks into five groups, based on each stock s historical price volatility. The first group has stocks with the lowest values and are deemed Low Risk, while the 5 th group has the highest values and are designated High Risk. Designations of Below-Average Risk, Average Risk, and Above-Average Risk correspond to the second, third, and fourth groups of stocks, respectively. Coverage Team QCA Lead Analyst Analyst Copy Editor Content Ed. 11C Kalyan Nandy Moumita C. Chattopadhyay Sanjoy De Anuja Mitra Moumita C. Chattopadhyay Equity Research HCN Page 8