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Morningstar | Guidance Raises Can't Mask a Disappointing Quarter for Ventas

Nothing in Ventas' second-quarter results is enough to change our long-term outlook on the company or sector, which leads us to maintain our $65 fair value estimate and no-moat rating. That said, the company's results for the second quarter were a disappointment. Normalized funds from operation came in at $1.08 for the quarter but included $27 million in prepayment fees collected on the early retirement of a $735 million secured debt loan made to hospital partner Ardent. Removing the $0.08 impact of this non-recurring item, Normalized FFO came in at $1 for the quarter, 4 cents below our estimate. The miss is mainly attributable to the senior housing rate growth coming in lower than we anticipated while expenses came in higher than our estimate. The company did raise the low-end of FFO guidance by 3 cents to a new range of $4.02-$4.07, although given the first-half results the run-rate FFO at the midpoint for the second half will be $0.96. Even accounting for the reduction from the Ardent loan closing earlier than we expected, management's guidance would suggest we might need to reconsider our 2018 estimates for the senior housing portfolio.

The senior housing operating portfolio reported same-store NOI growth down 3.1% for the quarter, 1.3% lower than our estimate. While the occupancy drop of 1.6% was close to our estimate, the company only saw rate go up 2.1% compared with our up-4.0% estimate. Expenses were also higher than we expected as labor costs were up almost 4% and Ventas had to increase marketing expenses across the portfolio to hold on to as much occupancy as they could in the face of new supply. The company did raise the low-end of same-store NOI growth by 1% to a new range of down 3% to down 1%, but even at the midpoint that implies the second half of the year will be down 3% compared with our estimate of down 1.1%. Ventas is having to deal with peak levels of supply and we may need to adjust our already negative outlook on 2018 for the sector.

Despite the negative performance in senior housing for the quarter, we continue to see glimmers of light at the end of the tunnel for the space. Management pointed out that construction starts in the second quarter were the lowest amount since 2012 and are now less than half of the level they reached at the peak in 2015. Considering that the peak construction starts are delivering now and causing 2018's negative performance, we should see supply come down significantly over the next few years. Management said the annualized level of starts in their trade areas represent just 1.6% of inventory, which is below the current 2% growth rate of the 80-plus population. Additionally, the first members of the baby boomer generation will turn 75 in 2022, which will quickly ramp up demand for senior-housing properties. While the 2018 numbers are disappointing, the short-term results do not alter our long-term view that the sector is bound for a major supply-demand inflection in the next few years.