Capital Senior Living released its second quarter earnings yesterday, and there was some good news with the bad. On the good news front, occupancy has increased from the February low of 75.3% to 81.8% at the end of July, for a whopping 650 basis point increase. That is among the best we have heard in the industry. Some of the increase came from discounting early on in the recovery, and management said these incentives have begun to decline.
The bad news on the occupancy front is that the rate of increase has significantly slowed. April saw a 143-basis point increase, followed by 134 bps in May, and then slowed to 85 in June and a paltry 25 in July. Now, as we have statistically proved, historically, the third quarter is the strongest quarter for census gains for the industry, and this is not the way to start the quarter, especially when leads and tours have been peaking. July should have been much higher, but there was no explanation.
Other good news is that they have extended by one year a $45 million bridge loan, that was due this December, which eases some liquidity concerns. They have the ability to extend it a bit after that, as well. But the debt level of the company is still too high, and total debt continues to exceed the value of the 60 owned communities. Let us explain.
Total debt is just under $800 million, but at least the average interest expense is low. The problem is the cash flow, even with the second quarter census increase. Annualizing the second quarter cash flow and deducting a 5% management fee (much less than their 19% of revenues G&A expense), we derive a value just over $510 million using a 6% cap rate, which would be a low cap rate for the portfolio. And this cash flow excludes a capex reserve. That is a far cry from the debt outstanding.
With average rates just above $3,500 per month, each 100-basis point increase in census, assuming an incremental margin of 70% on that increase (they assume 60%), would yield about $30 million of incremental value using that low 6% cap rate (assuming all else stays the same). That is a lot of 100-basis point increases to make up the differential between the value of the assets today and the debt outstanding. And we know that will not happen in the first quarter next year, which is always a down quarter for census. So, if the new investment by Conversant Capital is approved by shareholders in the fourth quarter, they will have the cash to make the census and necessary capex push, but will it be enough? That is the $64 question. If they are losing momentum in census to start the third quarter, it may be a slower go than anyone wants to admit.
The one thing that we didn’t like was that in the earnings report, on the last page, they report an 860-basis point sequential increase in operating margin from the first quarter to the second. That is basically impossible to do, especially in these times. When asked by the one analyst on the call, they explained that the expenses in the second quarter excluded real estate taxes and insurance expense, even though the footnote simply said management fees and transaction/conversion costs were excluded. And by the way, they said they have always excluded taxes and insurance. Wrong.
They have always included them in this table in the supplemental, and the first quarter expenses in the table in the earnings release included them. How do $36.1 million in reported expenses both include (first quarter) and exclude (second quarter) real estate taxes and insurance? They don’t. So why report a 40% sequential increase in your operating margin when the comparison is apples to oranges? That should have stuck out like a sore thumb to anyone reviewing the numbers (alas, there is still no CFO). If it was a careless clerical mistake, then own up to it, but don’t present your numbers that show to an unwitting investor that your operating margin posted an 860-basis point sequential increase. It did not. Talk about misleading. If our understanding is wrong, we would love to hear from management to shed some light on where our analysis took a wrong turn. At this point in their game, management needs transparency, and we are not seeing it.
In addition, they have been clear they have had negative working capital for several years, but accounts payable increased by 47% sequentially, which leads us to believe they have been slow on paying some of their bills, which we suppose is understandable given the situation. But their quarterly cash burn rate is $8.5 million after interest expense but before capex and debt principal payments, and their unrestricted cash is just about $15 million (before the recap). That would give them until the end of the year to operate excluding those other payments, so the recap of the company had better get approved, as expensive as it is and as bad as it is for common shareholders.
As we have said before, there are few other options, and no one else seems to want to belly up to the bar. And where has top shareholder (13.7%) Arbiter Partners Capital Management been all these months? They have already lost their shirt. No better ideas? At least Cap Senior will have one investor who will have a huge, new financial incentive to stay the course. What that course will be is anyone’s guess. Let’s just hope the three-year strategic plan called “SING” (Stabilize, Invest, Nurture, Grow) does not become SINK.
