Brookdale Senior Living released its second quarter 2023 earnings and seemed to gush with optimism. But remember the old saying, under promise and over perform. While there was some positive news in the quarter, they still have a long way to go.
The first big news was that Adjusted EBITDA increased by 60.5% over the year-ago-quarter to $81.4 million. The bad news was that this was an 8% decline from the first quarter when it was $88.6 million. Revenues increased year over year by 10.9% while facility operating expenses increased by only 3.4%. In this inflationary environment that is quite good. The company is now cash flow positive after lease and interest expense, but before capex.
Other than this, highlights include that occupancy at the end of July was the highest since the pandemic bottom, at 78.5%, which was 10 basis points higher than where it was at the end of last September. RevPOR posted a nice 8.8% increase year over year to $5,939, but this was down slightly from the first quarter.
Some big news was a re-do of their lease expiration with LTC Properties. You may remember that Brookdale informed LTC early this year that they were not going to renew the leases at the end of December, which had an annual lease payment of close to $15 million covering 35 properties, most of which are small. Now, they have come back and negotiated a renewal for 10 of the 35 properties, located in Colorado (six) and Kansas (four) for six years, at an initial lease rate of $8.0 million plus 2% annual escalators. We assume these were the better performing communities in that portfolio to pay that much in rent for a much smaller group.
In addition, there now is a purchase option that can be exercised in 2029, and LTC has committed to fund $4.5 million for capex in the first two years of the lease, at an initial rate of 8%, much like they had done with the entire portfolio in past years. This seems like a win-win. LTC keeps a good tenant they like at a higher rent per building, and Brookdale retains management income from 10 properties with a purchase option.
In other lease news, Brookdale and Welltower agreed to extend the maturity of one lease involving 39 communities from the end of 2026 to June 30, 2032. This amendment did not change the annual payment and kept the annual escalator rate the same. In addition, Welltower will provide up to $17 million for capex. The other lease, for the remaining 35 properties, will be re-classified as an operating lease with no change in net cash payment. They also replaced the net worth covenant with one that is more beneficial to Brookdale. These are all good changes for Brookdale.
Some of the financial improvements came as a result of a decline in underperforming communities. In the first quarter, there were 288 communities with a census of 75% or lower. This improved to “just” 271 communities, or 42% of the portfolio, in the second quarter. If Brookdale is to hit any of its forecasts, these communities need to continue on this trajectory, and quickly. CEO Cindy Baier made a big play about increasing the company’s annual senior housing segment net operating income to $1.1 billion, and what that would do for its value and future.
Annualized 2023 revenue and net operating income are about $2.8 billion and $700 million, respectively, at current census levels. At 84.5% occupancy (pre-pandemic level), that is projected to grow to $3.1 billion and $900 million, respectively. Then, at 89.0% occupancy (historical high), they grow to $3.3 billion and $1.1 billion, respectively.
The problem is that at the upper end, that implies a 35% operating margin, or nearly 1,000 basis points higher than today. We just don’t see them getting there in the next several years, despite the fact that new development is at historic lows and can’t really ramp up for another three years to cause any competitive problems. We believe that comparisons to “pre-pandemic” anything are meaningless because we are in a different world now and we don’t believe industry margins will recover all that was lost during the pandemic. Some companies will, but not the entire sector.
We would love to see Brookdale hit these numbers, for what it would do for its shareholders as well as for the industry. And we would love to help. It’s just going to be a hard and long road. On a day that the overall market was in negative territory, Brookdale’s shares soared by 21% to $4.58. Obviously, investors liked what they saw and heard. Now comes the hard part, delivery.
