Undervalued Dividend Growth Stock of the Week: Ventas (VTR)

Investors don’t have to predict the future.

We simply have to look around our world, then make educated assumptions about where things are going.

When I look around, I see a multitude of long-term, global trends.

These trends are inescapable.

They’re also profitable.

I can’t predict the future. Nobody can.

But successful investors don’t bother trying.

We instead take advantage of the obvious around us.

I did just that on my way to going from below broke at 27 years old to financially free and retired at 33, as I lay out in my Early Retirement Blueprint.

It was obvious that having a job until I was old and used up wasn’t a very nice idea.

So I found an obvious investment strategy that changed my life.

That strategy is dividend growth investing.

This strategy advocates buying up shares in world-class enterprises that pay reliable and rising cash dividends.

After all, shareholders are the collective owners of any publicly-traded company.

And it’s obvious that they deserve their fair share of growing profit – hence, growing dividends.

The strategy unlocked financial freedom for me, allowing me to build my real-money FIRE Fund in the process.

Jason Fieber's Dividend Growth PortfolioI would buy shares in some of the best businesses that can be found on the Dividend Champions, Contenders, and Challengers list.

And I’d make sure to pay the appropriate price.

Because it’s obvious that you should always aim to get the best possible deal on anything you buy – especially stocks.

Price is what you’ll pay, but value is what you’ll get.

An undervalued dividend growth stock should provide a higher yield, greater long-term total return potential, and reduced risk. 

This is relative to what the same stock might otherwise provide if it were fairly valued or overvalued.

Price and yield are inversely correlated. All else equal, a lower price will result in a higher yield.

That higher yield correlates to greater long-term total return potential.

This is because total return is simply the total income earned from an investment – capital gain plus investment income – over a period of time.

Prospective investment income is boosted by the higher yield.

But capital gain is also given a possible boost via the “upside” between a lower price paid and higher estimated intrinsic value.

And that’s on top of whatever capital gain would ordinarily come about as a quality company naturally becomes worth more over time.

These dynamics should reduce risk.

Undervaluation introduces a margin of safety.

This is a “buffer” that protects the investor against unforeseen issues that could detrimentally lessen a company’s fair value.

It’s protection against the possible downside.

Buying above-average dividend growth stocks at below-average valuations can lead to phenomenal long-term wealth and passive income creation.

Fortunately, the valuation part of the equation is actually easier than it might first appear to be.

Fellow contributor Dave Van Knapp has made it even easier, via the introduction of Lesson 11: Valuation.

Part of a comprehensive series of “lessons” on DGI, Lesson 11 spells out how to value just about any dividend growth stock out there.

With all of this in mind, let’s take a look at a high-quality dividend growth stock that appears to be undervalued right now…

Ventas Inc. (VTR)

Ventas Inc. (VTR) is a real estate investment trust that invests in health care facilities that include seniors housing, specialty care facilities, medical office buildings, and hospitals.

The company owns approximately 1,200 properties in the US and Canada. 735 properties are seniors housing, representing the largest class of properties for Ventas.

The company’s NOI breaks down as follows: 54%, Seniors Housing; 27%, Office; 7%, Inpatient Rehabilitation (IRF) and Long-Term Acute Care (LTAC); 6%, Health Systems; 4%, Loans; 1%, International Hospitals; 1%, Skilled Nursing.

I noted earlier how important it is to take advantage of the obvious, instead of trying to predict the future (which is impossible).

Well, it doesn’t get much more obvious than the fact that humans age and often need professional assistance in old age.

In fact, there are more people growing older.

America is getting larger.

The USA had an estimated population of approximately 329 million people as of November 2018. That’s up ~6.5% from approximately 309 million people in 2010.

America is also getting older. According to the US Census Bureau, its median age was 38.2 years old in 2018, compared to 37.2 years in 2010.

Furthermore, there are approximately 74 million people in the Baby Boomer generation (born between 1946 and 1964), which represents America’s largest generation.

That’s a lot of people. And many of them will almost certainly need access to the facilities that Ventas owns.

This bodes well for shareholders.

Dividend Growth, Growth Rate, Payout Ratio and Yield

It also bodes well for the company’s ability to pay out those reliable and rising cash dividends.

As it sits, Ventas has increased its dividend for nine consecutive years.

The 10-year dividend growth rate is 5.9%, which is a very solid when you consider that it’s coming on top of a yield of 5.49%.

That yield, by the way, is almost 30 basis points higher than the stock’s own five-year average yield.

Assuming a static valuation, the sum of yield and dividend growth should equate to annualized total return.

That’s a 10%+ annualized total return, with much of it coming in the form of a fat dividend.

However, it must be noted that Ventas recently declared a fourth quarter dividend that was unchanged from the third quarter dividend.

The fourth quarter is usually when Ventas raises its dividend, indicating that the dividend is now “frozen”.

I wouldn’t expect this dividend freeze to remain in place for long, though, as Ventas simply has to work through some supply issues that have been challenging senior housing.

The payout ratio is 82.4% of the FY 2019 FFO/share midpoint guidance of $3.845.

It might look high against a more typical EPS payout ratio, but REITs typically operate with high payout ratios against FFO/share. REITs are legally obligated to pay out at least 90% of taxable net income to shareholders in the form of a dividend.

This payout ratio is really only slightly elevated off of recent numbers from Ventas. And the dividend is certainly secure right now.

Of course, we invest in where a company is going, not where it’s been.

Revenue and Earnings Growth

I’ll now build out a growth trajectory for Ventas, which will help us determine how much the stock might be worth.

This trajectory will largely rely on a 10-year top-line and bottom-line growth track record from Ventas, and I’ll also show you a professional near-term growth forecast that will be weighed against that.

Blending the proven past with a future forecast like this should allow us to extrapolate a reasonable growth projection.

Ventas grew revenue from $936 million to $3.721 billion from FY 2009 to FY 2018.

That’s a compound annual growth rate of 16.57%.

This is obviously highly, highly impressive.

That said, REITs often do put up some huge top-line growth numbers, as a REIT is basically a growth vehicle.

In order to fund that growth, they rely on regularly issuing debt on equity. That’s because of the aforementioned legal structure that forces them to return a lot of cash flow back to shareholders.

Thus, it’s particularly vital to view a REITs growth through a per-share prism (and also keep an eye on the debt).

That per-share growth is looked at in terms of funds from operations per share (FFO/share), which is a more accurate measure of a REIT’s growth than looking at earnings per share (due to limitations/skewing of GAAP EPS for REITs).

FFO/share for Ventas expanded from $2.58 to $3.64 over this period, which is a CAGR of 3.90%.

So we now see a clearer picture of what’s happening here at Ventas.

The outstanding share count more than doubled over the last decade, reducing much of that blistering top-line growth.

Now, a long-term 4% FFO/share growth rate is still very good for a REIT. Especially when coupled with a starting ~5.5% yield.

Looking forward, CFRA is forecasting a 2% CAGR in FFO/share for Ventas over the next three years.

CFRA sees some continued weakness in the senior housing market. But they believe this will be somewhat offset by the strength in medical offices and triple net leases.

The intense competition in senior housing has led to a lot of supply, and this will take some time to work through.

On the other hand, US demographics are extremely favorable to Ventas over the long run. There’s an oncoming wave of massive demand. It’ll take time to right-size supply and demand, but this is a monumental generational shift.

A near-term slowdown is certainly possible. Even likely, based on some of the recent results from Ventas, as further evidenced by the dividend freeze.

Business does ebb and flow. We’re in an ebb here. But I think Ventas will sooner rather than later return to a flow more on par with their long-term average.

Meantime, the dividend is secure. And they are in a position to modestly grow it.

I would expect something closer to a low-single-digit dividend growth rate over the long term, with perhaps a slower ramping up over the next year or two.

The 10-year DGR was a bit too aggressive when we look at FFO/share growth over that same time frame. This has had the effect of causing an elevated, although not dangerous, payout ratio.

With the current near-term forecast calling for low-single-digit FFO/share growth, the dividend is unlikely to grow faster than that.

Financial Position

Moving over to the balance sheet, the REIT is in good shape.

They have $22.6 billion in assets against $12.4 billion in liabilities.

Their senior unsecured debt has investment-grade ratings from the three major ratings agencies: Standard & Poors, BBB+; Moody’s, Baa1; Fitch, BBB+.

The fixed charge ratio is almost 5.

I usually like to show profitability metrics, but they’re tough to gauge for a REIT. That’s because GAAP numbers often don’t apply or don’t show an accurate picture of results.

There’s a lot to like about Ventas.

The demographics tailwind is just now starting to gust. Sure, there are some supply issues to work through. But the demand is already there, and it will almost certainly increase.

What’s really interesting about Ventas is that it’s an investment into two areas that have been massive long-term wealth creators for investors: healthcare and real estate.

When you buy Ventas stock, you’re simultaneously investing in both.

Of course, there are some risks to consider.

Regulation, competition, and litigation are omnipresent risks in every industry.

Regulation is of particular concern to Ventas. Any kind of major healthcare reform would likely impact them.

There’s also the risk of technology encroaching on the business model, by way of technology making it easier for seniors to stay at home. Technology that makes a number of services “on-demand”, such as food and assistance, could greatly improve the mobility and autonomy of seniors.

Finally, any rise in interest rates will affect both the business and the stock.

Rising rates would make debt servicing more expensive.

And higher yields on competing investments could make Ventas shares less appealing.

Stock Price Valuation

Overall, this seems like a fantastic long-term investment if one can buy shares at an attractive valuation.

Well, the valuation looks attractive right now…

The P/FFO ratio is sitting at 15.02.

That’s based on FY 2019 FFO/share midpoint guidance.

With the broader market’s P/E ratio closer to 20, this stock appears to be a rare bargain.

The P/S ratio of 5.6 is also well off of the stock’s own five-year average P/S ratio of 6.2.

There’s also the P/CF ratio, which is 14.6. That’s notably lower than the 15.6 three-year average.

And the yield, as noted earlier, is quite a bit higher than its own recent historical average.

So the stock does look cheap. But how cheap might it be? What would a reasonable estimate of intrinsic value look like? 

I valued shares using a dividend discount model analysis.

I factored in an 8% discount rate (due to the high yield) and a long-term dividend growth rate of 3%.

That DGR is about half of what Ventas has done with its dividend growth over the last decade.

However, as I noted, I think they were too aggressive with dividend growth, leading to the frozen dividend they have now.

The payout ratio is elevated, but it’s not dangerously high.

But I believe it would be prudent to grow the dividend in line with FFO/share.

I’m balancing the long-term FFO/share growth of ~4% against the near-term forecast for 2% FFO/share growth. So I’m splitting the difference here.

The dividend growth might come in lower than this over the near term. But I think there’ll be a ramping up, and I believe that Ventas is capable of growing its dividend in this low-single-digit range for the long haul.

The DDM analysis gives me a fair value of $65.30.

The reason I use a dividend discount model analysis is because a business is ultimately equal to the sum of all the future cash flow it can provide.

The DDM analysis is a tailored version of the discounted cash flow model analysis, as it simply substitutes dividends and dividend growth for cash flow and growth.

It then discounts those future dividends back to the present day, to account for the time value of money since a dollar tomorrow is not worth the same amount as a dollar today.

I find it to be a fairly accurate way to value dividend growth stocks.

I was being anything but aggressive with my valuation, yet the stock still looks very cheap here.

But we’ll now compare that valuation with where two professional stock analysis firms have come out at.

This adds balance, depth, and perspective to our conclusion.

Morningstar, a leading and well-respected stock analysis firm, rates stocks on a 5-star system.

1 star would mean a stock is substantially overvalued; 5 stars would mean a stock is substantially undervalued. 3 stars would indicate roughly fair value.

Morningstar rates VTR as a 4-star stock, with a fair value estimate of $64.00.

CFRA is another professional analysis firm, and I like to compare my valuation opinion to theirs to see if I’m out of line.

They similarly rate stocks on a 1-5 star scale, with 1 star meaning a stock is a strong sell and 5 stars meaning a stock is a strong buy. 3 stars is a hold.

CFRA rates VTR as a 4-star “BUY”, with a 12-month target price of $66.00.

We have a very tight consensus here. Averaging the three numbers out gives us a final valuation of $65.10, which would indicate the stock is possibly 13% undervalued.

Bottom line: Ventas Inc. (VTR) is a high-quality real estate investment trust with a huge demographics tailwind at its back. With a market-smashing 5.5% yield, nine consecutive years of big dividend raises, and the potential that shares are 13% undervalued, this stock should be on every dividend growth investor’s radar right now.

-Jason Fieber

Note from DTA: How safe is VTR’s dividend? We ran the stock through Simply Safe Dividends, and as we go to press, its Dividend Safety Score is 68. Dividend Safety Scores range from 0 to 100. A score of 50 is average, 75 or higher is excellent, and 25 or lower is weak. With this in mind, SPG’s dividend appears Safe with a very unlikely risk of being cut. Learn more about Dividend Safety Scores here.

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