S&P Upgrades Welltower (HCN) to 'BBB+'; Outlook Stable

S&P Global Ratings raised its corporate credit rating on Welltower Inc. (NYSE: HCN) to 'BBB+' from 'BBB'. The outlook is stable. We also raised the issue-level rating on the company's senior unsecured notes to 'BBB+' from 'BBB' and the issue-level rating on the preferred shares to 'BBB-' from 'BB+'.

"The upgrade reflects our favorable opinion of the company's plan to dispose of $3.3 billion of assets in the fourth quarter of 2016. Approximately $1.9 billion of the proceeds are from the sale of SNFs, which are facing a myriad of challenges such as: increased Medicare Advantage enrollees (which results in shorter patient stays and lower fees per day); bundled payments (a focus on patient outcomes rather than on services rendered); overall challenges related to government reimbursement; labor cost inflation; and litigation threats from the Department of Justice. Of the SNF sale proceeds, $1.7 billion was Genesis Healthcare Inc. properties ( previously Welltower's second-largest tenant). Genesis represented 13.7% of Welltower's net operating income (NOI) at the end of the second quarter and it will decline to 7.1% on a pro forma basis," said credit analyst Michael Souers. "Moreover, Welltower has plans to dispose of an additional $620 million of Genesis properties in 2017, which would bring its exposure down further."

Our stable outlook is supported by our view that Welltower's portfolio repositioning efforts have improved the company's asset quality, with significantly less reliance on government reimbursement. We expect cash flows derived from Welltower's large and relatively diverse portfolio are supported by favorable demographics, adequate rent coverage of its triple-net leased assets, and modest lease rollover. Although we continue to expect a rapid pace of growth, primarily from acquisitions, we expect the investments to be financed in a conservative manner, driving down leverage and improving coverage measures. We expect Welltower will maintain FCC in the low- to mid-3x area, debt to undepreciated capital in the high-30% area, and debt to EBITDA in the high-5x range over the next two years.

We would consider lowering the rating should Welltower pursue aggressive debt-financed growth or encounters portfolio/tenant stress that weighs on credit measures, with FCC falling back below 3x and debt to EBITDA rising above 7x for a sustained period.

While unlikely over the next 24 months, we would consider raising the rating on the company by one notch if the company's senior housing operating assets continue to outpace peers and generate low to mid-single-digit NOI growth in the face of industry-wide supply pressures. In addition, we would also need to see Welltower's financial metrics improve further, such that FCC strengthens to around 4x with debt to EBITDA falling to the low-5x area for a sustained period.

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