What to Buy: Leisureworld Senior Care Corp (TSX: LW, OTC: LWSCF)

Why to Buy Now: Leisureworld is one of Canada’s leading owner/operators of senior housing, particularly long-term care (LTC). The small company primarily operates in Ontario, and it’s the second-largest LTC provider in the province.

The LTC business not only has significant barriers to entry thanks to the Canadian government’s stringent licensing requirements, but it also has exceptionally high occupancy rates, averaging 99 percent in the most recent quarter.

Leisureworld should enjoy a significant tailwind as more and more of Canada’s baby boomers retire. Equally important, a substantial portion of the company’s LTC revenue is derived from government funding, which means its core business is supported by a stable, recession-resistant income stream.

And as the company’s long-term growth story unfolds, investors are amply compensated by its CAD0.075 per month payout, which translates into an 8 percent yield at current share prices.

After hitting an all-time high earlier this year, the company’s shares began a protracted selloff in mid-August because its second-quarter results failed to meet analyst expectations. But the selling was overdone, and shares have started rising again, while analyst sentiment has improved markedly following more recent results.

Leisureworld’s shares are still down about 13.6 percent from their year-to-date high, and we believe this offers an attractive entry point. Buy Leisureworld below USD11.85.

Please note this is technically a micro-cap stock, with relatively low trading volume–the average daily trading volume over the trailing three months for the TSX-listed shares was roughly 105,000. Over that same period, the average daily trading volume for the OTC-listed shares was just 6,200.

That means shares may trade at wider bid/ask spreads than larger-cap fare. As such, investors should always employ limits set near the market price to purchase or sell shares.

Ari: Though Canadian firm Leisureworld Senior Care Corp (TSX: LW, OTC: LWSCF) and its predecessors have been in the long-term care business since 1972, it’s only been a public company since March 2010.

We ordinarily prefer names with longer track records as public companies, particularly with regard to navigating different business cycles as well as interest-rate environments, but the ultra-high occupancy rates of Leisureworld’s core long-term care (LTC) business give us confidence.

The company should also enjoy a massive tailwind from favorable demographics. Canada had a post-WWII baby boom of its own, and the ranks of eligible seniors are growing by 4 percent annually. And the wait list for LTC housing in Ontario is currently 20,000. While that might attract competitors, the license required to be an LTC provider in Ontario is a significant barrier to entry.

Even better, the company’s LTC business enjoys a stable, recession-resistant revenue stream from the Canadian government. Roughly 70 percent of the revenue for Leisureworld’s LTC homes comes from government funding, courtesy of Canada’s Ministry of Health and Long-Term Care (MOHLTC).

And the fact that it’s still a relatively small company, with a market capitalization of just USD411 million, means that it has ample room to grow. Equally important, Leisureworld’s CAD0.075 monthly dividend translates into a current yield of 8 percent. So investors are being well compensated while the company’s long-term growth story plays out.

Leisureworld is one of the largest operators of senior housing in Canada and the second-largest long-term care provider in Toronto. The company owns and operates 35 LTC homes in Ontario, with more than 5,700 beds. It also owns and operates 10 retirement residences in Ontario and British Columbia, with 1,065 suites. Finally, under its management services division, it manages over 1,100 LTC beds and nearly 430 retirement suites. Its Preferred Health Care Services subsidiary is an accredited provider of professional nursing and support services.

Khoa: I see the share price is well off its 52-week high. What happened?

Ari: Leisureworld’s shares hit an all-time high of CAD13.13 per share back in April, trading near those levels until mid-August when the company reported results for its Retirement Residence (RR) segment that failed to meet analyst expectations.

Analysts were concerned that the occupancy rates in the RR segment had declined from the prior quarter. Management noted that some of the attrition was due to residents leaving because they required greater care. The company is now working to provide such services to residents in this segment, which should boost retention while providing additional revenue.

As a result, the firm’s shares took a hit, falling as much as 21.8 percent, to CAD10.27 in early November. They’ve recovered somewhat since then, recently trading near CAD11.34, though at that level, they’re still down about 13.6 percent from the aforementioned all-time high. We think investors overreacted and that the stock’s swoon provides an attractive entry point.

Khoa: What’s the breakdown on each segment’s contribution to the bottom line?

Ari: Although the RR segment accounts for a relative sliver of the company’s revenue, at around 7.2 percent in the most recent quarter, its higher margins mean that it delivers an outsize contribution toward net operating income (NOI), recently 19.6 percent of overall NOI.

The RR segment’s average occupancy rate for the third quarter was 78.5 percent, up 3.7 percentage points from a year ago. On a year-to-date basis, the division’s occupancy rate has averaged 76.8 percent, up 4.1 percentage points from a year ago.

Leisureworld’s LTC segment accounted for 81.3 percent of third-quarter revenue and 75.5 percent of NOI, while its Home Care division contributed 4.6 percent toward revenue and 4.9 percent to NOI. Occupancy rates for the company’s LTC segment averaged 99 percent for the third quarter and 98.9 percent on a year-to-date basis. Both results were essentially flat compared to a year ago.

Khoa: It’s hard to improve too much from a 99 percent occupancy rate! But what about the company’s bottom line?

Ari: It’s important to note that since going public the company has yet to turn a profit. That may sound like a deal killer, but it’s not uncommon for tiny companies at this stage to be unprofitable even as they’re still growing.

The important thing is the trajectory of both revenue and profits, which is upward for both measures. Revenue has consistently grown since the company’s 2010 initial public offering (IPO), from 213.6 million in 2010 to a projected 351 million for full-year 2013. Meanwhile, earnings have improved from a loss of -0.41 per share in 2010 to a projected loss of -0.205 per share for full-year 2013.

For the third quarter, the company’s NOI rose 6 percent year over year, to CAD16.2 million, while on a year-to-date basis NOI is up 10.6 percent, to CAD45.8 million, versus the comparable year-ago period.

And diluted funds from operations (FFO) per share climbed 8 percent, to CAD0.264, excluding the impact of Leisureworld’s subscription receipts, which were issued to help finance its acquisition of Specialty Care Inc, which closed earlier this month. These instruments are currently recorded as a liability, but will eventually be converted to common shares.

Khoa: I understand that acquisition is a bit of a game changer for the company.

Ari: Indeed! The acquisition increases the bed count in Leisureworld’s LTC segment by 28 percent and raises the suite count in the RR division by 44 percent. Management expects the acquisition to be 14 percent accretive to the company’s adjusted funds from operations per share during its first full year of operations.

As such, analysts are forecasting an even better 2014. According to Bloomberg, Revenue is forecast to rise 29 percent in 2014, to CAD454.3 million, while adjusted earnings per share are expected to jump 54 percent, for an even narrower loss of -0.07 per share.

As a result, Bay Street is exhibiting more bullish sentiment toward the stock, with six analysts currently rating the stock a “buy,” four “holds” and no “sells.” Earlier this year, by contrast, when the stock was trading near its all-time high, it had two “buys,” seven “holds” and one “sell,” while after its second-quarter results disappointed, it had four “buys,” five “holds” and one “sell.”

Clearly, analysts have largely overcome their earlier misgivings and believe the shares currently trade at an attractive entry point. Indeed, their consensus 12-month target price is CAD12.79, which suggests a potential return of 13.2 percent above the current share price. These expectations largely comport with the type of stocks we seek for our Portfolio: securities that offer moderate price appreciation accompanied by a high payout that’s sustainable over the medium to long term.

Khoa: How well is the payout covered and what are the prospects for future dividend growth?

Ari: Leisureworld paid its first dividend shortly after its IPO in early 2010. Since then, it’s boosted its payout once, by 6 percent earlier this year, taking its monthly payout to CAD0.075 from CAD0.0708. The company’s payout ratio based on adjusted funds from operations (AFFO) was 73.8 percent for the third quarter and 77 percent for the first nine months of the year. At those levels, future dividend growth will likely be modest, though the payout is reasonably well covered.

Khoa: What should investors expect with regard to taxation on dividends?

Ari: Before proceeding, it should be noted that we’re not tax professionals, and that subscribers should consult their accountant or tax advisor to confirm the treatment of these dividends.

Our understanding is that thanks to the tax treaty between the US and Canada, the Canadian government withholds just 15 percent of the payout (as opposed to the 25 percent rate that would prevail without the agreement). Depending on their individual tax situation, investors should be able to recover some or all of that amount in the form of a credit at tax time by filing Form 1116.

Once the amount withheld by the Canadian government is offset by a credit, most investors should just be liable for the US dividend tax rate of 15 percent. Of course, that rises to 20 percent if your taxable income exceeds $400,000 as an individual or $450,000 as a couple.

The Canadian Revenue Agency (CRA) implemented a new rule earlier this year that requires US investors to file Form NR301 through their brokers in order to receive the reduced rate of withholding. Follow this link to learn more about the form and its requirements.

Finally, since Leisureworld is organized as a corporation, individual retirement accounts (IRA) and other tax-advantaged retirement accounts should be exempt from the Canadian government’s withholding.

Buy Leisureworld below USD11.85. Please note this is technically a micro-cap stock, with relatively low trading volume–the average daily trading volume over the trailing three months for the TSX-listed shares was roughly 105,000. Over that same period, the average daily trading volume for the OTC-listed shares was just 6,200.

That means shares may trade at wider bid/ask spreads than larger-cap fare. As such, investors should always employ limits set near the market price to purchase or sell shares.