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I’m looking to build massive passive income in my portfolio by loading up on dividend stocks. But with the global economy teetering on the edge of recession, I want to be sure I choose sturdy shares that can weather any impending economic storms.
In particular, I like real estate investment trusts (REITS) right now because interest-rate rises have beaten down their prices badly. While investors are busy piling into so-called ‘value’ stocks, bidding up their price in the process, I hope to find some unloved REITs in the bargain bin.
The REIT sector includes options as diverse as shopping centres, warehousing, and apartment blocks. I’m anxious to avoid any ‘cyclical’ businesses. That’s because I want to protect myself from accidentally getting on a rollercoaster just as it comes screaming down the tracks.
As grey and unexciting as it sounds, I’m interested in one particular REIT that specialises in care homes: Target Healthcare (LSE:THRL).
As well as offering a fat 8% dividend, Target Healthcare capitalises on a demographic trend. The number of over 85s in the UK is forecast to nearly double to 3.3m over the next 25 years. Sadly, the number of people with dementia is also predicted to rise rapidly, from around 1m currently to 1.6m by 2040.
Target Healthcare is a relatively small fish, with a market cap of £500m. It owns 101 properties across the width and breadth of the UK.
Importantly, its properties are of a high standard, with 96% of rooms having en-suite washing facilities. That is vital for residents’ hygiene, privacy, and dignity. That compares with just 29% of care home rooms in the UK.
In addition, Target Healthcare has 34 different companies renting out its properties, providing a good degree of diversification. Its average lease period spans close to three decades, and annual rental growth is baked into the contracts. That means Target Healthcare has shored up a stable and expanding source of income.
Unfortunately, Target Healthcare has a lot more debt than equity on its books. To be precise, it has 33 times more debt than equity. That is like you or me buying a £250,000 house by putting down a measly deposit of £7,500 (just 3%, when the UK average is 15%) and funding the rest with a bank loan.
With the old world of cheap credit firmly in the rear-view mirror, I am weary of highly leveraged companies. As rates increase, so might Target Healthcare’s repayments. That would squeeze earnings per share, possibly leading to dividend cuts. The company currently pays out 82% of its earnings as dividends. Compression of its bottom line could quickly eat into shareholder payouts.
Target Healthcare’s share price is historically low, trading at 86p today compared with 110p one year ago and 105p at issuance all the way back in 2013.
That leaves the company looking significantly undervalued, with a price-to-book ratio of 0.72.
There’s a lot to like about Target Healthcare. The business benefits from demographic tailwinds, and it is trading at a big discount despite its generous dividend.
Still, I will not be adding it to my portfolio, as I worry how its imprudent use of debt might impact its earnings in a rising interest-rate environment.