Finding Green in America's Gray


By Amey Stone Investors looking for a play on the aging of America have an obvious choice in Sunrise Senior Living (SRZ). The percentage of the U.S. population made up of people 85 and older is expanding at a rate four times faster than that of the broader population, to about 6 million by 2011. That's clearly a growth market.

And Sunrise, founded in 1981 and based in McLean, Va., is a pioneer in providing the aged with a combination of housing and care in a setting that has as little as possible in common with a traditional nursing home. Aging seniors want to be surrounded by creature comforts in their golden years, and that's what Sunrise aims to provide.

It's increasingly dominant in what for the past several years has been a consolidating industry. In June, 2003, Sunrise acquired Marriott Senior Living, more than doubling its capacity. It now manages nearly 400 complexes with room for nearly 44,000 residents in 27 major U.S. metropolitan areas as well as London, Toronto, and Vancouver. In the past year the average occupancy rate has climbed to 86.2% from 83.8%.

TOO HIGH? Earnings are growing too. According to Sunrise, what it calls "core" earnings per share (which factors out the impact of real estate sales), climbed from 50 cents in 2002 to an estimated $1.06 in 2003. In 2004, it says core earnings should climb to between $1.55 and $1.60.

The stock had a bang-up year in 2003, jumping 56%, from $25 to $39. But so far in 2004, it has suffered a dip, as some investors started to worry that it was getting overpriced. On Jan. 5, Legg Mason analyst Jerry Doctrow downgraded Sunrise to a hold based purely on valuation after it blew past his previous price target of $35. The stock slid to $36 following his call and closed Jan. 9 at $37.62.

Should investors be worried? After all, they've been burned before by getting overly excited about the prospects for companies in the once much-hyped "assisted-living" sector. The group suffered a Internet-style bubble of its own in the late '90s, when investors threw so much capital at the sector that companies made the mistake of overbuilding. Saddled with debt, some went bankrupt, some merged, and many investors lost their shirts.

NEW MODEL. Sunrise, which did a good job avoiding saturated markets, managing its properties, and handling its debt, emerged as a survivor. "In the late 1990s, it did have hiccups, but it was clearly by far the most successful," says Frank Morgan, an analyst with Jefferies & Co., who says Sunrise is still "the standout in the industry."

Long-term financial results are hard to decipher, however, mainly because three years ago Sunrise embarked on a plan to change its business model from owning and operating assisted-living properties to managing them in return for a slice of revenues.

Now near completion, the plan was to sell off its underlying real estate and sign long-term contracts to manage facilities. The goal, which has largely been met, was to reduce debt levels, stabilize earnings, and clear up confusion among investors who worried about Sunrise's exposure to the vagaries of the real estate market.

GROWTH STRATEGY. "We're in the business of providing care to seniors," says Charles Post, Sunrise's senior vice-president for corporate strategy and capital markets. "That's what we're the best at. We're not necessarily the most efficient long-term owner of real estate."

Having sold $1.6 billion in property (mostly to major institutional real estate investors), Sunrise now has only $400 million in real estate remaining on the books. Debt is down by $726 million, and it has $180 million in cash. Sunrise still plans to develop new properties, but it's doing so in joint ventures.

Some pieces are yet to fall into place. Post says future earnings growth, estimated at 15% a year, will come in equal parts from internal expansion (basically improving operations, adding services, and upping occupancy rates at existing properties), building new complexes (including internationally), and signing new third-party management deals.

TIME FOR A BREATHER? Morgan is confident that Sunrise can stay on track and bases his buy rating on the stock on its ability to implement that transition while also building its portfolio of properties. He says Sunrise remains "one of the premier ways to play growth in the elderly population."

However, Doctrow says he still wants to see the Marriott acquisition fully integrated and, most important, wants Sunrise to show it can sign more contracts to manage assisted-living complexes as a third party in the coming year. He notes in his Jan. 5 report that he wouldn't recommend investors buy the stock until he sees progress on both fronts.

After 2003's sharp gains, "We believe it is a reasonable time to let SRZ shares catch their breath," Doctrow wrote. Nonetheless, he concedes that the stock could climb as high as $47 in the next 12 months if Sunrise meets its earnings goals.

A lot has changed at Sunrise and in the assisted-living sector. But "one thing that hasn't changed through all this is that people don't want to live in a nursing home," says Morgan. That means that even though Sunrise's finances aren't simple, buying its stock still seems a straightforward way to play a significant demographic trend. Stone is senior writer for BusinessWeek Online in New York


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