New Zealand Professional Investment Services Firm

Forsyth Barr

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New Zealand Professional Investment Services Firm, Forsyth Barr

Equity Bottom-Up

<h2>Aged Care Sector<br>FY22 Preview; Low Expectations</h2>
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<p>The three more care exposed aged care operators&nbsp;Arvida&nbsp;(ARV), Oceania&nbsp;Healthcare&nbsp;(OCA), and&nbsp;Ryman&nbsp;Healthcare&nbsp;(RYM) report&nbsp;full year FY22 earnings over the next two weeks.&nbsp;After a difficult six months with average share prices down ~-30%&nbsp; we believe expectations have been sufficiently lowered, notwithstanding some material headwinds.&nbsp;We expect focus to be on; (1) inflationary cost pressures in general, but particularly for care staff. We estimate that care EBITDA&nbsp;will halve in FY22 relative to FY21; (2) exposure to higher debt funding costs. We estimate current average debt cost of around 3–4%, approximately half of current market rates,&nbsp;path to&nbsp;market rates will be important; and (3) comments on ability to hold (or even continue to raise) unit prices given&nbsp;the rapidly weakening housing market.</p>
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<h3>Care EBITDA margins likely to halve&nbsp;— focus on the path ahead</h3>
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<p>We estimate that "fully loaded" care earnings will halve on average in FY22 over FY21&nbsp;driven by increased care costs. Some of the cost increase will be of one off in nature, and we will pay particular attention to forward looking comments in relation to operating expenses.&nbsp;We expect OCA to fare substantially better than ARV and RYM due to its fast growing care suite model, with care EBITDA down "only" -25%,&nbsp; including cost allocation for "other costs"&nbsp;while we expect it to more than halve for RYM and ARV.&nbsp;This is&nbsp;offset by the fact that OCA is much more exposed to care earnings than the other two operators.&nbsp;</p>
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<h3>Cleaning for ifs and buts, we expect declining earnings for OCA and RYM but increasing for ARV&nbsp;</h3>
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<p>ARV made a major acquisition&nbsp;(Arena Living) and raised equity last year, OCA made a minor acquisition (Waterford), raised equity at the very end of FY21, and&nbsp;also changed fiscal year end so is effectively comparing against a 10 month year.&nbsp;Adjusting for these factors we&nbsp;are looking for organic underlying "like for like" earnings growth of +6% for ARV&nbsp;but a&nbsp; ~-10% decline&nbsp;for OCA and RYM. For OCA the decline is driven by higher exposure to care and for RYM it is a combination of higher interest expense, depreciation and&nbsp; corporate costs. Our main focus is on annuity EBITDA which we expect to grow meaningfully for the first time in five years for RYM.&nbsp;We are at the bottom end of Visible Alpha consensus for ARV and RYM primarily due to higher costs. OCA does not have Visible Alpha consensus but we are at the low end of&nbsp;Eikon&nbsp;consensus.&nbsp;</p>
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<h3>Interest expense&nbsp;— an ignored line item about to make a comeback&nbsp;</h3>
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<p>The aged care operators in general and RYM in particular have added substantial amounts of debt over the last couple of years. The interest expense has not been in focus as; (1) interest rates have been continuously falling, and (2) a large proportion (50–70%) is capitalised. We believe this is about to change. We estimate that applying today's market rates of 5–6% would reduce RYM's underlying earnings by 10–15% and reduce already negative cash flow by &gt;NZ$50m per annum. The impact for ARV is less, as it is paying higher rates today and is less levered. OCA also likely have a significantly smaller impact but we do not have disclosure about capitalised interest expense. We will look for comments around path to normalisation and potential de-leveraging considerations.&nbsp;</p>
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Aged Care Sector FY22 Preview; Low Expectations


The three more care exposed aged care operators&nbsp;Arvida&nbsp;(ARV), Oceania&nbsp;Healthcare&nbsp;(OCA), and&nbsp;Ryman&nbsp;Healthcare&nbsp;(RYM) report&nbsp;full year FY22 earnings over the next two weeks.&nbsp;After a difficult six months with average share prices down ~-30%&nbsp; we believe expectations have been sufficiently lowered, notwithstanding some material headwinds.&nbsp;We expect focus to be on; (1) inflationary cost pressures in general, but particularly for care staff. We estimate that care EBITDA&nbsp;will halve in FY22 relative to FY21; (2) exposure to higher debt funding costs. We estimate current average debt cost of around 3–4%, approximately half of current market rates,&nbsp;path to&nbsp;market rates will be important; and (3) comments on ability to hold (or even continue to raise) unit prices given&nbsp;the rapidly weakening housing market.


Care EBITDA margins likely to halve&nbsp;— focus on the path ahead


We estimate that "fully loaded" care earnings will halve on average in FY22 over FY21&nbsp;driven by increased care costs. Some of the cost increase will be of one off in nature, and we will pay particular attention to forward looking comments in relation to operating expenses.&nbsp;We expect OCA to fare substantially better than ARV and RYM due to its fast growing care suite model, with care EBITDA down "only" -25%,&nbsp; including cost allocation for "other costs"&nbsp;while we expect it to more than halve for RYM and ARV.&nbsp;This is&nbsp;offset by the fact that OCA is much more exposed to care earnings than the other two operators.&nbsp;


Cleaning for ifs and buts, we expect declining earnings for OCA and RYM but increasing for ARV&nbsp;


ARV made a major acquisition&nbsp;(Arena Living) and raised equity last year, OCA made a minor acquisition (Waterford), raised equity at the very end of FY21, and&nbsp;also changed fiscal year end so is effectively comparing against a 10 month year.&nbsp;Adjusting for these factors we&nbsp;are looking for organic underlying "like for like" earnings growth of +6% for ARV&nbsp;but a&nbsp; ~-10% decline&nbsp;for OCA and RYM. For OCA the decline is driven by higher exposure to care and for RYM it is a combination of higher interest expense, depreciation and&nbsp; corporate costs. Our main focus is on annuity EBITDA which we expect to grow meaningfully for the first time in five years for RYM.&nbsp;We are at the bottom end of Visible Alpha consensus for ARV and RYM primarily due to higher costs. OCA does not have Visible Alpha consensus but we are at the low end of&nbsp;Eikon&nbsp;consensus.&nbsp;


Interest expense&nbsp;— an ignored line item about to make a comeback&nbsp;


The aged care operators in general and RYM in particular have added substantial amounts of debt over the last couple of years. The interest expense has not been in focus as; (1) interest rates have been continuously falling, and (2) a large proportion (50–70%) is capitalised. We believe this is about to change. We estimate that applying today's market rates of 5–6% would reduce RYM's underlying earnings by 10–15% and reduce already negative cash flow by &gt;NZ$50m per annum. The impact for ARV is less, as it is paying higher rates today and is less levered. OCA also likely have a significantly smaller impact but we do not have disclosure about capitalised interest expense. We will look for comments around path to normalisation and potential de-leveraging considerations.&nbsp;


Aged Care Sector: FY22 Preview; Low Expectations