New Zealand Professional Investment Services Firm

Forsyth Barr

We are proud to be a New Zealand owned firm, with 21 offices throughout the country and over 300 employees. We assist personal, institutional and corporate clients providing a full range of investment services.

Forsyth Barr is a foundation New Zealand Exchange firm (NZX) and accredited market participant. We have been confirmed by the Financial Markets Authority as a Qualifying Financial Entity (QFE).

Research is the cornerstone of our advice. We have one of New Zealand's leading teams of analysts. Our global affiliations ensure comprehensive research coverage of all major investment markets.

New Zealand Professional Investment Services Firm, Forsyth Barr

Equity Bottom-Up

<h2>Aged Care<br>Valuation Support versus Negative Momentum</h2>
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<p>Omicron has arrived in NZ and with it an acceleration of the&nbsp;underperformance&nbsp;in the aged care names, now down approximately -20% over the last three months, under performing the S&amp;P/NZX 50 Index by around -10%.&nbsp;We believe the sell-off is a combination of (1) nervousness around residential house prices, and (2)&nbsp;fears around what the consequences of Omicron will be for the sector. Neither of these issues are likely to go away short term, however, valuation support is starting to look very strong, particularly for the smaller aged care names. Near-term&nbsp;we see momentum keeping the upper hand&nbsp;but on a 12 month and longer-term view&nbsp;we continue to view the aged care sector as attractive.&nbsp;During&nbsp;the 2020 COVID-19 sell-off, the aged care names sold off very aggressively but recovered quickly.</p>
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<h3>Omicron is here, short-term headwinds are material, medium-term cost pressures will likely persist&nbsp;</h3>
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<p>On Sunday, January 23, New Zealand was placed into the red traffic light setting due to community spread of Omicron. For the aged care sector, as discussed in our strategy report "Omicron — Ready or Not", published on January 20, this will impact the sector primarily in two ways; (1) sales activity is likely to reduce significantly during the acute phase of the outbreak, which could last for several months, and (2) operating expenses are likely to increase. With respect to fundamental value, we foresee a modest impact. The aged care sector has navigated previous outbreaks relatively unscathed and has the benefit of almost two years of preparation. However, this outbreak will be different and meaningful outbreaks at aged care facilities are highly likely.&nbsp;&nbsp;</p>
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<h3>House price risks increasing</h3>
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<p>The New Zealand&nbsp;aged care names make the majority of their underlying earnings&nbsp;from new sales and&nbsp;resales&nbsp;of independent living units (ILUs) which are highly geared to house prices.&nbsp;We are of the view that the risks of a meaningful house price correction has increased significantly over the last six months. However, the aged care names have only modestly started to eat into the ~+45% national house price appreciation experienced since prior to COVID-19.&nbsp;Hence, we see the risks around house prices to primarily be one of multiple contraction (a proportion of which we view has most likely already occurred) rather than earnings. Our base case is for largely flat residential house prices which should be enough to support strong growth in underlying earnings for at least another 24 months. The Omicron outbreak may blur this picture during the May (March year-end) earnings season, underpinning our view that negative momentum will dominate near-term.&nbsp;</p>
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<h3>Valuation support near record levels&nbsp;</h3>
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<p>The aged care names are currently valued at an average P/E of ~15x and a P/B of ~1.35x —&nbsp;near record low levels in recent years (excluding the March 2020 sell-off). Oceania&nbsp;Healthcare&nbsp;(OCA) is currently valued below book value, and&nbsp;Arvida&nbsp;(ARV) just above book value, a book value which we expect to continue to increase despite house price growth stalling.&nbsp;We continue to prefer the smaller (and lower valued) aged care names and rate both OUTPERFORM.&nbsp;We also believe&nbsp;Ryman&nbsp;Healthcare&nbsp;(RYM's)&nbsp;high leverage and high (relative) valuation makes it more susceptible even on a medium to longer-term basis and reiterate our UNDERPERFORM rating.&nbsp;</p>
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<h3>Reducing earnings estimates</h3>
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<p>We reduce our FY22 estimates by an average of ~-20% due to our expectations of meaningfully lower&nbsp;resales&nbsp;and new sales in Q1CY22 as well as higher operating costs. We have also reduced our FY23 and FY24 estimates by&nbsp;~-10% primarily reflecting our expectations that higher&nbsp;costs, operational and construction,&nbsp;will be sticky.&nbsp;Our target prices&nbsp;decline by ~-6%&nbsp;reflecting the lowered estimates, partly offset by roll forward of our target price period.&nbsp;</p>
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Aged Care Valuation Support versus Negative Momentum


Omicron has arrived in NZ and with it an acceleration of the&nbsp;underperformance&nbsp;in the aged care names, now down approximately -20% over the last three months, under performing the S&amp;P/NZX 50 Index by around -10%.&nbsp;We believe the sell-off is a combination of (1) nervousness around residential house prices, and (2)&nbsp;fears around what the consequences of Omicron will be for the sector. Neither of these issues are likely to go away short term, however, valuation support is starting to look very strong, particularly for the smaller aged care names. Near-term&nbsp;we see momentum keeping the upper hand&nbsp;but on a 12 month and longer-term view&nbsp;we continue to view the aged care sector as attractive.&nbsp;During&nbsp;the 2020 COVID-19 sell-off, the aged care names sold off very aggressively but recovered quickly.


Omicron is here, short-term headwinds are material, medium-term cost pressures will likely persist&nbsp;


On Sunday, January 23, New Zealand was placed into the red traffic light setting due to community spread of Omicron. For the aged care sector, as discussed in our strategy report "Omicron — Ready or Not", published on January 20, this will impact the sector primarily in two ways; (1) sales activity is likely to reduce significantly during the acute phase of the outbreak, which could last for several months, and (2) operating expenses are likely to increase. With respect to fundamental value, we foresee a modest impact. The aged care sector has navigated previous outbreaks relatively unscathed and has the benefit of almost two years of preparation. However, this outbreak will be different and meaningful outbreaks at aged care facilities are highly likely.&nbsp;&nbsp;


House price risks increasing


The New Zealand&nbsp;aged care names make the majority of their underlying earnings&nbsp;from new sales and&nbsp;resales&nbsp;of independent living units (ILUs) which are highly geared to house prices.&nbsp;We are of the view that the risks of a meaningful house price correction has increased significantly over the last six months. However, the aged care names have only modestly started to eat into the ~+45% national house price appreciation experienced since prior to COVID-19.&nbsp;Hence, we see the risks around house prices to primarily be one of multiple contraction (a proportion of which we view has most likely already occurred) rather than earnings. Our base case is for largely flat residential house prices which should be enough to support strong growth in underlying earnings for at least another 24 months. The Omicron outbreak may blur this picture during the May (March year-end) earnings season, underpinning our view that negative momentum will dominate near-term.&nbsp;


Valuation support near record levels&nbsp;


The aged care names are currently valued at an average P/E of ~15x and a P/B of ~1.35x —&nbsp;near record low levels in recent years (excluding the March 2020 sell-off). Oceania&nbsp;Healthcare&nbsp;(OCA) is currently valued below book value, and&nbsp;Arvida&nbsp;(ARV) just above book value, a book value which we expect to continue to increase despite house price growth stalling.&nbsp;We continue to prefer the smaller (and lower valued) aged care names and rate both OUTPERFORM.&nbsp;We also believe&nbsp;Ryman&nbsp;Healthcare&nbsp;(RYM's)&nbsp;high leverage and high (relative) valuation makes it more susceptible even on a medium to longer-term basis and reiterate our UNDERPERFORM rating.&nbsp;


Reducing earnings estimates


We reduce our FY22 estimates by an average of ~-20% due to our expectations of meaningfully lower&nbsp;resales&nbsp;and new sales in Q1CY22 as well as higher operating costs. We have also reduced our FY23 and FY24 estimates by&nbsp;~-10% primarily reflecting our expectations that higher&nbsp;costs, operational and construction,&nbsp;will be sticky.&nbsp;Our target prices&nbsp;decline by ~-6%&nbsp;reflecting the lowered estimates, partly offset by roll forward of our target price period.&nbsp;


Aged Care: Valuation Support Versus Negative Momentum

Ryman Healthcare

Aged Care: Valuation Support Versus Negative Momentum