Regis Healthcare Ramping Up Developments

This story features REGIS HEALTHCARE LIMITED. For more info SHARE ANALYSIS: REG

-Earnings growth priced in?
-Narrowing distance to peers
-Development & acquisition strategy
 

By Eva Brocklehurst

Aged care provider Regis Healthcare ((REG)) is gearing up to open a net 1,028 new places, expected to deliver a boost to earnings growth. The company updated the market on its development pipeline along with the first half results. The bulk of developments will be delivered from FY17 which resulted in modest guidance for FY16.

First half results were weaker than UBS expected, the key reason being higher staff and interest costs. The broker updates its forecasts to allow for the new places and expects this to deliver 10-11% to profit growth in FY17 and FY18.

The broker does not believe there is substantial risk associated with the trend decline in RADs (refundable accommodation deposits). Government changes in July 2014 created a slight shift in resident preference for DAPs (daily accommodation payments) but, as resident preferences tend to be sticky, the broker does not envisage any changes in preference are enough to cause balance sheet risk.

The government is set to review the current aged care funding environment this year and outcomes should be set out in late 2017. UBS rates the chance of further negative funding changes before then as low.

In evaluating the non-organic growth in the aged care sector, in the form of acquisitions or developments, UBS believes traditional measures of returns do not properly account for the timing difference in income from either strategies. The broker uses an internal rate of return (IRR) measure and concludes that acquisitions actually provide better shareholder value.

The broker believes the current market has priced in the earnings growth in the stock, as Regis Healthcare is trading on the highest multiple with the lowest growth outlook in the sector. The company is a high quality operator with a strong track record and, while it is appropriate for the market to ascribe a premium for greater certainty, UBS believes the stock is fully priced at current levels.

RAD inflows fell slightly short of Deutsche Bank's expectations and are expected to remain subdued in the second half. Nevertheless the broker remains confident the development pipeline will deliver stronger income in FY17, as a number of newly developed sites open.

This should support a return to double digit earnings growth and a stable debt profile. The uplift in staff costs offset some of the benefits of refurbishment payments and higher DAP payments, the broker contends.

The increased preference for DAPs and the large capital expenditure incurred in the first half resulted in a weaker net cash position and, while this is not expected to reverse in the second half, Deutsche Bank remains confident it will stabilise as new facilities are opened in FY17.

Payment preferences among industry peers suggest a trend towards a combination of RAD/DAP. RADs are a standard bond price set by the facility while the DAP is the equivalent which is paid periodically. The proportion of incoming residents opting for a combination of payments is now 41% versus 28% in the prior half. Those electing a RAD only payment fell to 51% from 68%.

Deutsche Bank notes Regis Healthcare has a much lower proportion of RAD-only payments and higher proportion of RAD/DAP combination payments that its listed peers.

Morgans is happy with the results and the guidance that promises the second half will be similar to the first. Minor reductions are made to forecasts relating to higher depreciation charges.

The broker previously applied a 10% premium to valuation to set its price target but has now halved that premium, given the valuation gap to other listed players is closing. The price target falls to $5.73 from $6.00 and as the shares are trading within 10% of that target the rating is moved down to Hold from Add.

The broker remains a strong supporter of the aged care sector and will look for any price weakness as an opportunity to upgrade. Upside risk comes from more operational beds on hand, while the downside risk relates to any changes in government funding arrangements.

Macquarie has no qualms, upgrading to Outperform from Neutral. Guidance for the full year was above expectations and the payroll supplement headwind has now cycled. An additional 234 development places are being created, with growth expected to be 20% by 2019.

The broker is also at ease with the potential impact from changes to the regulatory environment, which are as yet unclear. Macquarie likes the company's consistent and disciplined strategy based on developments, in tandem with acquisitions when targets are attractively priced.

FNArena's database shows two Buy and two Hold ratings. The consensus target is $5.91, suggesting 14% upside to the last share price. Targets range from $5.70 (UBS) to $6.20 (Deutsche Bank).
 

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