Australia | Mar 07 2016
-Freedom expands care capability
-Risk of acceleration in development
-On track for retirement earnings target
By Eva Brocklehurst
The transition to a pure residential retirement business is underway for Aveo Group ((AOG)) and this remains the key driver of the stock. The first half results benefitted from the last of the major apartment settlements.
Brokers are mindful that the non-retirement business produces a substantial level of earnings and if the sell-down proceeds according to plan then the capital required to ramp up development will be available.
Moelis notes there is $567m in cash to be recycled and the development business should increasingly boost returns, providing an additional 500 sites from FY19. Care services have been expanded following the Freedom Aged Care acquisition.
This $215.5m acquisition is to be funded via $83.5m in stock and $10m cash, and assumes $88m in debt with a potential $34m deferred payment. It makes strong strategic sense to Moelis, as it expands resident care capability while providing the additional beds. The broker, not one of the eight monitored daily on FNArena's database, has a Buy rating and $3.40 target.
When profits from the sale of non-retirement assets are excluded, the first half result was in line with Macquarie's expectations. The mix of business has changed slightly, with care and support reduced and development increased. The reduction in care and support revenue in the half was largely driven by the earlier-than-expected departure of residents from the Durack facility, which is undergoing significant refurbishment.
The non-retirement sell-down has progressed well but Macquarie purposely assumes a conservative realisation of non-retirement assets in its numbers as, while this is an important catalyst for the acceleration of village development, the profits are best viewed as one-off. Nonetheless, the broker has included a more rapid realisation of the non-retirement portfolio in its calculations, which inflates near-term earnings estimates.
Macquarie prefers a discounted cash flow approach to valuing retirement operators because of the lag between completion of a village and mature earnings. In Aveo's case the broker includes half of its development target to reflect the risk of a strong acceleration in development rates.
Macquarie has a strong bias towards organic development but acknowledges there are some robust arguments in favour of the Freedom acquisition. If the acquisition was judged solely on financial criteria the broker would be a lot less comfortable.
It has a unique offering where residents can stay in serviced apartments while receiving relatively high levels of care. Aveo intends to roll out a similar service offering across a number of its its villages over time and, hence, the acquisition makes strategic sense to Macquarie.
Earnings in the first half were boosted by land sales but Morgans also considers the company is on track to deliver on its retirement returns target of 6-6.5% in FY16. The main sensitivity in the broker's model rests with development settlements.
Morgans expects the Freedom acquisition will contribute positively with the main drivers being better quality contracts, a significant increase in new development sales and expansion of care services. The broker expects the Freedom acquisition will be materially accretive in FY17 and beyond.
With the acquisition of Freedom, Aveo becomes the largest owner/operator in Australia. Freedom owns and operates more than 1,000 units in 15 villages across Australia. Aveo has stated the order of priority for the allocation of the $567m in sale proceeds is $188m for retirement development pre FY18, $127m for developments post FY18 and $242m for acquisitions, further buy-backs or debt re-payments.
Ord Minnett upgrades earnings forecasts by 4-6% for the next three years, with around one third of this upgrade from the acquisition and the rest from better residential and development prices and margins.
The company's targets imply earnings will rise to over $75m for FY16, expecting a much stronger second half with around 153 retirement development sales forecast. The company's target for earnings over $110m in FY18, ex Freedom, is a taller order, in the broker's opinion.
There are three Buy ratings and one Hold (Ord Minnett) on FNArena's database. The consensus target is $3.63, suggesting 15.9% upside to the last share price. Targets range from $3.11 (Ords) to $4.35 (Macquarie).
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