Anxiety Grows Over Planned Cuts To Aged Care Funding

This story features ESTIA HEALTH LIMITED, and other companies. For more info SHARE ANALYSIS: EHE

-Cuts to take time to flow through
-Question of ability to offset cuts
-Long-term fundamentals supportive
 

By Eva Brocklehurst

The Australian government's May budget is provoking consternation among analysts of the aged care sector. The government has stated an intention to reduce aged care funding by 2.5% over four years. On the surface this did not appear too severe at the time, but several brokers have paused to review their forecasts.

Listed operators are yet to publicly clarify what the impact of the changes will be or comment about their ability to offset the changes with revenue measures. The industry is currently seeking independent assessment of the impact.

Adding to the anxiety, media reports suggest Estia Health ((EHE)) is one of those in the aged care sector under audit from the federal government for inconsistencies in terms of accessing the Aged Care Funding Instrument (ACFI).

Concerns have been raised about the practice of re-classifying residents of acquired facilities into higher care categories, which attracts extra government funding. The reports suggest Estia Health's average daily payment per patient, already significantly higher than industry average, has grown at a faster pace than peers.

Bank of America Merrill Lynch, after discussions with the sector, believes listed operators face no earnings growth from FY17 to FY19. The broker estimates Regis Healthcare ((REG)), Japara Healthcare ((JHC)) and Estia Health will lose $24 per resident per day in funding by FY19. BA-ML downgrades its rating on all three to Underperform.

Government funding comes from the ACFI, through which it pays a fixed daily amount per resident with extra funding available for those requiring more care. Existing residents will not be affected by the new ACFI rates, so the reduction will take time to move through earnings outcomes. Incoming residents will be subject to the new rates as will any resident whose care is re-assessed. BA-ML expects the frequency of re-assessment to slow.

Brokers assume a number of offsetting measures will be implemented, including raising accommodation prices and services rates for non-concessional residents and using excess ACFI scoring points for some residents to re-classify to higher revenue categories. Yet BA-ML suggests only those operators with below-average accommodation prices and no additional service charges would be able to offset any reductions in ACFI rates, and this does not apply to listed operators.

Competition in the aged care sector is intense, as the industry develops and builds retirement villages and nursing care to accommodate a sharply growing need. While noting data showing just 60% of the industry is profitable, BA-ML also highlights the statistic that 60% of operators in the industry are not-for-profit, so profitability statistics do not necessarily reflect an efficient industry.

Morgan Stanley has also held discussions with unlisted operators and strengthens its thesis of low organic growth for Japara Healthcare and Estia Health. Unlisted operators have indicated the cuts to the ACFI rate are more significant than they had previously thought. ACFI rates of mature assets are forecast to be flat in FY17 and declining by around 2% in FY18.  The ability of both companies to manage the changes will be scrutinised at the full year results presentation in August.

While listed operators are confident additional services revenue, scale benefits and management of some costs will partially offset the lower funding, the broker warns the bear case scenario centres on a larger portion of the revenue decline at mature assets flowing through to lower earnings. This, the broker asserts, would be a catalyst for further downgrades in the sector.

Meanwhile, Morgan Stanley reiterates a preference for Aveo Group ((AOG)), which has had success in New Zealand with its retirement model. The implementation of its strategy in Australia is expected to drive higher turnover and lower risk.

Furthermore, Stockland ((SGP)) is expected to emulate the Aveo Way contract at generic villages, which involves a higher fee for certainty and automatic buy-back. The broker expects higher returns for Aveo over the long term if this contract becomes the norm, although this is not a base case.

UBS believes the FY17 reforms will penalise those pursuing higher care level funding to support growth in average numbers and frailty. UBS lowers its profit estimates across the listed operators by 3% for FY17 and 4-6% for FY18 and believes the net impact will be subject to their ability to offset the changes with revenue measures and cost management.

Yet UBS also believes the emphasis on budget estimates is overdone. If history is any guide, estimates for any year will not be final numbers. UBS considers it fair to assume that the higher funding accessed by listed operators implies greater exposure to the ACFI reductions. Yet the broker calculates a reduction greater than $20 per resident per day applied to the entire industry is a highly improbable outcome.

UBS maintains reactions post the budget have priced in a worst case scenario for the aged care stocks. The broker highlights that a reduction in high complexity ACFI carries a risk that fewer providers will be willing to offer those services, with the unwanted and ultimate fall-out being pressure on the bed block at public hospitals as these patients are more difficult to place.

Notwithstanding the likelihood of subsequent budgets increasing overall spending in residential aged care, the fact that the greater impact of the reductions is felt in outer years means operators have more ability to adapt, and UBS is confident the larger operators, both listed and unlisted, will be able to manage with little net impact to the bottom line.

Morgans concurs, suggesting the long-term fundamentals are supportive and there is an opportunity for operators to make adjustments to offset a reasonable proportion of future cuts to funding.

In the case of Regis Healthcare, the broker observes a deep pipeline of existing and greenfield developments is at hand and uses the uncertainty and share price weakness to add to positions. The broker also recently upgraded Japara Healthcare to Add, citing the large number of beds in its building pipeline.

In the wake of the sell off in the sector, CLSA has also upgraded to Buy ratings on Japara Healthcare and Regis Healthcare. The broker believes it is hard to estimate operator exposure to the potential changes in resident eligibility scores based on publicly available information. Still, the cuts suggest the decline in sector funding will be $4.83 per day in FY18, on a top-down basis. This is also broadly in line with a bottom-up analysis by the broker, which suggests a reduction of $4.96, or 9.8%.
 

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