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Consistent returns and continuing growth

Target Healthcare REIT 15 November 2021 Update
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Target Healthcare REIT

Consistent returns and continuing growth

Results and acquisition update

Real estate

15 November 2021

Price

118.2p

Market cap

£734m

Net debt (£m) at 30 September 2021

7.2

Net LTV at 30 September 2021

1.0%

Shares in issue

620.2m

Free float

100%

Code

THRL

Primary exchange

LSE

Secondary exchange

N/A

Share price performance

%

1m

3m

12m

Abs

2.6

(4.7)

4.2

Rel (local)

(0.7)

(6.1)

(11.3)

52-week high/low

125.4p

109.4p

Business description

Target Healthcare REIT invests in modern, purpose-built residential care homes in the UK let on long leases to high-quality care providers. It selects assets according to local demographics and intends to pay increasing dividends underpinned by structural growth in demand for care.

Next events

Q122 DPS paid

26 November 2021

Analyst

Martyn King

+44 (0)20 3077 5745

Target Healthcare REIT is a research client of Edison Investment Research Limited

The FY21 results and Q122 trading update show a continuation of Target Healthcare REIT’s consistent record of positive accounting returns on both an annual and quarterly basis, substantially delivered by growing dividends. Target says its pipeline of acquisitions is its strongest ever and deployment of the proceeds of its well-received recent equity raise and associated gearing promise further growth and diversification.

Year end

Rental income (£m)

Adj. net
earnings* (£m)

Adjusted
EPS* (p)

EPRA NAV/
share (p)

DPS
(p)

P/NAV/
share (x)

Yield
(%)

06/21

50.0

26.0

5.46

110.4

6.72

1.07

5.7

06/22e

58.4

33.4

5.63

111.2

6.76

1.06

5.7

06/23e

71.9

41.0

6.61

115.1

6.86

1.02

5.8

06/24e

76.5

42.2

6.81

119.6

6.96

0.98

5.9

Note: *Adjusted earnings exclude revaluation movements, non-cash income arising from the accounting treatment of lease incentives and guaranteed rent review uplifts, and acquisition costs, and include development interest under forward fund agreements.

DPS continuing to grow but deployment defers cover

Dividends and recurring earnings are continuing to increase, driven by acquisitions, development completions and inflation linked (predominantly RPI) rent reviews. The latter, along with continuing yield compression, is also generating increases in property valuations and supporting growth in net asset value. Deployment of the £125m (gross) proceeds of September’s upsized and oversubscribed equity issue and associated debt funding substantially lifts our adjusted ‘cash’ earnings forecasts. The c 20% increase in shares outstanding reduces our adjusted EPS forecasts (by c 14% in FY22) but as acquisitions are completed and fully contribute, we expect DPS to grow further and be effectively covered by adjusted earnings in FY23 and FY24 (and well covered by EPRA earnings). We assume c £285m of acquisitions by end-FY22, including the imminent completion of a substantial 18-home portfolio (£9.1m in annual rents) while a prudent level of gearing (LTV of around 30%) is maintained.

Sustainably meeting a long-term need

The care home sector is driven by demographics rather than the economy and a growing elderly population and a shortage of quality homes suggests a strong demand in years to come. The pandemic has had a near-term impact on tenant operators, but rent collection remained robust and admissions and occupancy are rebuilding. Target is unwavering in its focus on asset quality (along with location and the operational and financial performance of tenants). It believes modern, purpose-built homes with flexible layouts and high-quality residential facilities are key to providing sustainable, long-duration inflation-linked income; appealing to residents and allowing tenants to provide better and more effective care.

Valuation: Attractive indexed, long-term income

The FY22e DPS represents an attractive 5.7% yield, with good prospects for continuing DPS growth, and supports the c 6% premium to Q122 net asset value. The robust performance of tenant operators and rent collections through the COVID-19 pandemic is a positive indicator for a re-rating/DPS yield tightening.

Consistent and continuing growth

In this note we discuss recent financial and operational performance and our expectations for capital deployment and portfolio growth and diversification. Target completed a substantial well-received, upsized and oversubscribed £125m (gross) equity raise in September, ahead of results for the year to 30 June 2021 (FY21) on 20 October. It has since provided an update on the three months that ended 30 September 2021 (Q122). Dividends and recurring earnings have continued to increase, driven by acquisitions, development completions and inflation linked (predominantly RPI) rent reviews. The latter, along with continuing yield compression, is also generating increases in property valuations and supporting growth in net asset value. With its equity raising, Target reported a strong £230m acquisition pipeline (‘its strongest ever’) across 24 modern, purpose-built care homes, with contracted rents of £12.9m reflected in an expected weighted average net initial yield of 5.6%. This provides us with comfort that the proceeds of the equity raise and associated capital raise will be deployed fairly swiftly and the investment manager can continue to identify attractive investment opportunities despite the continuing compression of market yields. We begin this report with a review of recent financial performance.

Exhibit 1: Summary of FY21 financial performance

FY21

FY20

FY21/FY20

Edison FY21e

£m unless stated otherwise

IFRS

Adj.

Adj. Earnings*

IFRS

Adjustments

Adj. Earnings*

Adj. Earnings*

Adj. Earnings*

Rent revenue

41.2

41.2

36.0

36.0

14.4%

40.7

Income from guaranteed rent reviews & lease incentives

8.7

(8.7)

0.0

8.2

(8.2)

0.0

Total revenue

50.0

(8.7)

41.2

44.3

(8.2)

36.0

14.4%

40.7

Investment management fee

(5.8)

(5.8)

(5.3)

(5.3)

10.1%

(5.9)

Credit loss allowance & bad debts

(2.7)

(2.7)

(2.1)

(2.1)

(2.9)

Other expenses

(2.6)

(2.6)

(2.2)

0.0

(2.2)

20.8%

(2.5)

Operating profit before property gains/(losses)

38.9

(8.7)

30.1

34.7

(8.2)

26.5

13.7%

29.5

Realised/unrealised gains/(losses) on properties

10.8

(10.8)

0.0

2.3

(2.3)

0.0

Operating profit

49.6

(19.5)

30.1

37.0

(10.6)

26.5

13.7%

29.5

Net finance cost

(5.7)

0.9

(4.8)

(5.4)

1.1

(4.3)

12.5%

(4.3)

Development interest under forward fund agreements

0.0

0.6

0.6

0.0

1.0

1.0

-33.6%

0.9

Net earnings

43.9

(17.9)

26.0

31.6

(8.4)

23.2

12.0%

26.1

Other data:

FY21

FY20

FY21/FY20

IFRS EPS (p)

9.23

7.18

28.5%

EPRA EPS (p)

7.16

6.92

3.5%

Adjusted EPS (p)

5.46

5.27

3.5%

DPS declared (p)

6.72

6.68

0.6%

Dividend cover - EPRA earnings

1.05

1.00

Dividend cover - Adjusted earnings

0.80

0.76

IFRS NAV per share (p)

110.5

108.0

2.3%

EPRA NTA per share (p)

110.4

108.1

2.2%

108.1

EPRA NTA total return/accounting total return

8.4%

6.8%

6.4%

Investment properties

677.5

610.1

11.1%

Borrowings

130.0

152.0

Cash

21.1

36.4

Gross LTV

19.2%

24.9%

Source: Target Healthcare REIT, Edison Investment Research

FY21 adjusted earnings were very close to our forecast and EPRA NTA and EPRA NTA total return were both above our forecast, driven by a stronger revaluation movement in H221. Adjusted earnings increased by 12% with strong revenue growth partly offset by credit loss provisions and bad debt charges relating to the small number of struggling tenants that have responded positively to active asset as discussed below. Equity raising to fund continuing asset growth held back earnings in per-share terms but cash-dividend cover improved and we expect full cover of progressive distributions as acquisitions/commitments (past and prospective) fully contribute.

Key features of the FY21 results included:

Contracted rental income increased by 5.6% to £41.2m (and reached £43.2m by end-Q122, including the completion of two forward funded pre-let developments, acquisitions, and indexed rent uplifts). FY21 like-for-like rent growth of 0.1% was held by back by the re-tenanting of one home (see below) and relatively lower inflation for much of the period. Q122 growth included a 0.6% like-for-like uplift, with completed rent reviews showing an average 3.3% increase.

Adjusted cash rental income (excluding non-cash IFRS smoothing adjustments) increased c £4.2m, or c 14% year on year, and total adjusted revenue by c 13%.

Total expenses increased by £1.6m or c 16%, within which investment management fees increased by £0.5m or c 10%, in line with average net assets, and other administrative expenses increased by £0.5m or c 22%, reflecting the growth in business, equity raising, and fees associated with asset management initiatives, particularly aimed at the small number of struggling operators. Provisions for doubtful rental income also increased by c £0.5m to £2.7m.

Interest expense increased with average borrowing through the year, although period-end debt was lower as equity proceeds were temporarily used to repay flexible debt.

Lower interest income under forward-funding agreements reflected a lower average balance of funding extended in the period.

Adjusted earnings increase by £2.8m or c 12% to £26.0m or adjusted EPS of 5.46p (FY20: 5.27p). The average number of shares was 8% higher in FY21. Not shown in Exhibit 1, EPRA earnings (which unlike adjusted earnings includes IFRS rent smoothing but excludes interest in respect of forward funding agreements) increased at a similar rate to £34.0m (FY20: £30.5m) or EPS of 7.16p (FY20: 6.92p).

The EPRA cost ratio improved to 16.9% (FY20: 20.1%) and on the company’s adjusted earnings basis the cost ratio was 20.1% (FY20: 25.7%). The total expense ratio (TER) was 1.55%, slightly above the FY20 level of 1.51% due to the increased equity base, yet to be fully deployed on a geared basis.

DPS increased by 0.6% to 6.72p and was 105% covered on an EPRA basis and 80% covered by adjusted ‘cash’ earnings. A Q122 DPS of 1.69p has been declared, in line with the increased FY22 DPS target of 6.76p (+0.6%).

IFRS earnings and net asset value included £9.4m of net unrealised gains on investment properties and held for sale assets and £1.3m of realised gains on disposal. On a like-for-like basis, valuations increased by 3.5%, a combination of rental growth and a compression in the EPRA topped up net initial yield to 5.83% from 6.04% at end-FY20. The Q122 portfolio value increased by 0.7% on a like-for-like basis, with the EPRA-topped up net initial yield compressing slightly to 5.82%.

EPRA net tangible assets per share (EPRA NTA) increased 2.3% to 110.4p and including DPS paid the total return was 8.4%.1 Q122 EPRA NTA per share increased 0.8% to 111.3% with a quarterly total return of 2.3%.

Dividends added back but not reinvested. On the company basis, including reinvestment of dividends, the total return was 8.8% in FY21 and 2.3% in Q122.

Exhibit 2: Q122 EPRA NTA development

Pence per share

Notes

EPRA NTA at 30 June 2021

110.4

Revaluation gains

0.9

Acquisition costs

(0.1)

Net impact of equity issuance at a premium to NTA

0.4

Movement in revenue reserve

1.1

EPRA earnings excluding IFRS rent smoothing.

4th FY21 interim dividend paid

(1.4)

Q421 DPS of 1.68p divided by the endQ122 increased number of shares.

EPRA NTA at 30 June 2021

111.3

Source: Target Healthcare REIT

Portfolio and asset management developments

Target’s portfolio continues to grow and at 30 September 2021 (end-Q122) was valued at £702.7m, comprising 79 properties (of which 76 operational and three pre-let forward-funded developments), let to 28 individual tenants (the largest, Ideal Carehomes, representing c 13% of the total). Two of the four assets under development at end-FY21 reached practical completion during Q122 (Rudheath, Cheshire and Droitwich Spa, Worcestershire) and one was acquired, in Holt, Norfolk, with a maximum commitment of £12.8m. Also during Q122, Target acquired a completed home in Liverpool for £5.5m (including costs).

Exhibit 3: Portfolio summary

Sep-21

Jun-21

Dec-20

Jun-20

Q122

FY21

H121

FY20

Properties

79

77

76

73

Beds

5,474

5,331

5,277

5,073

Tenants

28

28

27

27

Contracted rent (£m)

43.2

41.2

40.6

39

Portfolio value (£m)

702.7

684.8

647.7

617.6

WAULT*

28.8 years

28.8 years

28.7 years

29.0 years

EPRA Topped-up net initial yield

5.82%

5.83%

5.97%

6.04%

Source: Target Healthcare REIT. Note: *Weighted average unexpired lease term.

Since end-Q22, an additional pre-let forward-funded asset has been acquired in Weymouth, Dorset for a maximum consideration of £14.3m.

Resilient through the COVID-19 pandemic

The COVID-19 pandemic has had a financial impact on Target’s tenant operators, especially due to curtailed admissions and reduced occupancy, although this has recently begun to normalise. In total, 95% of FY21 rents have been collected and rent cover2 for mature homes (those that have had the same operator for a three-year period or more, therefore excluding newly developed homes not yet stabilised) was 1.5x compared with the c 1.6x that Target expects during normal trading conditions. The robustness of rent cover during a difficult trading period for tenant operators was partly attributable to the temporary government support that was put in place to support a vital service. Excluding this, Target estimates rent cover dipped to 1.2x but expects a return to 1.6x or more as trading conditions normalise. Setting rents at the right level is key to the sustainability of income and Target believes rent cover of 1.6x provides sufficient flexibility to allow for variances in occupancy and operational performance. As shown in Exhibit 4 it is consistent with rent costs at c 20% of revenues for the typical home.

Rent cover is a key measure for measuring the underlying profitability of tenants and the sustainability of rents. The ratio tracks operational cash earnings at the home level (before rent) with the agreed rent and is presented on a rolling 12-month basis.

Exhibit 4: Illustrative revenue and cost structure as a basis for 1.6x rent cover

Split of revenues/costs

Private fees

75

Local authority fees

25

Total income

100

Direct costs

(57)

Gross margin

43%

Overheads

(11)

EBITDARM*

32

Rent

(20)

EBITDAM**

12

Split of revenues/costs

Private fees

Local authority fees

Total income

Direct costs

Gross margin

Overheads

EBITDARM*

Rent

EBITDAM**

75

25

100

(57)

43%

(11)

32

(20)

12

Source: Target Healthcare REIT. Note: *Earnings before interest, depreciation, amortisation, rent and management costs or home level cash earnings before rent. **Home level cash earnings after rent.

Across the portfolio, COVID-19 case numbers have been very low in recent months, supported by the vaccination programme and easing of restrictions on home visits, with tenant operators reporting an increase in occupancy as admissions normalise. Having dipped by more than 10 percentage points to a little under 70% at the low point earlier in 2021, occupancy for mature homes improved by c five percentage points in Q122 and by a further c two percentage points in Q222, with strong enquiry levels from potential residents.

Most of the recent and ongoing rent arrears relate primarily to two tenants across four of the homes and, although not helped by the pandemic, reflect more fundamental performance issues. Asset management initiatives aimed at addressing these were delayed by the physical restrictions in place during the lockdowns but have recently completed. For one tenant, a new operator of two immature homes, trading performance has improved. For one of these homes, rents have been paid monthly in full since December 2020 and for the other home rent has been partially paid and Target expects the tenant to commence paying rent in full during Q4 2021. The position with the other tenant has been resolved with outstanding rents partially settled and the homes re-tenanted. The first re-tenanting occurred during FY21, providing an immediate valuation and net rental income uplift and the second has recently completed at a similar rent and short rent-free period to cover capex mitigated by a lengthened lease.

Consistent returns

The resilience of Target’s strategy has been reflected in consistently positive accounting returns3 since IPO in January 2013, on both a quarterly and annual basis up to 30 September 2021 (end-Q122). The cumulative total return (adjusted for dividends paid but not assuming reinvestment of dividends) over the period has been 67.7% or an average annualised rate of 6.1%. Dividends have accounted for c 80% of the total. On the dividend reinvested basis reported by Target, the annualised total return to 30 June 2021 was 7.8%. Most recently, Q122 showed a return on 2.3% (2.4% assuming dividend reinvestment).

Change in net asset value plus dividends paid. Unlike the company’s measure of returns, we do not assume reinvestment of dividends. Consequently, the returns quoted by Target are higher.

Exhibit 5: NAV total return record

FY14*

FY15

FY16

FY17

FY18

FY19

FY20

FY21

Q122

Cumulative

Opening EPRA NAV/NTA (p)

98.0**

94.7

97.9

100.6

101.9

105.7

107.5

108.1

110.4

98.0

Closing EPRA NAV/NTA (p)

94.7

97.9

100.6

101.9

105.7

107.5

108.1

110.4

111.3

111.3

DPS paid

6.5

6.1

6.2

6.3

6.4

6.5

6.7

6.7

1.7

53.0

EPRA NAV/NTA total return

3.3%

9.7%

9.0%

7.5%

10.1%

7.8%

6.8%

8.4%

2.3%

67.7%

Compound annual average return

6.1%

Source: Target Healthcare REIT, Edison Investment Research. Note: Company published total returns are on a dividend reinvested basis and are higher. *22 January 2013 to 30 June 2014. **Adjusted for IPO costs.

Consistent returns reflect steady and visible income growth with inflation-linked rents and long-term, triple net leases. Notwithstanding the pandemic, tenant performance has been supported by strong demographically driven demand for care home places, a shortage of quality accommodation and above-inflation fee growth. Attracted by the resilient income profile of the care home property sector, investor demand has been, and remains, strong, especially for high quality assets, leading to yield compression and capital growth. New entrants to the investment market such as Cofinimmo from Belgium and Korian REIT from France raises the prospect that valuation yields will further compress, benefiting capital growth but increasing the prices that must be paid for assets. Nevertheless, as we discuss in the next section, the investment manager continues to identify attractive acquisition opportunities and is confident of delivering further accretive portfolio growth.

Equity raised for further growth

Having substantially deployed the proceeds of the February 2021 £60m (gross) equity raise,4 and noting its strongest pipeline of acquisition opportunities to date, in September 2021 Target completed a further £125m (gross) equity raise, upsized5 and oversubscribed. The c 108.7m new shares issued represented a c 21% increase in shares outstanding and the issue price of 115p was at a 4.2% premium to the 30 June 2021 EPRA NTA per share of 110.4p.

Prior to the September equity raise, Target had had committed £51m to four modern care homes, including one pre-let forward funded development, since the February equity raise.

Target initially targeted gross proceeds of c £100m but this was increased to £125m in consideration of strong investor demand for the shares and the strength of the acquisition pipeline.

The strong pipeline of investment opportunities disclosed with the issue amounted to an aggregate c £230m (including costs), across 24 modern, purpose-built care homes, with an expected weighted average net initial yield of 5.6%. If completed, this pipeline would add 1,625 new beds, increase contracted rent by £12.9m pa, slightly increase the WAULT from 28.5 years to 28.8 years, and add further diversification, including seven new tenants, all known and approved by the investment manager. More specifically the announced pipeline comprised:

A significant portfolio of 18 operational care homes for which an exclusivity agreement was in place and due diligence underway. Historically, to satisfy its strict acquisition criteria,6 Target has built its portfolio in a granular way with a focus on individually selected assets. However, in this case the investment manager has an extremely in-depth knowledge of the portfolio assets, having sourced 17 of the 18 on behalf of the vendor. The portfolio generates £9.1m pa of contracted rent with 100% of rents collected through the pandemic.

Target’s strict acquisition criteria target high-quality, modern, purpose-built care homes with en-suite wet-room facilities. Just 3% of beds within the pipeline assets are en-suite only (ie without en-suite wet-room facilities).

A further six assets in the final stages of due diligence, consisting of three operational modern care homes and three pre-let forward funded development projects.

Reflecting the upsizing of the equity raise and the investment manager’s ability to identify attractive investment opportunities, we forecast Target to acquire assets to a value of £285m (including costs) by the end of March 2022 (end-Q322), including the c £34m committed since end-FY21.

Funding and balance sheet impact

Including the £125m (gross) equity proceeds and associated debt funding, our assumed level of investment should allow Target to maintain a prudent level of gearing (loan to value ratio (LTV) of around 30%), well below the maximum permitted level of 35%. Historically the company has targeted a c 25% LTV, but the robust performance demonstrated through the challenging pandemic period suggests that a slightly higher gearing level is consistent with the company’s return targets and provides an offset the compression in asset yields.

With the September equity raise proceeds temporarily used to repay flexible debt, end-Q122 gross borrowing was £80m and including cash of c £73m the net LTV was just 1%. However, the required borrowing to complete the transactions that we expect is ahead of the existing aggregate £220m of facilities (Exhibit 6) but negotiations to add c £100m of long-term funding are at an advanced stage. Our forecasts assume that £300m of the increased facilities are drawn, sufficient to fund acquisitions and current and future investment commitments.

Exhibit 6: Summary of existing debt portfolio

Lender

Facility type

Facility

Term

Margin

RBS

Term loan

£30m

Nov-25**

SONIA + 2.18%

Revolving credit facility

£40m*

Nov-25**

SONIA + 2.33%

HSBC

Revolving credit facility

£100m

Nov-23***

SONIA + 2.17%

ReAssure

Term loan & revolving credit facility

£50m

Jan-32

Fixed 3.28%

Source: Target Healthcare REIT. Note: *HSBC facility includes two one-year extension options subject to HSBC approval.

Of the total existing debt facilities, £80m are fixed rate/hedged and £140m floating rate. The weighted average term to maturity at end-FY21 was 4.8 years and the weighted average cost of drawn debt was 2.9%. All existing loans are secured against investment properties owned by the group with maximum LTV requirements of 50–60% and interest cover ratios of a minimum 300%. All covenants have been complied with during the past year.

ESG at the core of strategy

In common with most companies across the sector, Target is giving an increasing focus to its environmental, social and governance (ESG) strategy. As a starting point, the social impact that its homes can generate is significant and closely aligned with ESG principles. Target invests in modern, purpose-built care homes and within its investment selection puts an unwavering focus on the quality of the physical assets. It seeks good-quality tenants capable of providing strong levels of care, sustainably, over the long term and as an engaged landlord, works with tenants to support their operations and care quality. The contribution that modern, purpose-built homes can make in supporting care quality have been highlighted by the pandemic. Modern home configuration and design, including en-suite wet room facilities and generous communal space, make it possible to comfortably isolate individual floors, parts of floors or even individual rooms, to control the spread of infection, safely support visiting and exercise, and provide good air quality.

The board of Target is fully independent and brings a depth of relevant experience and skills to the company.

Having grown the portfolio with a focus on modern, purpose-built properties, incorporating sustainable and responsible investing principles, 100% of Target’s homes have EPC7 ratings of A-C, of which 92% are rated A-B.

Energy performance certificates

Government reforms are positive for the sector

The fundamental drivers of the care home sector remain strongly positive, primarily driven by demographics (an ageing population with increasingly complex care needs) with little correlation to the wider economy. In recent years, capacity has failed to keep pace with this growing need and in many cases homes that are more reliant on local authority funding have been starved of the resources to maintain adequate staffing and levels of care. The recently announced reforms to health and adult social care aim to address this and targets a cumulative £36bn in new investment in health and social care over the next three years, funded by a 1.25% ring-fenced increase in the national insurance levy. It is the government’s intention to improve the integration of the NHS and social care system to both improve outcomes and generate efficiencies (for example, freeing up hospital beds by increasing access to appropriate alternative care. Most of this new funding will go to the NHS, but £5.4bn pa of additional social care funding, including residential care for the elderly, will be available from 2022–25. The government will set out detailed plans in a ‘white paper’ later in the year, which is expected to make clear exactly how the new proposals will operate. Depending on the detail, as well as providing additional resources to fund more and better services, the reforms have the potential to provide greater certainty to care home operators in their long-term planning, an essential element in making sure that future needs are met.

Under the government’s proposals, more people will become eligible for state support for social care, including elderly care, and from October 2023 nobody will pay more than £86,000 for adult social care in their lifetime. Those with assets of less than £20,000 will have their care costs fully met by the state and those with assets of between £20,000 and £100,000 will receive some means-tested state support. State support currently cuts off where assets are more than £23,250.

Combined with the growing, demographically driven need for elderly care, the reduced funding burden on individuals is likely to increase the number of requests that local authorities receive for long-term care. In 2019/20, of the 1.9m requests to local authorities (of which 1.4m were from elderly people), only 839,000 of applicants received the care support requested, primarily reflecting limited resources available. The fees paid by local authorities to providers are currently too low and are reset annually, making it difficult for the providers to plan and recruit or retain staff. Because of low fees, local authority funded recipients of residential care are subsidised by privately funded residents and the government is keen to address this and ensure that local authorities pay a ‘fair rate’. This appears to be positive for local authority funded fees and while the government is also proposing that self-funders will be able to ask their local authority to arrange their care for them so that they may find better value care, it remains to be seen how this will work in practice. We believe it is very unlikely that providers of self-funded care will be willing to accept lower fees, especially for existing residents. Operators that are focused on local authority funded care appear clear beneficiaries but operators that provide a mix of self-funded and local authority care should also benefit, and this includes many of Target’s tenant operators. Across its portfolio, while 62% of underlying operator fees include some element of self-funding (44% purely self-funding and 18% a mix of self-funding and public funding),8 38% is purely publicly funded. Publicly funded fee exposure for Target’s tenants has increased slightly through the pandemic as the industry-wide increase in vacancy has been tilted towards self-funding (at end-FY20 the purely self-funded share for Target operators was 48%). We believe this mainly reflects the greater discretion that self-paying residents are likely to have over the timing of admission as well as the desire by the NHS to free up hospital beds and is likely to revert as home occupancy returns to normal. The mix of funding is reflected in average weekly fees charged by operators, with an average of £966 at 30 June 2021 compared with the market average of £790 estimated by the Laing Buisson consultancy.

Public funding comprises local authority funding and NHS funding.

Exhibit 7: Sources of income for Target’s tenant operators

Source: Target Healthcare REIT, 30 June 2021

Forecasts and valuation

Summary of forecast changes

Our forecasts are shown in detail in Exhibit 12 and summarised below. The September equity raise increased the number of shares outstanding by c 21% (and we estimate that this will increase FY22 average shares in issue by c 15%). We forecast the proceeds of the equity raise (and associated gearing) to be committed by the end of H122, but the full annualised impact will only be felt in FY24 as forward-funded projects complete during FY23.

Exhibit 8: Summary of forecast changes

Rental income (£m)

Adj. net earnings (£m)

Adjusted EPS (p)

EPRA NAV/share (p)

DPS (p)

Old

New

Change (%)

Old

New

Change (%)

Old

New

Change (%)

Old

New

Change (%)

Old

New

Change (%)

06/22e

56.4

58.4

3.5

33.6

33.4

-0.7

6.6

5.6

-14.3

109.4

111.2

1.6

6.80

6.76

-0.6

06/23e

59.5

71.9

20.7

35.5

41.0

15.4

6.9

6.6

-4.9

111.9

115.1

2.8

6.88

6.86

-0.3

06/24e

N/A

76.5

N/A

N/A

42.2

N/A

N/A

6.8

N/A

N/A

119.6

N/A

N/A

6.96

N/A

Source: Edison Investment Research

This has a notable impact on FY22e earnings, although we expect dividend cover to be maintained at the FY21 level (80%) on an adjusted (‘cash’) earnings basis. For FY23 and FY24 we forecast dividends to be effectively covered on an adjusted basis and well covered on an EPRA earnings basis, with DPS growing by c 1.5% pa in FY23 and FY24.

Exhibit 9: Dividend cover projections

FY21 actual

FY22e

FY23e

FY24e

Dividend cover by EPRA earnings

105%

97%

119%

127%

Dividend cover by adjusted (‘cash’) earnings

80%

80%

96%

98%

Source: Target Healthcare REIT FY21 data. Edison Investment Research forecasts

Key forecasting assumptions

Our estimates assume £285m of new investment from end-FY21, including the c £34m of commitments already announced, all at a 5.6% net initial yield. We assume that £230m is committed by the end of 2021 (end-Q222), and that £45m of this commitment is to forward-funded developments that we assume will reach completion by Q323 (March 2023). We assume a further £55m of commitment by March 2022 (Q322). The first full year rent contribution from all assumed investments and development completions is thus FY24. Our other forecasting assumptions include:

Rent indexation of 3% pa, broadly in line with the treasury consensus expectations.

Expenses substantially driven by investment manager fees with a marginal rate of 0.95% on average net assets of more than £500m. Other expenses include a sharp decline in impairment of rent receivables (£2.7m in FY21, or more than 6% of cash rents) with a return to a background level of c 1%.

Gross revaluation movements broadly in line with rent indexation, effectively assuming no change in valuation yields. As reported under IFRS in the income statement, in FY22e this is substantially offset by acquisition costs and IFRS smoothing rent effects. Our revaluation assumptions have a positive impact on LTV. Assuming no revaluation impact (unlikely as given contractually indexed rent uplifts this would imply margin widening of c 0.5%) and would increase LTV by c 250bp.

Exhibit 10: Revaluation movements

£m

FY21 actual

FY22e

FY23e

FY24e

Gross unrealised revaluation movement (incl held for sale)

21.4

22.8

27.9

29.0

Acquisition costs written off

(2.3)

(11.5)

0.0

0.0

Movement in lease incentives

(0.9)

0.0

0.0

0.0

Net realised and unrealised valuation movement

18.2

11.3

27.9

29.0

Movement in fixed or guaranteed rent reviews

(8.7)

(9.7)

(12.0)

(12.8)

Gains/(losses) on revaluation of investment properties as per income statement

9.4

1.6

15.9

16.2

Acquisition costs as % purchase value

4.3%

4.2%

N/A

N/A

Gross revaluation as % opening portfolio value

3.5%

3.4%

2.9%

2.8%

Gross revaluation gain per share (p)

4.2

3.7

4.5

4.7

Source: Target Healthcare REIT FY21 data. Edison Investment Research forecasts.

Valuation

Target aims to provide shareholders with attractive and sustainable returns, primarily in the form of quarterly dividends. DPS has increased each year since IPO and has been the driver of consistent returns as shown in Exhibit 10 above. The current year DPS target of 6.76p (+0.6% vs FY21) represents an attractive yield of 5.7%. The shares trade at a c 6% premium to Q122 EPRA NTA per share of 111.3p, similar to the average since IPO but below the high of c 11%.

In Exhibit 11 we show a summary of the performance and valuation of a group of REITs that we consider to be Target’s closest peers within the broad and diverse commercial property sector. The group is invested in the primary healthcare, supported housing and care home sectors, all targeting stable, long-term income growth derived from long-lease exposures.

Exhibit 11: Peer valuation and performance summary

WAULT (years)

Price (p)

Market cap. (£m)

P/NAV (x)*

Yield (%)**

Target yield (%)***

Share price performance

1 month

3 months

YTD

12 months

Assura

11

70

1878

1.23

4.1

4.2

-4%

-10%

-8%

-8%

Civitas Social Housing

23

92

573

0.85

6.0

6.0

5%

-21%

-12%

-15%

Impact Healthcare

19

119

380

1.07

5.4

5.4

1%

1%

9%

14%

Primary Health Properties

12

151

2134

1.31

4.1

4.1

-2%

-10%

-1%

1%

Residential secure Income

N/A

98

168

0.93

5.1

5.1

0%

-8%

10%

8%

Triple Point Social Housing

26

96

387

0.90

5.4

5.4

-4%

-14%

-14%

-11%

Average

18

1.05

5.0

5.0

-1%

-10%

-3%

-2%

Target Healthcare

29

118

734

1.06

5.7

5.7

2%

-4%

4%

4%

UK property sector index

1,925

3%

-1%

20%

21%

UK equity market index

4,195

2%

1%

14%

18%

Source: Company data, Refinitiv pricing at 15 November 2021. Note: *Based on last reported NAV. **Based on trailing 12-month DPS declared. ***Based on current financial year company DPS target.

In terms of average share price performance, the peer group has trailed the overall UK property sector and FTSE All-Share Index over the past year as less defensive, more cyclical areas of the market have rebounded. Over the same period, Target’s share price performance has been stronger than the average for the group, although its yield remains above average on both a 12-month trailing basis and based on each company’s current financial year target dividends. Target’s P/NAV is in line with the average. There are several factors that suggest a continuing positive outlook for the shares including a combination of the WAULT with no break clauses and upwards-only, triple net rents, mostly linked to RPI, which provides considerable visibility over a growing stream of contracted rental income. Rent indexation also offers considerable protection against inflation at a time when inflation expectations are increasing.9 The resilience of Target’s business model during the pandemic, with no interruption to quarterly dividends, is a further positive indicator for the rating of the shares.

Most rents are capped and collared. Our expectation is that the average cap is c 4%, providing full inflation protection up to this level.

Exhibit 12: Financial summary

Year to 30 June (£m)

2017

2018

2019

2020

2021

2022e

2023e

2024e

INCOME STATEMENT

Rent revenue

17.8

22.0

27.9

36.0

41.2

48.7

59.9

63.8

Movement in lease incentive/fixed rent review adjustment

5.1

6.3

6.4

8.2

8.7

9.7

12.0

12.8

Rental income

22.9

28.4

34.3

44.2

49.9

58.4

71.9

76.5

Other income

0.7

0.0

0.0

0.0

0.1

0.0

0.0

0.0

Total revenue

23.6

28.4

34.3

44.3

50.0

58.4

71.9

76.5

Gains/(losses) on revaluation

1.6

6.4

6.2

1.7

9.4

1.6

15.9

16.2

Realised gains/(losses) on disposal

0.0

0.0

0.0

0.6

1.3

0.0

0.0

0.0

Management fee

(3.8)

(3.7)

(4.7)

(5.3)

(5.8)

(7.4)

(7.8)

(8.0)

Other expenses

(1.2)

(1.5)

(2.7)

(4.3)

(5.3)

(3.2)

(3.5)

(3.6)

Operating profit

20.1

29.6

33.0

37.0

49.6

49.3

76.5

81.1

Net finance cost

(0.8)

(2.0)

(3.1)

(5.4)

(5.7)

(7.1)

(10.0)

(10.2)

Profit before taxation

19.3

27.6

29.9

31.6

43.9

42.3

66.5

70.9

Tax

(0.2)

0.0

0.0

0.0

0.0

0.0

0.0

0.0

IFRS net result

19.1

27.6

29.9

31.6

43.9

42.3

66.5

70.9

Adjust for:

Gains/(losses) on revaluation

(2.2)

(6.4)

(6.2)

(1.7)

(9.5)

(1.6)

(15.9)

(16.2)

Other EPRA adjustments

0.4

0.0

0.7

0.5

(0.3)

0.0

0.0

0.0

EPRA earnings

17.3

21.2

24.5

30.5

34.0

40.7

50.7

54.7

Adjust for fixed/guaranteed rent reviews

(5.1)

(6.3)

(6.4)

(8.2)

(8.7)

(9.7)

(12.0)

(12.8)

Adjust for development interest under forward fund agreements

0.0

0.3

2.0

1.0

0.6

2.4

2.3

0.3

Adjust for performance fee

1.0

0.6

0.0

0.0

0.0

0.0

0.0

0.0

Group adjusted earnings

13.2

15.7

20.1

23.2

26.0

33.4

41.0

42.2

Average number of shares in issue (m)

252.2

282.5

368.8

440.3

475.4

593.1

620.2

620.2

IFRS EPS (p)

7.58

9.77

8.10

7.18

9.23

7.13

10.73

11.43

EPRA EPS (p)

6.87

7.50

6.63

6.92

7.16

6.86

8.17

8.82

Adjusted EPS (p)

5.23

5.54

5.45

5.27

5.46

5.63

6.61

6.81

Dividend per share (declared)

6.28

6.45

6.58

6.68

6.72

6.76

6.86

6.96

Dividend cover (Adjusted earnings)

0.83

0.82

0.82

0.76

0.80

0.80

0.96

0.98

BALANCE SHEET

Investment properties

266.2

362.9

469.6

570.1

629.6

914.7

954.4

970.6

Other non-current assets

4.0

27.1

37.6

46.0

54.8

64.6

76.5

89.3

Non-current assets

270.2

390.1

507.2

616.1

684.4

979.3

1,030.9

1,059.9

Cash and equivalents

10.4

41.4

26.9

36.4

21.1

16.9

12.6

13.2

Other current assets

25.6

3.4

4.3

11.2

12.9

4.2

4.5

4.6

Current assets

36.0

44.8

31.2

47.6

34.0

21.1

17.1

17.9

Bank loan

(39.3)

(64.2)

(106.4)

(150.1)

(127.9)

(278.2)

(299.0)

(299.8)

Other non-current liabilities

(4.0)

(4.7)

(7.1)

(6.4)

(6.8)

(9.8)

(10.6)

(11.0)

Non-current liabilities

(43.3)

(68.9)

(113.5)

(156.5)

(134.7)

(288.0)

(309.6)

(310.8)

Trade and other payables

(6.0)

(7.4)

(11.8)

(13.1)

(18.5)

(22.5)

(24.4)

(25.2)

Current Liabilities

(6.0)

(7.4)

(11.8)

(13.1)

(18.5)

(22.5)

(24.4)

(25.2)

Net assets

256.9

358.6

413.1

494.1

565.2

689.8

714.0

741.8

Adjust for derivative financial liability

0.0

0.1

0.7

0.2

(0.3)

(0.3)

(0.3)

(0.3)

EPRA net assets

256.9

358.7

413.8

494.3

564.9

689.6

713.7

741.6

Period end shares (m)

252.2

339.2

385.1

457.5

511.5

620.2

620.2

620.2

IFRS NAV per ordinary share

101.9

105.7

107.3

108.0

110.5

111.2

115.1

119.6

EPRA NAV per share

101.9

105.7

107.5

108.1

110.4

111.2

115.1

119.6

EPRA NAV total return

7.5%

10.1%

7.8%

6.8%

8.4%

6.8%

9.6%

9.9%

CASH FLOW

Cash flow from operations

4.4

23.6

20.5

25.6

29.2

46.4

51.0

53.0

Net interest paid

(0.6)

(1.4)

(2.3)

(4.1)

(4.2)

(6.3)

(9.2)

(9.4)

Tax paid

(0.5)

(0.1)

0.0

(0.1)

(0.0)

0.0

0.0

0.0

Net cash flow from operating activities

3.2

22.1

18.2

21.5

25.0

40.2

41.8

43.6

Purchase of investment properties

(63.3)

(90.0)

(99.6)

(117.5)

(51.4)

(283.5)

(23.8)

0.0

Disposal of investment properties

0.0

0.0

0.0

14.1

7.8

7.3

0.0

0.0

Net cash flow from investing activities

(63.3)

(90.0)

(99.6)

(103.4)

(43.6)

(276.2)

(23.8)

0.0

Issue of ordinary share capital (net of expenses)

0.0

91.7

48.9

78.2

58.3

121.9

0.0

0.0

(Repayment)/drawdown of loans

20.9

26.0

42.0

44.0

(22.0)

150.0

20.0

0.0

Dividends paid

(15.6)

(17.4)

(23.6)

(29.2)

(31.5)

(40.0)

(42.4)

(43.0)

Other

0.0

(1.5)

(0.3)

(1.6)

(1.5)

0.0

(0.0)

0.0

Net cash flow from financing activities

5.3

98.8

67.0

91.4

3.3

231.8

(22.4)

(43.0)

Net change in cash and equivalents

(54.7)

31.0

(14.5)

9.5

(15.3)

(4.2)

(4.4)

0.6

Opening cash and equivalents

65.1

10.4

41.4

26.9

36.4

21.1

16.9

12.6

Closing cash and equivalents

10.4

41.4

26.9

36.4

21.1

16.9

12.6

13.2

Balance sheet debt

(39.3)

(64.2)

(106.4)

(150.1)

(127.9)

(278.2)

(299.0)

(299.8)

Unamortised loan arrangement costs

(0.7)

(1.8)

(1.6)

(1.9)

(2.1)

(1.8)

(1.0)

(0.2)

Net cash/(debt)

(29.6)

(24.6)

(81.1)

(115.6)

(108.9)

(263.1)

(287.4)

(286.8)

Gross LTV

14.2%

17.1%

21.6%

24.9%

19.2%

28.8%

29.3%

28.5%

Net LTV

10.5%

6.4%

16.2%

18.9%

16.1%

27.1%

28.1%

27.2%

Source: Target Healthcare REIT, Edison Investment Research

General disclaimer and copyright

This report has been commissioned by Target Healthcare REIT and prepared and issued by Edison, in consideration of a fee payable by Target Healthcare REIT. Edison Investment Research standard fees are £60,000 pa for the production and broad dissemination of a detailed note (Outlook) following by regular (typically quarterly) update notes. Fees are paid upfront in cash without recourse. Edison may seek additional fees for the provision of roadshows and related IR services for the client but does not get remunerated for any investment banking services. We never take payment in stock, options or warrants for any of our services.

Accuracy of content: All information used in the publication of this report has been compiled from publicly available sources that are believed to be reliable, however we do not guarantee the accuracy or completeness of this report and have not sought for this information to be independently verified. Opinions contained in this report represent those of the research department of Edison at the time of publication. Forward-looking information or statements in this report contain information that is based on assumptions, forecasts of future results, estimates of amounts not yet determinable, and therefore involve known and unknown risks, uncertainties and other factors which may cause the actual results, performance or achievements of their subject matter to be materially different from current expectations.

Exclusion of Liability: To the fullest extent allowed by law, Edison shall not be liable for any direct, indirect or consequential losses, loss of profits, damages, costs or expenses incurred or suffered by you arising out or in connection with the access to, use of or reliance on any information contained on this note.

No personalised advice: The information that we provide should not be construed in any manner whatsoever as, personalised advice. Also, the information provided by us should not be construed by any subscriber or prospective subscriber as Edison’s solicitation to effect, or attempt to effect, any transaction in a security. The securities described in the report may not be eligible for sale in all jurisdictions or to certain categories of investors.

Investment in securities mentioned: Edison has a restrictive policy relating to personal dealing and conflicts of interest. Edison Group does not conduct any investment business and, accordingly, does not itself hold any positions in the securities mentioned in this report. However, the respective directors, officers, employees and contractors of Edison may have a position in any or related securities mentioned in this report, subject to Edison's policies on personal dealing and conflicts of interest.

Copyright: Copyright 2021 Edison Investment Research Limited (Edison).

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New Zealand

The research in this document is intended for New Zealand resident professional financial advisers or brokers (for use in their roles as financial advisers or brokers) and habitual investors who are ‘wholesale clients’ for the purpose of the Financial Advisers Act 2008 (FAA) (as described in sections 5(c) (1)(a), (b) and (c) of the FAA). This is not a solicitation or inducement to buy, sell, subscribe, or underwrite any securities mentioned or in the topic of this document. For the purpose of the FAA, the content of this report is of a general nature, is intended as a source of general information only and is not intended to constitute a recommendation or opinion in relation to acquiring or disposing (including refraining from acquiring or disposing) of securities. The distribution of this document is not a ‘personalised service’ and, to the extent that it contains any financial advice, is intended only as a ‘class service’ provided by Edison within the meaning of the FAA (i.e. without taking into account the particular financial situation or goals of any person). As such, it should not be relied upon in making an investment decision.

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Frankfurt +49 (0)69 78 8076 960

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United Kingdom

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General disclaimer and copyright

This report has been commissioned by Target Healthcare REIT and prepared and issued by Edison, in consideration of a fee payable by Target Healthcare REIT. Edison Investment Research standard fees are £60,000 pa for the production and broad dissemination of a detailed note (Outlook) following by regular (typically quarterly) update notes. Fees are paid upfront in cash without recourse. Edison may seek additional fees for the provision of roadshows and related IR services for the client but does not get remunerated for any investment banking services. We never take payment in stock, options or warrants for any of our services.

Accuracy of content: All information used in the publication of this report has been compiled from publicly available sources that are believed to be reliable, however we do not guarantee the accuracy or completeness of this report and have not sought for this information to be independently verified. Opinions contained in this report represent those of the research department of Edison at the time of publication. Forward-looking information or statements in this report contain information that is based on assumptions, forecasts of future results, estimates of amounts not yet determinable, and therefore involve known and unknown risks, uncertainties and other factors which may cause the actual results, performance or achievements of their subject matter to be materially different from current expectations.

Exclusion of Liability: To the fullest extent allowed by law, Edison shall not be liable for any direct, indirect or consequential losses, loss of profits, damages, costs or expenses incurred or suffered by you arising out or in connection with the access to, use of or reliance on any information contained on this note.

No personalised advice: The information that we provide should not be construed in any manner whatsoever as, personalised advice. Also, the information provided by us should not be construed by any subscriber or prospective subscriber as Edison’s solicitation to effect, or attempt to effect, any transaction in a security. The securities described in the report may not be eligible for sale in all jurisdictions or to certain categories of investors.

Investment in securities mentioned: Edison has a restrictive policy relating to personal dealing and conflicts of interest. Edison Group does not conduct any investment business and, accordingly, does not itself hold any positions in the securities mentioned in this report. However, the respective directors, officers, employees and contractors of Edison may have a position in any or related securities mentioned in this report, subject to Edison's policies on personal dealing and conflicts of interest.

Copyright: Copyright 2021 Edison Investment Research Limited (Edison).

Australia

Edison Investment Research Pty Ltd (Edison AU) is the Australian subsidiary of Edison. Edison AU is a Corporate Authorised Representative (1252501) of Crown Wealth Group Pty Ltd who holds an Australian Financial Services Licence (Number: 494274). This research is issued in Australia by Edison AU and any access to it, is intended only for ‘wholesale clients’ within the meaning of the Corporations Act 2001 of Australia. Any advice given by Edison AU is general advice only and does not take into account your personal circumstances, needs or objectives. You should, before acting on this advice, consider the appropriateness of the advice, having regard to your objectives, financial situation and needs. If our advice relates to the acquisition, or possible acquisition, of a particular financial product you should read any relevant Product Disclosure Statement or like instrument.

New Zealand

The research in this document is intended for New Zealand resident professional financial advisers or brokers (for use in their roles as financial advisers or brokers) and habitual investors who are ‘wholesale clients’ for the purpose of the Financial Advisers Act 2008 (FAA) (as described in sections 5(c) (1)(a), (b) and (c) of the FAA). This is not a solicitation or inducement to buy, sell, subscribe, or underwrite any securities mentioned or in the topic of this document. For the purpose of the FAA, the content of this report is of a general nature, is intended as a source of general information only and is not intended to constitute a recommendation or opinion in relation to acquiring or disposing (including refraining from acquiring or disposing) of securities. The distribution of this document is not a ‘personalised service’ and, to the extent that it contains any financial advice, is intended only as a ‘class service’ provided by Edison within the meaning of the FAA (i.e. without taking into account the particular financial situation or goals of any person). As such, it should not be relied upon in making an investment decision.

United Kingdom

This document is prepared and provided by Edison for information purposes only and should not be construed as an offer or solicitation for investment in any securities mentioned or in the topic of this document. A marketing communication under FCA Rules, this document has not been prepared in accordance with the legal requirements designed to promote the independence of investment research and is not subject to any prohibition on dealing ahead of the dissemination of investment research.

This Communication is being distributed in the United Kingdom and is directed only at (i) persons having professional experience in matters relating to investments, i.e. investment professionals within the meaning of Article 19(5) of the Financial Services and Markets Act 2000 (Financial Promotion) Order 2005, as amended (the ‘FPO’) (ii) high net-worth companies, unincorporated associations or other bodies within the meaning of Article 49 of the FPO and (iii) persons to whom it is otherwise lawful to distribute it. The investment or investment activity to which this document relates is available only to such persons. It is not intended that this document be distributed or passed on, directly or indirectly, to any other class of persons and in any event and under no circumstances should persons of any other description rely on or act upon the contents of this document.

This Communication is being supplied to you solely for your information and may not be reproduced by, further distributed to or published in whole or in part by, any other person.

United States

Edison relies upon the ‘publishers' exclusion’ from the definition of investment adviser under Section 202(a)(11) of the Investment Advisers Act of 1940 and corresponding state securities laws. This report is a bona fide publication of general and regular circulation offering impersonal investment-related advice, not tailored to a specific investment portfolio or the needs of current and/or prospective subscribers. As such, Edison does not offer or provide personal advice and the research provided is for informational purposes only. No mention of a particular security in this report constitutes a recommendation to buy, sell or hold that or any security, or that any particular security, portfolio of securities, transaction or investment strategy is suitable for any specific person.

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Frankfurt +49 (0)69 78 8076 960

Schumannstrasse 34b

60325 Frankfurt

Germany

London +44 (0)20 3077 5700

280 High Holborn

London, WC1V 7EE

United Kingdom

New York +1 646 653 7026

1185 Avenue of the Americas

3rd Floor, New York, NY 10036

United States of America

Sydney +61 (0)2 8249 8342

Level 4, Office 1205

95 Pitt Street, Sydney

NSW 2000, Australia

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