Target Healthcare REIT — Continuing DPS and positive total returns

Target continues to work closely with tenants and, assisted by the wider availability of COVID-19 testing across the sector, says that just a handful of the 71 operational homes in its portfolio are reporting confirmed or suspected cases. These represent less than 0.3% of the 4,925 beds, down from a peak in the third week of April of 3.2% (162 beds).

In its 6 July trading update Target reported that 96% of the rent payable in respect of the recent quarter dates (24 June in England, Wales and Northern Ireland and 28 May in Scotland) had been collected, after allowing for agreements in respect of a limited proportion of the 71 operational homes to pay monthly in advance, and excluding two immature care homes on which agreements were in place prior to the pandemic. The 4% of rent currently outstanding relates to care homes where active asset management initiatives have been put in place which Target says provides it with strong visibility of value recovery in the near term.

RPI rental uplifts continued to support growth in the rent roll and increasing property valuations in Q420, as it has throughout the year. The unaudited Q4 EPRA NAV per share increased slightly to 108.1p (Q320: 108.0p) and including the 1.67p Q320 DPS paid the NAV total return in the quarter was 1.6%. A Q420 DPS of 1.67p has been declared for payment on 28 August, bringing the total for the year to 6.68p as expected, up 1.5% compared with FY19.

The quarterly data indicate a full year NAV total return of 6.8%, with a positive return in each period, and takes the cumulative total return since IPO to 55.8% or an annual average compound return (dividends added back but not reinvested) of 6.1%. More than 80% of the total return has been in the form of dividend distributions.

Also consistently positive throughout the quarters were the recurring income returns, shown in the quarterly data and in Exhibit 3 as the ‘movement in the revenue reserve’, and the capital returns (property revaluation less acquisition costs).

Exhibit 4 shows a bridge of the unaudited EPRA NAV movement during the year with dividend payments exceeding recurring income and the difference made up by net positive capital movements (net property revaluation less refinance costs).

Target’s last equity fund-raising was in September 2019 (Q120) when it raised £80m (gross) in an oversubscribed issue of 72.4m shares. The equity proceeds were quickly deployed in Q220 and acquisitions continued into Q320. However, the COVID-19 pandemic then slowed further deployment of available debt capital, with two potential acquisitions postponed at a late stage of negotiation, until a clearer picture of the impact of the pandemic could be assessed. As a result, the balance sheet remained liquid with modest gearing (loan to value or LTV) through Q420. The relatively modest growth in the portfolio valuation during the quarter reflected positive revaluation (driven by RPI-linked rental growth), as has been the case throughout the year, and continuing investment in forward funded pre-let development assets.

Target has £180m of committed banking facilities comprising £80m of fully drawn fixed rate term loan facilities and £100m of more flexible variable rate revolving credit facilities £72m drawn). Adjusting the drawn debt of £152m for £36.4m of cash, the Q420 net LTV was 18.7%. The weighted average cost of the drawn debt, including amortisation of loan arrangement fees, was 2.87% with a weighted average term to expiry of 4.24 years.

With continuing robust rent collection (see below), falling infection rates reported at properties within the portfolio, and a generally improving operational environment for the tenant operators, in early July Target resumed its portfolio growth with the acquisition of a new-build care home in Bicester, Oxfordshire for a consideration of £15m (including the costs of acquisition), funded from existing cash resources. The high quality 66-bed, purpose-built home is let to Ideal Carehomes, Target’s largest existing tenant, and increases the number of homes leased by it to 12. With the 6 July announcement of the acquisition, Target reported that the financial position of the group remained robust with remaining uncommitted capital resources of £26m and a still modest LTV of 20.6%.

The investment manager is analysing and performing due diligence on a number of investment opportunities, both near-term and early stage, but notes that any decision on future acquisitions will take into account both market conditions and the funds available to the group.

Also since end-Q420, practical completion has been reached on the forward funded development of an 80-bed home in Burscough, Lancashire. The home is pre-let to existing tenant, Athena, and opened to tenants in July 2020. The currently remaining forward funded development is at Rudheath, Cheshire, acquired for £9.7m (including transaction costs) in Q320. The home is pre-let at completion to an existing tenant of the group, L&M Healthcare. Planning consent was received in October 2019 with the development phase expected to take 16 months.

We expect Target to report audited full-year results in mid-September and we will reassess our financial forecasts at that time with the detail that will become available. Our analysis of the quarterly data suggests that EPRA and adjusted earnings are likely to be lower than our current forecasts, which explains the unaudited end-Q420 EPRA NAV per share of 108.1p being slightly below our forecast 108.9p.

Applied to the average shares in issue, the unaudited quarterly data suggest EPRA earnings, excluding the non-cash IFRS adjustment for fixed or guaranteed rent uplifts (recognised as income on a straight line basis over the length of the lease), of around £22m, compared with our forecast £23.6m on this same basis. Reported EPRA earnings includes the non-cash IFRS adjustments and will be closer to £30m. Given recent bank debt drawings to maintain a liquid balance sheet while continuing investment in the forward funding assets, net interest expense may be slightly higher than we have allowed for. However, we suspect that the main difference with our forecasts is likely to be related to prudential non-cash provisioning against the rent receivables, both COVID-19 related and other, and in part related to IFRS accounting rules. H120 included c £0.3m of provisioning, relating to recently established homes rather than COVID-19, and in our forecasts we had allowed c £0.5m in H220.

Adjusted earnings, on which dividend decisions are made and against which dividend cover is measured, also includes the coupon accrued under forward funding agreements, and we also add back the non-recurring net refinancing costs that we estimate at £0.4m. Our £24.9m forecast for Adjusted earnings includes £0.8m accrued forward funding coupon but the slight delay in completions during the pandemic suggest this may be higher, at perhaps £1.0m. This suggests that adjusted earnings are likely to be c £23.4m for the year compared with dividends paid of c £29.4m (cover of c 80%).

Positively, in FY21 we would expect the provisioning to fall away, in part or in full, while our existing forecasts do not yet allow for Target’s return to acquisitions which we expect to have a positive impact.

Based on the FY20 aggregate annual DPS of 6.68p, the shares trade with a yield of 6.0% and a slight premium to NAV.

In Exhibit 7 we show a comparison of Target with its nearest competitors. With investors attracted by secure, long-term yield, the group has performed relatively well over the past 12 months. However, compared with the primary healthcare investors and the social housing investors, the share price performance of the care home investors has lagged the peer group average. We believe this is because rents for primary healthcare and social housing are ultimately funded by government, representing a strong covenant, while the care home sector has inevitably been more challenged by the COVID-19 pandemic. With rent collection to support dividends remaining robust, while benefitting from similar positive demographic trends compared with the peer group, there is good potential for Target’s yield differential to narrow versus the peer group average of 4.6%.