Nearing full investment

Target Healthcare REIT 1 August 2017 Update
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Target Healthcare REIT

Nearing full investment

NAV update

Real estate

1 August 2017

Price

120.25p

Market cap

£303m

Net debt (£m) at 30 June 2017

29.6

Shares in issue

252.2m

Free float

90%

Code

THRL

Primary exchange

LSE

Secondary exchange

N/A

Share price performance

%

1m

3m

12m

Abs

2.1

1.9

7.1

Rel (local)

1.0

(0.2)

(3.3)

52-week high/low

120.5p

107.2p

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

Final results

September 2017

Analysts

Julian Roberts

+44 (0)20 3077 5748

Martyn King

+44 (0)20 3077 5745

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

Target has provided a NAV and portfolio update as at 30 June. The previously announced acquisition of a newly-built home in Leicestershire and the forward funding of one in Merseyside bring the portfolio to a total of 47 properties and closer to management’s target of a 20% loan-to-value (LTV) ratio (14.2% at 30 June). We have adjusted our estimates for the NAV update and to account for the timing of the new investments. Target has the longest lease portfolio of any UK REIT, producing stable income streams from high-quality and purpose-built modern care homes. These support a prospective dividend yield of 5.2%.

Year end

Revenue (£m)

EPRA EPS (p)

EPRA NAV/
share (p)

Price/EPRA NAV/share (x)

DPS
(p)

Yield
(%)

06/15

12.7

5.71

97.9

1.23

6.12

5.1

06/16

16.3

4.56

100.6

1.20

6.18

5.1

06/17e

21.3

4.81

101.9

1.18

6.28

5.2

06/18e

26.5

6.47

103.5

1.16

6.34

5.3

Note: *PBT and EPS are normalised, excluding amortisation of acquired intangibles, exceptional items and share-based payments.

NAV and pipeline update

At 30 June 2017 EPRA NAV stood at £256.9m, or 101.9p per share, from 101.5p at 31 March. The Q3 dividend of 1.57p was covered by 2p of IFRS earnings, but not yet by EPRA EPS, which excludes 0.5p of revaluation. Passing rent was £20.3m, up 2.8% in the quarter, representing a 6.75% net initial yield. 70bp of the rental increase were due to rent reviews and the rest from acquisitions. The portfolio was valued at £282.0m at 30 June, after a like-for-like increase of c 0.5% (£1.3m), broadly in line with rental growth, and a £6.1m acquisition. Subsequent purchases have taken the portfolio to £298.6m. This steady performance shows the team’s success in delivering stable, predictable income from a growing portfolio of long leases (the weighted average unexpired lease term was 29.5 years at 30 June).

Two new properties

The Amwell in Melton Mowbray was acquired in early July for £8.4m and let for 35 years to Melton Care, a joint venture between Care Concern and local operator Magnum Care. The £8.2m forward funding agreement is for a land acquisition and the development of a high-quality care home in Birkdale, which will be carried out with Athena Healthcare. Athena will lease the completed property for 35 years from completion, expected by March 2019. The investments represent a yield in line with the rest of the portfolio (c 7%).

Valuation: Long leases support dividend

Target’s premium to EPRA NAV remains in the mid-teens, supported by the attractive 5.2% prospective dividend, paid from a growing portfolio of leases with the longest average unexpired term of any UK REIT. The company remains conservatively geared at 14.2% LTV, with a target of 20% at full investment. The care home market enjoys long-term secular demand, which is likely to provide further investment opportunities for Target to participate in this growth.

Summary of NAV update

The full year results will be published in September, but the NAV update gave a brief overview of the balance sheet, which we have used to update our model. The update contains no surprises and Target continues to execute management’s strategy of investing in purpose-built homes in areas with a supportive local economy and demographics. The main points are summarised below:

At 30 June 2017 the portfolio of 45 assets was valued at £282.0m (31 March: 44 and £274.6m). Of the increase, £6.1m was from the acquisition of a care home in Dover and £1.3m from valuation increases. The latter were equivalent to c 0.5% of the existing portfolio value, broadly in line with the like-for-like rental growth.

The rent roll stood at £20.3m, up 2.8% from £19.8m at 31 March. Of the increase, c £0.14m, or 0.7%, was due to rent increases and the rest was from new leases on acquired properties. Portfolio net initial yield was up slightly at 6.75% (31 March: 6.7%) and WAULT rose to 29.5 years over the period due to the addition of new 35-year leases.

Exhibit 1: Portfolio value and rent roll progression

Exhibit 2: WAULT and yield progression

Source: Company data

Source: Company data

Exhibit 1: Portfolio value and rent roll progression

Source: Company data

Exhibit 2: WAULT and yield progression

Source: Company data

Total borrowings were £40.0m, for an LTV ratio of 14.2%, excluding a cash balance of £10.4m. At 30 June, Target had £10m of capital available from its revolving credit facility. The company is close to agreeing a new debt facility with a new lender, replenishing its debt resources following the post-year end acquisitions.

EPRA NAV increased to £256.9m at 30 June from £256.1m at 31 March, equivalent to 101.9p per share.

Exhibit 3: EPRA NAV per share changes in the quarter

Source: Company data

New investments

The two acquisitions were announced on 12 July 2017 and are outlined below. Both new assets are in relatively prosperous areas with populations of potential residents. Once the forward-funded asset is built, both will fulfil Target’s criteria of having a long useful life ahead of them with less refurbishment and alteration required than older stock.

The Amwell in Melton Mowbray has 88 beds and welcomed its first residents in March 2017. The development was carried out by Melton Care to its own design and has excellent public spaces, large bedrooms with wet rooms en suite, a cinema, coffee shop and gym as well as a good location near the town centre, next to a park on the River Eye. The joint venture partners in Melton Care are Care Concern, a national operator with which Target works at several other homes, and local operator Magnum Care, which runs two other homes in Leicestershire. The 35-year lease has capped and collared RPI uplifts and the total acquisition cost was £8.4m.

The site in Birkdale, Merseyside, received planning permission in February 2017 for a 55-bed home, again with excellent amenities. The site acquisition and forward funding agreement have a total capped cost of £8.2m, with completion scheduled for March 2019, when the home will be let to Athena Healthcare for 35 years, again with capped and collared RPI uplifts. Athena has three operational homes and several under development; the Birkdale development will be the third Athena home owned by Target. This home will target the premium market and is located in an affluent suburb of Southport, an area with high demand for care homes.

Changes to estimates

We had previously assumed that Target would invest £40m in H217 (to 30 June 2017) and £20m in H118. The timing of the acquisitions announced on 12 July means that we have trimmed our H217 assumption to £35m but leave our H118 assumption unchanged. We have assumed that the forward funding will be disbursed as follows: £2.5m each in H118, H218 and H119, with the remaining £0.7m in the last quarter before the Birkdale home is completed by March 2019. We also assume that the funding will attract interest at the same rate as our assumed property yield of 7%.

The publication of a summary balance sheet has enabled us to make some assumptions about cash flow movements, but the FY17 financials overleaf remain estimates, pending final results to be announced in September. The changes to our estimates are summarised below. The slight increase in revenue is a result of the resilient net initial yield. That flows through to higher EPS and contributes to the increased EPRA NAV forecasts. We have not increased our dividend assumption.

Exhibit 4: Estimate changes

Revenue

EPRA EPS

EPRA NAV/share

DPS

Old (£m)

New (£m)

Change (%)

Old (p)

New (p)

Change (%)

Old (p)

New (p)

Change (%)

Old (p)

New (p)

Change (%)

2017e

23.4

23.4

0%

4.8

4.8

1%

100.7

101.9

2%

6.28

6.28

0%

2018e

27.9

28.1

1%

6.3

6.5

2%

102.3

103.5

2%

6.34

6.34

0%

2019e

28.7

29.2

2%

6.6

6.9

4%

105.2

106.5

2%

6.34

6.34

0%

Source: Edison Investment Research

Valuation: Long-term income

The 5.2% prospective yield is supported by 47 leases with 17 different tenants that have the longest WAULT of any UK REIT. Earnings will increase as Target becomes fully invested and approaches its planned LTV ratio of 20%, which we expect in FY18 as management deploys more debt capital, and we continue to expect the dividend to be fully covered in FY18. The c 18% premium to EPRA NAV is below the level of other REITs investing in healthcare assets, which trade at more than 20% above EPRA NAV, and shows the attraction of Target’s long-term, stable income streams to investors. Target’s valuation may continue to converge with peers as its track record and scale increase.

Exhibit 5: Financial summary

Year end 30 June

2013

2014

2015

2016

2017e

2018e

2019e

£000s

IFRS

IFRS

IFRS

IFRS

IFRS

IFRS

IFRS

Rent revenue

 

2,291

3,817

9,898

12,677

18,084

22,625

23,721

Movement in lease incentive or rent review

860

1,547

3,760

4,136

5,143

5,446

5,446

Rental income

 

3,151

5,364

13,658

16,813

23,227

28,071

29,167

Other income

0

0

66

61

195

0

0

Total revenue

 

3,151

5,364

13,724

16,874

23,422

28,071

29,167

Gains/(losses) on revaluation

(3,225)

(2,233)

(839)

425

804

(200)

971

Cost of corporate acquisitions

0

0

(174)

(998)

(2,941)

(1,363)

(194)

Total income

 

(74)

3,131

12,711

16,301

21,286

26,507

29,944

Management fee

(808)

(648)

(1,524)

(2,654)

(3,447)

(3,114)

(3,150)

Other expenses

0

(780)

(880)

(992)

(1,436)

(1,937)

(2,013)

Total expenditure

(808)

(1,428)

(2,404)

(3,646)

(4,883)

(5,051)

(5,163)

Profit before finance and tax

 

(882)

1,703

10,307

12,655

16,403

21,456

24,780

Net finance cost

93

190

(716)

(929)

(965)

(1,254)

(1,241)

Profit before taxation

 

(789)

1,893

9,591

11,726

15,438

20,202

23,540

Tax

(14)

(4)

(39)

(24)

(533)

0

0

Profit for the year

 

(803)

1,889

9,552

11,702

14,905

20,202

23,540

Movement in valuation of interest rate swap

0

0

0

(316)

223

0

0

Total comprehensive income for the year

 

(803)

1,889

9,552

11,386

15,128

20,202

23,540

Average number of shares in issue

58,618,032

105,231,661

119,160,560

171,734,587

252,180,851

252,180,851

252,180,851

IFRS earnings

(803)

1,889

9,552

11,386

15,128

20,202

23,540

Adjusted for rent arising from recognising
guaranteed rent review uplifts + lease incentives

(860)

(1,547)

(3,760)

(4,136)

(5,143)

(5,446)

(5,446)

Adjusted for valuation changes

3,225

2,233

839

(425)

(804)

200

(971)

Adjusted for corporate acquisitions

0

0

174

998

2,941

1,363

194

EPRA earnings

 

1,562

2,575

6,805

7,823

12,122

16,320

17,317

Adjusted for performance fee

0

150

466

871

745

800

800

Group adjusted EPRA earnings

 

1,562

2,725

7,271

8,694

12,867

17,120

18,117

IFRS EPS (p)

(1.37)

1.80

8.02

6.63

6.00

8.01

9.33

EPRA EPS (p)

 

2.66

2.45

5.71

4.56

4.81

6.47

6.87

Adjusted EPS (p)

2.66

2.59

6.10

5.06

5.10

6.79

7.18

Dividend per share (declared)

0.00

6.12

6.12

6.18

6.28

6.34

6.34

BALANCE SHEET

Investment properties

46,004

81,422

138,164

200,720

281,952

305,152

309,451

Trade and other receivables

0

0

2,530

3,742

3,763

3,763

3,763

Non-current assets

 

46,004

81,422

140,694

204,462

285,715

308,915

313,214

Trade and other receivables

1,300

6,524

6,457

13,222

11,000

11,000

11,000

Cash and equivalents

45,354

17,125

29,159

65,107

10,400

8,452

11,704

Current assets

 

46,654

23,649

35,616

78,329

21,400

19,452

22,704

Total assets

 

92,658

105,071

176,310

282,791

307,115

328,366

335,918

Bank loan

0

(11,764)

(30,865)

(20,449)

(40,000)

(57,000)

(57,000)

Interest rate swap

0

0

0

(316)

0

0

0

Trade and other payables

0

0

(2,530)

(3,742)

(3,763)

(3,763)

(3,763)

Non-current liabilities

 

0

(11,764)

(33,395)

(24,507)

(43,763)

(60,763)

(60,763)

Trade and other payables

(1,363)

(3,089)

(3,623)

(5,002)

(6,497)

(6,497)

(6,497)

Current Liabilities

 

(1,363)

(3,089)

(3,623)

(5,002)

(6,497)

(6,497)

(6,497)

Total liabilities

 

(1,363)

(14,853)

(37,018)

(29,509)

(50,260)

(67,260)

(67,260)

Net assets

 

91,295

90,218

139,292

253,282

256,855

261,106

268,658

Period end shares

95,221,629

95,221,629

142,298,226

252,180,851

252,180,851

252,180,851

252,180,851

NAV per ordinary share

 

95.9

94.7

97.9

100.4

101.9

103.5

106.5

EPRA NAV per share

 

95.9

94.7

97.9

100.6

101.9

103.5

106.5

Earnings yield on EPRA NAV

2.8%

2.6%

5.8%

4.5%

4.7%

6.3%

6.4%

Dividend yield on EPRA NAV

0.0%

6.5%

6.3%

6.1%

6.2%

6.1%

6.0%

CASH FLOW

Profit before tax

 

(789)

1,893

9,591

11,726

15,438

20,202

23,540

Adjusted for

Interest receivable

(93)

(201)

(99)

(173)

(138)

(80)

(80)

Interest payable

0

11

815

1,102

1,103

1,334

1,321

Revaluation gains on property portfolio

2,365

686

(2,921)

(4,787)

(4,943)

(700)

(1,099)

Cost of corporate acquisitions

2,941

1,363

194

(Increase)/decrease in trade and other receivables

(440)

(558)

(308)

(233)

4,543

0

0

Increase/(decrease) in trade and other payables

1,300

1,341

1,003

1,271

19

0

0

Total working capital adjustments

 

3,132

1,279

(1,510)

(2,820)

3,524

1,918

336

Interest paid

0

0

(613)

(854)

(892)

(1,334)

(1,321)

Interest received

93

161

99

173

138

80

80

Tax paid

0

0

(47)

(164)

(25)

0

0

Total other adjustments

 

93

161

(561)

(845)

(779)

(1,254)

(1,241)

Net cash flow from operating activities

 

2,436

3,333

7,520

8,061

18,184

20,866

22,635

Purchase of investment properties

(49,229)

(51,894)

(51,736)

(34,833)

(49,069)

(22,500)

(3,200)

Acquisition of subsidiaries

0

0

(5,845)

(27,091)

(27,867)

(1,363)

(194)

Net cash flow from investing activities

 

(49,229)

(51,894)

(57,581)

(61,924)

(76,936)

(23,863)

(3,394)

Issue of ordinary share capital

95,740

45,450

47,802

100,279

0

0

0

Expenses of issue

(1,882)

(930)

(1,158)

(2,778)

0

0

0

Sale of shares from treasury

0

0

0

14,799

0

0

0

(Repayment)/drawdown of bank loan

0

11,946

19,225

(10,638)

19,744

17,000

0

(Grant)/repayment of development loan and cost of bank facility

0

(3,300)

3,300

(2,170)

(185)

0

0

Dividends paid

(1,711)

(4,364)

(7,074)

(9,681)

(15,514)

(15,950)

(15,988)

Net cash flow from financing activities

 

92,147

48,802

62,095

89,811

4,045

1,050

(15,988)

Net change in cash and equivalents

 

45,354

241

12,034

35,948

(54,707)

(1,948)

3,253

Opening cash and equivalents

0

16,884

17,125

29,159

65,107

10,400

8,452

Closing cash and equivalents

 

45,354

17,125

29,159

65,107

10,400

8,452

11,704

Net debt (cash)

0

(17,125)

(17,395)

(44,658)

29,600

36,548

45,296

Source: Company data, Edison Investment Research

Edison is an investment research and advisory company, with offices in North America, Europe, the Middle East and AsiaPac. The heart of Edison is our world-renowned equity research platform and deep multi-sector expertise. At Edison Investment Research, our research is widely read by international investors, advisers and stakeholders. Edison Advisors leverages our core research platform to provide differentiated services including investor relations and strategic consulting. Edison is authorised and regulated by the Financial Conduct Authority. Edison Investment Research (NZ) Limited (Edison NZ) is the New Zealand subsidiary of Edison. Edison NZ is registered on the New Zealand Financial Service Providers Register (FSP number 247505) and is registered to provide wholesale and/or generic financial adviser services only. Edison Investment Research Inc (Edison US) is the US subsidiary of Edison and is regulated by the Securities and Exchange Commission. Edison Investment Research Limited (Edison Aus) [46085869] is the Australian subsidiary of Edison and is not regulated by the Australian Securities and Investment Commission. Edison Germany is a branch entity of Edison Investment Research Limited [4794244]. www.edisongroup.com

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