Rental growth and development progress

Target Healthcare REIT 30 April 2019 Update
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Target Healthcare REIT

Rental growth and development progress

Quarterly NAV update

Real estate

30 April 2019

Price

116.6p

Market cap

£449m

Net debt (£m) at 31 March 2019

62.9

Gross LTV as at 31 March 2019

17.6%

Shares in issue

385.1m

Free float

97%

Code

THRL

Primary exchange

LSE

Secondary exchange

N/A

Share price performance

%

1m

3m

12m

Abs

1.6

6.2

6.2

Rel (local)

(1.0)

(2.0)

7.3

52-week high/low

118p

106p

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

Q319 ex-dividend

2 May 2019

Q319 DPS paid

31 May 2019

Analysts

Martyn King

+44 (0)20 3077 5745

Andrew Mitchell

+44 (0)20 3681 2500

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

Target’s portfolio continued to perform well during the three months ended 31 March (Q319), with RPI-driven rental growth, increased property valuations and progress with the forward-funded development of pre-let, high-quality, purpose-built homes. Due diligence on potential further acquisition opportunities continues, in aggregate sufficient to fully deploy remaining debt capital resources.

Year end

Revenue (£m)

Adj. net earnings* (£m)

Adjusted EPS* (p)

EPRA NAV/
share (p)

DPS
(p)

P/NAV per share (x)

Yield
(%)

06/17

23.6

13.2

5.23

101.9

6.28

1.14

5.4

06/18

28.4

15.7

5.54

105.7

6.45

1.10

5.5

06/19e

34.4

21.0

5.68

106.5

6.58

1.10

5.6

06/20e

43.1

25.8

6.71

110.6

6.71

1.05

5.8

06/21e

44.4

26.6

6.91

115.1

6.84

1.01

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.

2.0% quarterly EPRA NAV total return

EPRA NAV per share increased c 0.4% during Q319 to 107.3p versus 106.9p at end-Q219. Including dividends paid during the quarter, the EPRA NAV total return was 2.0%, taking the cumulative return in the first nine months of the year to 6.1%. A third quarterly DPS of 1.64475p per share has been declared and will be paid 31 May 2019. The portfolio value increased to £477.1m during the period, with growth driven by continuing investment in the forward-funded developments (two completed in the period and five under construction) and underlying valuation gains. The latter were supported by rental growth on the mainly RPI-linked leases, with modest yield tightening in the period. Although there were no acquisitions completed in Q319, £6.9m has since been deployed and the pipeline remains strong. Our forecasts, including a fully covered FY20 DPS, are unchanged.

Demographics support long-term growth

Demographics should support growing care-home demand for years to come, while there is an undersupply of the modern, well-designed homes, fully equipped with en-suite wet rooms and suitable communal spaces that differentiate Target’s investment strategy. Investors continue to be attracted by long lease lengths and upwards-only RPI-linked rental growth, with strong competition for assets. Although increasing asset prices have a positive impact on the NAV, they make Target’s disciplined approach to acquisitions, targeting ‘future-proof assets’, an essential ingredient in delivering attractive and sustainable long-term returns.

Visible income growth supports premium to NAV

Target offers a growing dividend with visible inflation-linked potential for growth, which we expect to be fully covered by adjusted earnings in FY20. The dividend represents a highly attractive yield (FY19e: 5.6%) that supports the continuing c 10% premium to Q219 NAV.

Further details

We provide more details on the quarterly progress below. Despite Q319 EPRA NAV of 107.3p being slightly ahead of our full-year forecast of 106.5p, we have left our estimates unchanged for now. We anticipate an acceleration in acquisition activity, which is likely to generate future additional acquisition costs that will act as a drag on NAV, while the Q3 development completions occurred faster than we had allowed for, positively releasing the discount applied to funds invested during the construction phase. The quarterly movement in the revenue reserve (effectively EPRA earnings), appears consistent with our full-year forecast, that will benefit from a larger rent-generating asset base during Q419.

Exhibit 1: Composition of NAV changes

Sep-18

Dec-18

Mar-19

Q119

Q219

Q319

Opening EPRA NAV per share (p)

105.7

106.1

106.9

Net gains/(losses) on investment property revaluation, acquisition costs, construction cost discounting

0.7

1.0

0.9

Net effect of equity issuance

0.0

0.1

0.0

Movement in revenue reserve (excluding performance fee accruals)

1.3

1.1

1.1

Dividend paid

(1.6)

(1.4)

(1.6)

Closing EPRA NAV per share (p)

106.1

106.9

107.3

Source: Target Healthcare REIT

The portfolio value increased by 2.8% during the quarter, to £477.1m. The number of assets was unchanged at 61 but the number of operational assets increased to 56 as two forward-funded developments completed. Continuing investment into the forward-funded developments accounted for most of the portfolio growth, but like-for-like valuation movements also added 0.5%, driven mostly by rental growth and modest yield tightening. The end-Q319 EPRA topped-up net initial yield was 6.29% compared with 6.32% at end-Q219.

The two completed pre-let developments contributed 5.5pp of the overall 6.0% increase in contracted rents, to £29.7m, while like-for-like rent increases on the mostly RPI-linked leases added 0.5pp. The completed developments, at Earl Shilton in Leicestershire and Cumnor Hill in Oxfordshire, provide 140 bedrooms with full en-suite wet-room facilities and are let to operators with an established record of managing high-quality homes. Both are new to the group and contribute to an increasingly diverse tenant base that now numbers 23.

Development work continues on five additional pre-let forward-funded assets, all expected to complete in late FY19/early FY20. Completion of these assets, as well as the further forward purchase home that Target has contracted to acquire on completion, is expected to add an additional £3.7m to annual contracted rent and further diversify the tenant base to 26.

Since the end of the quarter, Target has acquired a 40-bedroom home in Formby, Merseyside, for £6.9m including acquisition costs. In line with Target’s strict investment criteria, the home, which opened in late 2017, provides high-quality facilities including full en-suite wet rooms. It is let on a 35-year RPI-linked lease, with cap and collar, to Athena Healthcare, a long-standing tenant of the group.

At the end of Q319 Target had drawn £84.0m of its £170m debt facilities, giving a gross loan to value ratio (LTV) of 17.6% or a net LTV 13.2% after adjusting for cash.

A number of near-term acquisition opportunities are in due diligence and the group says that if they all complete as anticipated, it would be able to fully deploy all available debt capital in the 2019 summer months. This suggests that although the current run-rate of acquisitions in H219 is a little below that reflected in our forecasts, there are good prospects for acquisitions to accelerate and even exceed our expectations.

Our forecasts, unchanged from our last update note, include £55m of additional investment commitment by the end of FY19, a level that we believe is consistent with re-gearing the balance sheet to a c 25% LTV, generating full dividend cover in FY20. We estimate that full-deployment of existing debt facilities would provide room for an additional c £24m of acquisitions, temporarily lifting LTV to c 28%, but increasing EPRA earnings.

Exhibit 2: Continuing positive EPRA NAV total return

Q319

FY19 YTD

Opening EPRA NAV per share (p)

106.9

105.7

Closing EPRA NAV per share (p)

107.3

107.3

Dividends paid (p)

1.6

4.9

NAV total return

2.0%

6.1%

Source: Target Healthcare REIT, Edison Investment Research

Exhibit 3: Financial summary

Year to 30 June (£000s)

2014

2015

2016

2017

2018

2019e

2020e

2021e

INCOME STATEMENT

Rent revenue

 

3,817

9,898

12,677

17,760

22,029

28,450

37,060

38,362

Movement in lease incentive/fixed rent review adjustment

1,547

3,760

4,136

5,127

6,334

5,903

6,000

6,000

Rental income

 

5,364

13,658

16,813

22,887

28,363

34,353

43,060

44,362

Other income

0

66

61

671

3

0

0

0

Total revenue

 

5,364

13,724

16,874

23,558

28,366

34,353

43,060

44,362

Gains/(losses) on revaluation

(2,233)

(839)

425

2,211

6,434

1,819

9,714

10,996

Cost of corporate acquisitions

0

(174)

(998)

(626)

0

0

0

0

Total income

 

3,131

12,711

16,301

25,143

34,800

36,172

52,774

55,358

Management fee

(648)

(1,524)

(2,654)

(3,758)

(3,734)

(4,983)

(5,255)

(5,453)

Other expenses

(780)

(880)

(992)

(1,236)

(1,458)

(1,520)

(1,600)

(1,600)

Total expenditure

(1,428)

(2,404)

(3,646)

(4,994)

(5,192)

(6,503)

(6,855)

(7,053)

Profit before finance and tax

 

1,703

10,307

12,655

20,149

29,608

29,669

45,918

48,304

Net finance cost

190

(716)

(929)

(808)

(2,010)

(3,179)

(4,512)

(4,576)

Profit before taxation

 

1,893

9,591

11,726

19,341

27,598

26,490

41,406

43,728

Tax

(4)

(39)

(24)

(219)

11

0

0

0

Profit for the year

 

1,889

9,552

11,702

19,122

27,609

26,490

41,406

43,728

Average number of shares in issue (m)

105.2

119.2

171.7

252.2

282.5

369.8

385.1

385.1

IFRS earnings

1,889

9,552

11,702

19,122

27,609

26,490

41,406

43,728

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

(1,547)

(3,760)

(4,136)

(5,127)

(6,334)

(5,903)

(6,000)

(6,000)

Adjust for valuation changes

2,233

839

(425)

(2,211)

(6,434)

(1,819)

(9,714)

(10,996)

Adjust for corporate acquisitions

0

174

998

420

0

0

0

0

EPRA earnings

 

2,575

6,805

8,139

12,204

14,841

18,768

25,692

26,733

Adjust for development interest under forward fund agreements

261

2237

141

-138

Adjust for performance fee

150

466

871

997

550

0

0

0

Group adjusted earnings

 

2,725

7,271

9,010

13,201

15,652

21,005

25,833

26,595

IFRS EPS (p)

1.80

8.02

6.81

7.58

9.77

7.16

10.75

11.36

Adjusted EPS (p)

 

2.59

6.10

5.25

5.23

5.54

5.68

6.71

6.91

EPRA EPS (p)

2.45

5.71

4.74

4.84

5.25

5.08

6.67

6.94

Dividend per share (declared)

6.00

6.12

6.18

6.28

6.45

6.58

6.71

6.84

BALANCE SHEET

Investment properties

81,422

138,164

200,720

266,219

362,918

513,043

530,028

540,823

Other non-current assets

0

2,530

3,742

3,988

27,139

34,544

42,004

48,233

Non-current assets

 

81,422

140,694

204,462

270,207

390,057

547,587

572,032

589,056

Cash and equivalents

17,125

29,159

65,107

10,410

41,400

5,217

6,964

7,738

Other current assets

6,524

6,457

13,222

25,629

3,365

6,093

6,093

6,093

Current assets

 

23,649

35,616

78,329

36,039

44,765

11,310

13,057

13,831

Bank loan

(11,764)

(30,865)

(20,449)

(39,331)

(64,182)

(134,716)

(145,216)

(145,716)

Other non-current liabilities

0

(2,530)

(4,058)

(3,997)

(4,673)

(5,131)

(5,131)

(5,131)

Non-current liabilities

 

(11,764)

(33,395)

(24,507)

(43,328)

(68,855)

(139,847)

(150,347)

(150,847)

Trade and other payables

(3,089)

(3,623)

(5,002)

(5,981)

(7,360)

(9,108)

(9,108)

(9,108)

Current Liabilities

 

(3,089)

(3,623)

(5,002)

(5,981)

(7,360)

(9,108)

(9,108)

(9,108)

Net assets

 

90,218

139,292

253,282

256,937

358,607

409,943

425,634

442,933

Period end shares (m)

95.2

142.3

252.2

252.2

339.2

385.1

385.1

385.1

IFRS NAV per ordinary share

 

94.7

97.9

100.4

101.9

105.7

106.5

110.5

115.0

EPRA NAV per share

 

94.7

97.9

100.6

101.9

105.7

106.5

110.6

115.1

CASH FLOW

Cash flow from operations

 

3,172

8,081

8,906

4,394

23,627

19,373

28,745

31,080

Net interest paid

161

(514)

(681)

(615)

(1,366)

(2,531)

(4,012)

(4,076)

Tax paid

0

(47)

(164)

(543)

(122)

14

0

0

Net cash flow from operating activities

 

3,333

7,520

8,061

3,236

22,139

16,856

24,733

27,004

Purchase of investment properties

(51,894)

(51,736)

(34,833)

(37,698)

(89,981)

(148,379)

(7,271)

0

Acquisition of subsidiaries

0

(5,845)

(27,091)

(25,552)

0

0

0

0

Net cash flow from investing activities

 

(51,894)

(57,581)

(61,924)

(63,250)

(89,981)

(148,379)

(7,271)

0

Issue of ordinary share capital (net of expenses)

44,520

46,644

97,501

0

91,729

49,049

0

0

(Repayment)/drawdown of loans

8,646

22,525

(12,808)

20,906

24,456

70,000

10,000

0

Dividends paid

(4,364)

(7,074)

(9,681)

(15,589)

(17,353)

(23,709)

(25,715)

(26,229)

Other

0

0

14,799

0

0

0

0

0

Net cash flow from financing activities

 

48,802

62,095

89,811

5,317

98,832

95,340

(15,715)

(26,229)

Net change in cash and equivalents

 

241

12,034

35,948

(54,697)

30,990

(36,183)

1,747

774

Opening cash and equivalents

16,884

17,125

29,159

65,107

10,410

41,400

5,217

6,964

Closing cash and equivalents

 

17,125

29,159

65,107

10,410

41,400

5,217

6,964

7,738

Balance sheet debt

(11,764)

(30,865)

(20,449)

(39,331)

(64,182)

(134,716)

(145,216)

(145,716)

Unamortised loan arrangement costs

(497)

(645)

(551)

(669)

(1,818)

(1,284)

(784)

(284)

Net cash/(debt)

 

4,864

(2,351)

44,107

(29,590)

(24,600)

(130,783)

(139,036)

(138,262)

Gross LTV

15.1%

22.8%

10.5%

14.2%

17.1%

25.1%

25.8%

25.1%

Net LTV

0.0%

1.7%

0.0%

10.5%

6.4%

24.1%

24.6%

23.8%

Source: Company data, Edison Investment Research

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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 £49,500 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.

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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 £49,500 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 Edison analyst 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.

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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.

United Kingdom

Neither this document and associated email (together, the "Communication") constitutes or form part of any offer for sale or subscription of, or solicitation of any offer to buy or subscribe for, any securities, nor shall it or any part of it form the basis of, or be relied on in connection with, any contract or commitment whatsoever. Any decision to purchase shares in the Company in the proposed placing should be made solely on the basis of the information to be contained in the admission document to be published in connection therewith.

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 (nor will such persons be able to purchase shares in the placing).

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

The Investment Research is a publication distributed in the United States by Edison Investment Research, Inc. Edison Investment Research, Inc. is registered as an investment adviser with the Securities and Exchange Commission. 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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