Civitas Social Housing — Focus returning to positive drivers

This report provides an update on recent developments at Civitas. For a detailed review of the company’s strategy and the opportunity within the care-based social housing sector, please see our July 2021 Outlook note.

Civitas shares have begun to recover the weakness that followed the publication of open letters by short-seller ShadowFall in September 2021.1 We attribute this recovery to the detailed response made by Civitas, which was supported by an active programme of investor engagement,2 accretive share repurchases, taking advantage of the discount to net asset value (NAV), and continuing positive accounting returns, confirmed by the interim results (H122) published in December 2021. However, although the discount to NAV has closed to c 10% (from c 20% during September 2021) we believe the share price recovery has some way to go. In August 2021 the shares traded at a c 10% premium to NAV, reflecting consistently positive accounting returns since its initial public offering (IPO) in November 2016, a robust performance during the pandemic with uninterrupted rent collection, long inflation-linked leases and strong underlying demand for supported housing.

Civitas has consistently delivered positive total returns3F3 on both an annual and quarterly basis since its IPO in November 2016. Dividends have been the main component of returns and have increased each year. Operational and financial resilience has been maintained. During the pandemic, rents were received in line with expectations and quarterly dividend payments have been uninterrupted. Since IPO Civitas has generated an aggregate NAV total return of 32.6% or an annual average of 6.0%. Dividends paid represent two-thirds of the total return in the period.

As Civitas has steadily increased its equity and debt capital to fund portfolio growth since IPO, dividends have run ahead of earnings and cash flow as this capital is deployed. Including the benefits of increased scale, Civitas estimates that dividends are now fully covered by earnings on a run rate basis.4 We note that had near-term dividend payments been restricted to a fully covered level, this would have had no impact on the achieved accounting total return, with increased NAV and capital returns offsetting reduced income returns.

In September 2021, the board recommenced share repurchases5 to manage the share price discount to NAV and underline its confidence in the company’s prospects and its firm belief that the issues raised by the short sellers were incorrect and misleading.

During September and November 2021 Civitas repurchased c 6.9m shares at an average c 91p, held in treasury, at an accretive c 16% discount to prevailing NAV per share. The narrowing discount has reduced the advantages of share repurchases versus accretive portfolio growth and there have been no further repurchases since 30 November.

A number of short positions became apparent in September 2021 but it appears that this has now substantially reduced and, since the interim results were published in early December 2021, both Michael Wrobel (non-executive chairman) and Paul Bridge (CEO, social housing at the investment adviser, Civitas Investment Management) have acquired shares6.

Local authority demand for SSH and other care-based social housing7 with similar characteristics remains strong and well ahead of existing supply. The demand for SSH reflects the value for money that it provides compared with the alternatives of residential care or long-stay hospitals, and a recognition of the enhancement to quality SSH can provide to those in need. Capital deployment has slowed in recent months, in part reflecting the pandemic but also the diversion of management time towards responding to the short-seller and the application of capital towards share repurchases. Several investment projects are presently under active consideration by Civitas as it continues to deploy the proceeds of the £85m M&G debt facility. This facility was fully drawn in late FY21 and contributes to the £76m H122 cash position. These opportunities are spread broadly across SSH (specialist supported living as well as high acuity specialist supported living and residential care8) and advanced homelessness.9 The ‘opportunity pool’ is well ahead of Civitas’s current available capital (we estimate c £25–30m), suggesting that in the near term it will be highly selective in the projects chosen while having significant longer-term acquisition opportunities subject to additional capital, both equity and debt capital. Debt raising should be supported by Civitas’s investment grade credit rating.10

As noted above, during the six months to 30 September 2021 (H122) Civitas continued to generate consistent financial returns for shareholders while continuing to generate strong social value. Specialist social impact consultancy The Good Economy estimates that Civitas’s portfolio generated a total social value of £127.0m pa during FY21, including £75.9m of fiscal savings for public budgets and £51.2m in respect of social impact through improved outcomes for residents.

In particular we note that:

The H122 portfolio comprised 648 individual properties providing homes for almost 4,400 residents, mostly vulnerable, younger adults with an average age of 32 years, receiving an average 43 hours per week of care. The properties are leased to diversified group of 17 different approved providers with an average unexpired lease length of 22.7 years and were independently valued at £946m, reflecting an IFRS valuation yield of 5.27%. Long average lease lengths have been a feature of the sector that has supported property valuations. However, as important as contractual lease length, it is the durability of cash flows that really underpin valuations. The positive demand-supply balance in the sector as well as the relatively young age of current and prospective residents underpins this durability. A young resident can be expected to live in their home for many years and the commissioning local authority has no incentive to move them from either a care or financial perspective. If the market were to move towards slightly lower lease lengths this should have no practical impact on cash flows and this is very likely to mitigate any potential impact on valuations.

Our reduced forecasts for FY22 and to a lesser extent for FY23 primarily reflect the impact of our revised acquisition assumptions. We have introduced a forecast for FY24.

We had previously indicated (see our November update) that our acquisition assumptions would be reviewed after the interim results. H122 acquisition investment of c £22m was below the £44m that we had forecast, to be followed by £25m in Q322. Our revised forecasts now include £25m of future acquisitions, at the end of FY22, only. This is an effective c £22m in overall deployment. The new assumption also includes a higher prudential cash position than previously, at c £40m compared with c £30m. Civitas has guided towards at least £30m. We continue to assume a gross acquisition yield of 5.6%.

The impact of these changes is primarily on net rental income with no significant changes in our other assumptions. We have not changed our DPS forecasts although full cover is delayed until FY23.

Despite a strong record of low volatility and consistently positive accounting returns, the targeted 5.55p aggregate FY22 DPS, represents a prospective yield of 5.8% while the shares are trading at a c 10% discount to the H122 NAV per share.

Compared with a group of companies that we would consider to be the closest peers to Civitas, investing in housing and healthcare properties, Civitas shares offer a noticeably higher yield than the average with a significantly lower P/NAV. Operational and financial performance during the pandemic has been robust, with rents collected as expected and with no impact on valuations. Yet to fully recover from recent weakness, the valuation of Civitas shares indicates significant potential while also delivering a material social benefit.