Target Healthcare REIT — Fully covered DPS and positive total return

Target Healthcare REIT (LSE: THRL)

Last close As at 20/04/2024

GBP0.77

1.00 (1.32%)

Market capitalisation

GBP475m

More on this equity

Research: Real Estate

Target Healthcare REIT — Fully covered DPS and positive total return

Target Healthcare REIT’s Q423 shows a second consecutive quarter of NAV growth, as property yields stabilise and indexed rent uplifts drive valuation growth. Rental growth and near-full rent collection are supporting earnings and delivering full dividend cover. Audited full year results will be published in early October.

Martyn King

Written by

Martyn King

Director, Financials

Elderly care image

Real Estate

Target Healthcare REIT

Fully covered DPS and positive total return

Q423 update

Real estate

9 August 2023

Price

73p

Market cap

£453m

Net debt (£m) at 30 June 2023

214.6

Net LTV at 30 June 2023

24.7%

Shares in issue

620.2m

Free float

100%

Code

THRL

Primary exchange

LSE

Secondary exchange

N/A

Share price performance

%

1m

3m

12m

Abs

1.8

(5.5)

(37.2)

Rel (local)

(1.9)

(2.4)

(36.9)

52-week high/low

117.2p

66.7p

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

FY23 results

Expected early October 2023

Analyst

Martyn King

+44 (0)20 3077 5700

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

Target Healthcare REIT’s Q423 shows a second consecutive quarter of NAV growth, as property yields stabilise and indexed rent uplifts drive valuation growth. Rental growth and near-full rent collection are supporting earnings and delivering full dividend cover. Audited full year results will be published in early October.

Year end

Rental income (£m)

Adjusted earnings* (£m)

Adjusted
EPS* (p)

NAV**/
share (p)

DPS
(p)

P/NAV
(x)

Yield
(%)

06/21

50.0

26.0

5.5

110.4

6.72

0.66

9.2

06/22

63.9

30.2

5.0

112.3

6.76

0.65

9.3

06/23e

67.7

37.2

6.0

104.5

6.18

0.70

8.5

06/24e

69.7

38.4

6.2

110.0

5.80

0.66

7.9

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. **NAV is net tangible assets (NTA) throughout this report.

Rent collection has increased to 99%

The unaudited Q423 NAV per share was 104.5p, up from 103.4p at end-Q323. Including DPS paid of 1.4p, fully covered by adjusted EPS of 1.5p, the quarterly NAV total return was 2.4%. Rent collection continues to improve (to 99% in Q4, up from 96% at H1) due to the completion of portfolio management initiatives and overall tenant profitability responding to improved trading conditions, with fee growth and occupancy recovery from the pandemic providing an offset to the inflationary cost pressure faced by operators. Rent cover, a key profitability metric, had improved to 1.5x at interims and, we expect, further since. This compares well to pre-pandemic norms despite being achieved at lower levels of underlying resident occupancy. This is currently c 84%, compared with a pandemic low of c 74%, but still around 6 percentage points below pre-pandemic levels.

Sustainably meeting a long-term need

A growing elderly population and the need to improve the existing estate point to continuing demand for modern, high-quality, ESG-compliant residential facilities. With its unwavering focus on asset quality, these are the homes in which Target invests. Not only are they appealing to residents (two-thirds private pay), but they also support operators in providing better, more efficient and more effective care. When let at sustainable rent levels in well-located areas, with strong supply/demand characteristics, they will always be attractive to existing or alternative tenants and are key to providing sustainable, long-duration, inflationlinked income.

Valuation: Attractive yield; positioned for DPS growth

The current, rebased annualised rate of quarterly DPS through H223 (5.6p), fully covered on a run-rate basis, reflects an attractive prospective yield of 7.7% and is a base from which to grow. We forecast 3.6% growth in FY24. Meanwhile, the discount to end-FY23 NAV is c 30%.

Further details on Q4 update

Property yields have stabilised with rental growth driving valuation gains. The Q423 EPRA net initial yield was 6.06% (topped-up net initial yield of 6.22%) compared to 6.05% in Q3 and 6.06% at midyear. NAV total returns were positive for the final two quarters of FY23, amounting to 4.5% during H223, substantially offsetting the negative 5.2% return reported in H123.

Following the mid-year rebasing of quarterly DPS to 1.4p, aggregate H2 DPS declared of 2.8p was fully covered by adjusted earnings of 3.0p. Exhibit 1 calculates NAV total return on a dividends-paid basis, such that Q323 reflects payment of the Q223 dividend declared.

Exhibit 1: Quarterly NAV development through FY23*

Sep-22

Dec-22

Dec-22

Mar-23

Jun-23

Jun-23

Jun-23

Pence per share

Q123

Q223

H123

Q323

Q423

H223*

FY23*

Opening EPRA NAV per share

112.3

112.1

112.3

103.0

103.4

103.0

112.3

Unrealised property revaluation gains/(losses)

(0.1)

(8.4)

(8.5)

0.5

1.0

1.5

(7.0)

Realised property revaluation gains/(losses)

0.0

0.0

0.0

0.1

0.0

0.1

0.1

Premium paid for interest rate swaps

0.0

(0.4)

(0.4)

0.0

0.0

0.0

(0.4)

Movement in revenue reserve

1.6

1.4

3.0

1.5

1.5

3.0

6.0

Dividend paid

(1.7)

(1.7)

(3.4)

(1.7)

(1.4)

(3.1)

(6.5)

Closing EPRA NAV per share

112.1

103.0

103.0

103.4

104.5

104.5

104.5

EPRA NTA total return

1.3%

-6.6%

-5.2%

2.0%

2.4%

4.5%

-1.2%

Source: Target Healthcare REIT. Note: *Unaudited.

Recycling capital

Since the end of H123, Target has exited Northern Ireland as part of its wider capital recycling and asset management strategy and has entered into two additional forward-funding schemes for the development of high-quality homes at Malvern in Worcestershire (Q323) and, since the end of Q423, at Weston-Super-Mare, Somerset.

The four homes that were sold in Northern Ireland represented c 2.5% of the overall portfolio value at the time (or c £22m), at a blended price that was c £0.6m ahead of the end-H123 carrying value. The proceeds can be recycled into the new (and existing) developments on a gradual basis as construction proceeds over the next year or so. The commitment to the Malvern home has not been disclosed but we assume £10m, and the maximum commitment to the Western-Super-Mare home is £16m.

Continuing asset management

The increase in rent collection to 99% substantially reflects improvements with two struggling tenants.

With one of these tenants, the re-tenanting of one of the four Target homes it operated was completed in Q323 with the effect of alleviating cash flow pressures and allowing it to return to a fully rent-paying position on its three remaining homes. Existing lease terms, including rent levels, were maintained with the incoming tenant being granted a short-term rent-free period to manage the rebuild in occupancy.

Improved trading conditions have benefited tenants across the portfolio, including one tenant in particular, the operator of two Target homes, that has historically been responsible for a significant proportion of rent arrears. Rent cover for the tenant has improved and H223 rents due were in full. We expect this will have continued through H2.

To further support the tenant’s plans for its business and grow the returns on its assets, Target will invest £2.5m in one of the homes, creating an additional 18 rooms, with capital works expected to be completed by September 2023. A portion of these will be immediately sub-let for three years by the operator to a local charitable organisation, at which point it is anticipated that the tenant will be able to take back the space for its own operation. Target’s rental income on the property will increase at a net initial yield consistent with the current property valuation and rent cover for the tenant is expected to improve. Post-completion, the tenant (including the sub-let) will represent 4.6% of the portfolio’s contracted rent. Previously provided for historical rent arrears will be partly written off, while rent deposits covering both properties operated by this tenant have been established to further strengthen the surety of rent receipts.

Continuing to forecast fully covered DPS growth through FY24

Target will publish full year results in September. Ahead of that, we have sought to reflect the unaudited quarterly key data, recent investment activity and tenant performance in our forecasts.

The quarterly data indicate that H223 adjusted ‘cash’ earnings and dividend cover were higher than we had previously forecast. On a full year basis, FY23 dividend cover is yet to fully reflect the mid-year rebasing.

The Q4 unaudited NAV per share is also ahead of our previous forecast, with property yields stabilising at a lower level than we had previously assumed. We assume that the net initial yield is maintained at the current level through FY24 with indexed rental growth generating property revaluation gains and growth in NAV.

Our previous forecast had assumed swift reinvestment of the Northern Irish asset sale proceeds into operational, immediately rent producing assets. Redeployment into development schemes defers rent income (until completion) with a partial offset from interest on the funds extended for construction.

We have also pushed back our assumed completion dates by around three months at existing development schemes at Olney, Holt and Dartmouth.

The gradual funding of the development schemes has a positive impact on borrowing requirements and interest costs, particularly marginal, unhedged floating rate debt.

In aggregate, the changes slightly reduce our forecast FY24 adjusted earnings but we continue to expect an increase in the rate of quarterly DPS (to 1.45p per quarter versus 1.40p per quarter in H223) and for this to be fully covered on a cash basis and strongly covered on an EPRA basis.

Exhibit 2: Forecast summary

New forecast

Previous forecast

Change

Change (%)

£m unless stated otherwise

FY23e

FY24e

FY23e

FY24e

FY23

FY24

FY23

FY24

Cash rental income

56.3

58.8

57.2

61.3

(0.8)

(2.5)

-1.5%

-4.1%

Credit loss allowance

(0.3)

(0.6)

(1.0)

(1.5)

0.7

0.9

Expenses

(10.3)

(10.5)

(10.6)

(10.7)

0.3

0.1

-2.9%

-1.3%

Net finance costs

(9.5)

(10.0)

(9.9)

(12.2)

0.4

2.3

-4.3%

-18.5%

Adjust for development interest under forward fund agreements

1.0

0.7

0.6

0.5

0.3

0.2

48.2%

42.0%

Adjusted earnings

37.2

38.4

36.2

37.4

0.9

1.0

2.6%

2.7%

Adjust for development interest under forward fund agreements

(1.0)

(0.7)

(0.6)

(0.5)

(0.3)

(0.2)

Non-cash IFRS adjustments

11.3

10.9

11.4

11.4

(0.1)

(0.5)

Adjust for interest rate cap premium

0.0

0.0

0.0

0.0

0.0

0.0

EPRA earnings

47.6

48.6

47.0

48.3

0.5

0.3

1.1%

0.7%

EPRA EPS (p)

7.7

7.8

7.6

7.8

0.1

0.1

1.1%

0.7%

Adjusted EPS (p)

6.0

6.2

5.8

6.0

0.2

0.2

2.6%

2.7%

DPS declared (p)

6.2

5.8

6.2

5.8

0.00

0.00

0.0%

0.0%

EPRA DPS cover (x)

1.24

1.35

1.23

1.34

Adjusted DPS cover (x)

0.97

1.07

0.95

1.04

EPRA NTA per share (‘NAV’) (p)

104.5

110.0

102.0

105.3

2.5

4.7

2.4%

4.4%

NAV total return

-1.2%

10.8%

-3.4%

8.9%

Source: Edison Investment Research

Debt financing at fixed cost

Of Target’s £320m of debt facilities, £230m was drawn at end-Q423, with an average term to maturity of 6.2 years and a blended cost of 3.7%, including amortisation of loan arrangement fees. 96% of drawn borrowings were fixed or hedged in a way that leaves Target with minimal exposure to a further rise in interest rates until 2025 and the flexibility to react to any decline in interest rates during this period. Our forecasts assume the drawing of just £20m of fully floating rate debt by endFY24. Market interest rate expectations remain volatile and, at the time of this report, indicate that the benchmark SONIA rate will have declined to below 5%. Including lending margin, this currently indicates an increase in borrowing costs, from 2025 onwards, on shorter-term floating rate borrowings as the interest rate hedges expire. At end-Q4, this was £30m with SONIA hedged at 3.0%.

Exhibit 3: Financial summary

Year to 30 June (£m)

2020

2021

2022

2023e

2024e

INCOME STATEMENT

Rent revenue

36.0

41.2

48.8

56.3

58.8

Movement in lease incentive/fixed rent review adjustment

8.2

8.7

10.2

11.3

10.9

Other income

0.0

0.1

4.8

0.1

0.0

Total revenue

44.3

50.0

63.9

67.7

69.7

Gains/(losses) on revaluation

1.7

9.4

5.5

(53.5)

21.2

Realised gains/(losses) on disposal

0.6

1.3

0.0

0.0

0.0

Management fee

(5.3)

(5.8)

(7.3)

(7.3)

(7.4)

Credit loss allowance & bad debts

(2.1)

(2.7)

(3.2)

(0.3)

(0.6)

Other expenses

(2.2)

(2.6)

(3.2)

(3.1)

(3.1)

Operating profit

37.0

49.6

55.7

3.6

79.8

Net finance cost

(5.4)

(5.7)

(6.6)

(10.2)

(10.8)

Profit before taxation

31.6

43.9

49.1

(6.6)

69.0

Tax

0.0

0.0

(0.0)

0.0

0.0

IFRS net result

31.6

43.9

49.1

(6.6)

69.0

Adjust for:

Gains/(losses) on revaluation

(0.2)

(9.5)

(5.6)

53.5

(21.2)

Other EPRA adjustments

(1.0)

(0.3)

(3.9)

0.6

0.8

EPRA earnings

30.5

34.0

39.7

47.6

48.6

Adjust for fixed/guaranteed rent reviews

(8.2)

(8.7)

(10.2)

(11.3)

(10.9)

Adjust for development interest under forward fund agreements

1.0

0.6

0.8

1.0

0.7

Adjust for interest cap premium paid

Group adjusted earnings

23.2

26.0

30.2

37.2

38.4

Average number of shares in issue (m)

440.3

475.4

599.1

620.2

620.2

IFRS EPS (p)

7.18

9.23

8.20

(1.07)

11.13

EPRA EPS (p)

6.9

7.2

6.6

7.7

7.8

Adjusted EPS (p)

5.3

5.5

5.0

6.0

6.2

Dividend per share (declared)

6.68

6.72

6.76

6.18

5.80

Dividend cover (EPRA earnings)

1.00

1.05

0.95

1.24

1.35

Dividend cover (Adjusted earnings)

0.76

0.80

0.72

0.97

1.07

BALANCE SHEET

Investment properties

570.1

631.2

857.7

799.5

847.9

Other non-current assets

46.0

54.8

65.9

81.3

91.4

Non-current assets

616.1

686.0

923.6

880.8

939.3

Cash and equivalents

36.4

21.1

34.5

15.4

15.6

Other current assets

11.2

11.3

5.5

9.5

5.3

Current assets

47.6

32.4

40.0

24.9

21.0

Bank loan

(150.1)

(127.9)

(231.4)

(227.1)

(247.5)

Other non-current liabilities

(6.4)

(6.8)

(7.1)

(7.3)

(7.3)

Non-current liabilities

(156.5)

(134.7)

(238.5)

(234.3)

(254.8)

Trade and other payables

(13.1)

(18.5)

(26.4)

(18.4)

(19.2)

Current Liabilities

(13.1)

(18.5)

(26.4)

(18.4)

(19.2)

Net assets

494.1

565.2

698.8

652.9

686.3

Adjust for derivative financial liability

0.2

(0.3)

(2.3)

(5.0)

(4.2)

EPRA net assets

494.3

564.9

696.5

647.9

682.0

Period end shares (m)

457.5

511.5

620.2

620.2

620.2

IFRS NAV per share (p)

108.0

110.5

112.7

105.3

110.6

EPRA NTA per share (p)

108.1

110.4

112.3

104.5

110.0

EPRA NTA total return

6.8%

8.4%

7.8%

-1.2%

10.8%

CASH FLOW

Cash flow from operations

25.6

29.2

35.6

40.4

52.6

Premium paid for interest rate cap

(2.6)

0.0

Net interest paid

(4.1)

(4.2)

(5.2)

(8.6)

(9.5)

Tax paid

(0.1)

(0.0)

(0.0)

0.0

0.0

Net cash flow from operating activities

21.5

25.0

30.4

29.2

43.1

Purchase of investment properties

(117.5)

(51.4)

(207.0)

(28.4)

(27.2)

Disposal of investment properties

14.1

7.8

4.4

25.1

0.0

Net cash flow from investing activities

(103.4)

(43.6)

(202.6)

(3.3)

(27.2)

Issue of ordinary share capital (net of expenses)

78.2

58.3

122.5

0.0

0.0

(Repayment)/drawdown of loans

44.0

(22.0)

104.8

(4.8)

20.0

Dividends paid

(29.2)

(31.5)

(39.8)

(40.0)

(35.7)

Other

(1.6)

(1.5)

(1.8)

(0.2)

0.0

Net cash flow from financing activities

91.4

3.3

185.6

(45.0)

(15.7)

Net change in cash and equivalents

9.5

(15.3)

13.4

(19.1)

0.2

Opening cash and equivalents

26.9

36.4

21.1

34.5

15.4

Closing cash and equivalents

36.4

21.1

34.5

15.4

15.6

Balance sheet debt

(150.1)

(127.9)

(231.4)

(227.1)

(247.5)

Unamortised loan arrangement costs

(1.9)

(2.1)

(3.4)

(2.9)

(2.5)

Net cash/(debt)

(115.6)

(108.9)

(200.3)

(214.6)

(234.4)

Gross LTV

24.9%

19.2%

25.8%

26.5%

26.9%

Net LTV

18.9%

16.1%

22.0%

24.70%

25.3%

Source: Target Healthcare REIT historical 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 £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.

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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.

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London, WC1R 4PS

United Kingdom

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Tetragon Financial Group — Leveraging up for new investments

Tetragon Financial Group (Tetragon) reported a 1.7% ROE in H123 and its NAV increased by 1.7% in total return terms. The portfolio gained 3.0% on the back of TFG Asset Management (which remains Tetragon’s largest asset, representing 50% of its NAV), private equity assets and its direct listed equity investments, while the remaining asset classes had a limited impact on NAV. Tetragon targets returns uncorrelated with broader equity markets and a 10–15% ROE (9.9% on average over the last five financial years, and 11.4% pa since IPO). In H123 Tetragon was a net investor and increased its credit facility utilisation to 75% (US$300m), deploying capital predominantly into private equity assets and hedge funds, and further supporting the growth of TFG Asset Management.

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