Impact Healthcare REIT — FY21 DPS target increased

Real Estate

Impact Healthcare REIT

FY21 DPS target increased

Q420 NAV update

Real estate

1 February 2021

Price	112.5p
Market cap	£359m

Gross debt (£m) as at 31 Dec 2020		76.1

Gross LTV as at 31 Dec 2020	17.8%
Shares in issue	319.0m
Free float	94%
Code	IHR

Primary exchange	LSE
Secondary exchange	N/A

Share price performance

%	1m	3m	12m
Abs	4.6	18.3	5.5
Rel (local)	7.7	2.4	20.4

52-week high/low

115p

62p

Business description

Impact Healthcare REIT, traded on the Main Market of the London Stock Exchange, invests in a diversified portfolio of UK healthcare assets, particularly residential and nursing care homes, let on long leases to high-quality operators. It aims to provide shareholders with attractive and sustainable returns, primarily in the form of dividends, underpinned by structural growth in demand for care.

Next events

FY20 results

Expected March 2021

Analyst

Martyn King

+44 (0)20 3077 5745

financials@edisongroup.com

Edison profile page

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

Impact Healthcare REIT’s tenant care home operators have demonstrated a high level of resilience during the pandemic, and the vaccine roll-out, which is proceeding quickly, should support efforts to rebuild occupancy. Rents have continued to be paid in full, as expected, and with the FY20 DPS target met, the FY21 target is increased by 1.9%, fully covered by our FY21e adjusted (cash) earnings. We expect continuing, selective and accretive acquisitions as available capital is deployed.

Year end	Net rental income (£m)	EPRA earnings* (£m)	EPRA EPS* (p)	EPRA NAV/ share (p)	DPS (p)	P/NAV/ share (x)**	Yield (%)**
12/18	17.3	12.4	6.5	102.9	6.00	1.09	5.3
12/19	24.0	17.6	6.9	106.8	6.17	1.05	5.5
12/20e	30.6	23.0	7.2	109.6	6.29	1.03	5.6
12/21e	36.4	27.5	8.6	113.1	6.41	0.99	5.7

Note: *EPRA earnings exclude fair value movements on properties and interest rate derivatives. **P/NAV and yield are based on the current share price.

Performing well and continuing selective growth

With the portfolio continuing to perform as expected, unaudited end-FY20 NAV was £349.5m or 109.6p per share. Including DPS paid, the FY20 NAV total return was 8.5%. Tenant care providers have shown operational and financial resilience, and rents have continued to be paid, without concessions or waivers. We expect inflation-indexed rent growth and a resumption of acquisitions to drive further growth in income and DPS. Impact recently acquired six properties for £21.3m (before costs), with a commitment to an additional £2.8m of capital expenditure to enhance the properties and to extend one of them, adding £1.7m to annualised rent roll (which now stands at £31.4m). With modest gearing and a strong pipeline of opportunities, we assume a further £30m of acquisitions. We have slightly increased our forecasts for recurring earnings, NAV and DPS.

Core income with asset management potential

Impact’s business model is built around long-term partnerships with a growing list of selected tenant operators, investing alongside them in suitable properties that they can operate efficiently, providing a good quality of care, to sustain a growing stream of long-term rental income. The portfolio has been built mainly through portfolio acquisitions, often less competitive, with attractive yields at acquisition typically and consistently in the range of 7.5%. The diverse portfolio mainly comprises a majority core of good-quality, upper middle-market homes alongside value-add assets where there is potential, working in partnership with tenants, to upgrade/extend facilities and reposition homes in their local markets. Asset management benefits residents and operators, and offers enhanced returns on a pure ‘buy-and-hold’ strategy.

Valuation: Attractive indexed income

With its growing income stream proving robust despite the pandemic, Impact’s target FY21 DPS of 6.41p represents an attractive yield of 5.7%, which we expect to be well covered by EPRA earnings and fully covered on an adjusted (“cash”) basis. The 3% premium to FY20 NAV compares with a peak of 11%.

Resilient tenant performance

Impact received 100% of its contracted rent for 2020 and has also confirmed receipt of 100% of the rent due on 1 January 2021 for quarterly and monthly rents payable in advance. This strong rent collection performance reflects an affordable level of rents in the homes and a good level of rent cover going into the pandemic, combined with a resilient operational and financial performance by tenants subsequently. During the year to 31 December 2019 (FY19), rent cover across all of Impact’s portfolio was 1.8x. This dipped to 1.7x in H120 as a result of the first wave of the pandemic, including a dip in occupancy, but rent cover increased in Q320 to a level above that of FY19. The improvement includes the positive impact of fee increases as well as government support measures for the sector. Impact has reported broadly stable occupancy across the portfolio during H220, still below usual levels, although the managers at the homes report good levels of enquiries. Impact has said that it does not anticipate new admissions rising substantially until the current lockdown restrictions on visitors to homes are eased and care home vaccinations have been completed, but the strong start to the vaccine roll-out is very encouraging. Residents at 100 (93%) of the homes owned by the group have received at least the first dose of a COVID-19 vaccination as at 28 January 2021, up from 60% as recently as 15 January.

Selectively investing again

In March 2020, as the first wave of the pandemic began, Impact suspended new acquisition activity, although in August 2020 it completed on the previously agreed c £47.5m acquisition of the nine-home Holmes Care portfolio, adding c £3.5m to annualised rents. With confidence growing in the ability of tenant operators to navigate the pandemic successfully, from both an operational and financial perspective, from September the investment manager re-engaged, on a selective and disciplined basis, with several potential acquisitions that meet its investment criteria, and which had demonstrated a similarly high level of resilience during the first wave of the pandemic.

Including the St Peters House acquisition, where the exchange of contracts was first announced in September, Impact recently confirmed the completed acquisitions of three individual homes (to be managed by two of the group's existing tenants) and a portfolio of three homes (to be managed by a new, twelfth care operator tenant for the group). Collectively, these transactions initially deploy £21.3m (before costs), with a commitment to an additional £2.8m of capital expenditure to enhance the properties and to extend one of them, and add £1.7m to annualised rent roll.

The portfolio now comprises 109 properties (108 at end-FY20), of which 107 are care homes let to the 12 care home tenant operators on long fixed-term leases (average unexpired lease term of 20 years before tenant extension options), with no break clauses, and subject to upward-only, RPI-linked rent reviews (capped and collared). The other two properties in the portfolio are co-located medical facilities let to the NHS. The portfolio annualised contracted rent roll is now £31.4m (up from £30.9m at end-FY20, including one of the above properties that was acquired since year-end).

Financials and valuation

We expect detailed FY20 results to be published in March 2021, but meanwhile the Q420 NAV update provides unaudited data for the portfolio value, net assets and gearing. We have adjusted our forecasts for this and other recent newsflow, with an uplift in rental income and EPRA earnings and, to a lesser extent, in EPRA NAV per share. The DPS target for FY21 is also very slightly above our previous expectation.

The increase in our FY20 net rental income and EPRA earnings forecast is primarily driven by the earlier recognition of income from the Holmes Care acquisition than we had allowed for.

For FY21 and FY22 the increase in forecast net rents and EPRA earnings is substantially driven by an upward adjustment to the non-cash IFRS rent smoothing adjustments. These adjustments primarily arise as a result of the long average lease length and accounting recognition, on a straight-line basis, of any contractual fixed minimum rent uplifts that exist.

Exhibit 1: Forecast changes

	Net rental income (£m)			EPRA earnings (£m)			EPRA EPS (p)			EPRA NAV/share (p)			DPS (p)
	New	Old	Change (%)	New	Old	Change (%)	New	Old	Change (%)	New	Old	Change (%)	New	Old	Change (%)
12/20e	30.6	30.4	0.7	23.0	22.6	1.8	7.2	7.1	1.8	109.6	108.7	0.8	6.29	6.29	0.0
12/21e	36.4	35.3	3.0	27.5	26.5	3.7	8.6	8.3	3.7	113.1	112.2	0.8	6.41	6.40	0.2
12/22e	37.7	36.8	2.4	28.3	27.5	2.9	8.9	8.6	2.9	117.0	115.9	0.9	6.54	6.53	0.2

Source: Edison Investment Research

The company measure of adjusted earnings, aimed at tracking underlying cash earnings, excludes the non-cash IFRS smoothing, and the changes to our forecast for this measure. On this basis FY20e also benefits from the earlier Holmes Care income recognition and FY21e and FT22e are also increased slightly. Importantly, while dividends are already well covered by EPRA earnings, we also expect full cover from FY21 on an adjusted (“cash”) earnings basis. Based on the current equity capital base we forecast cash dividend cover of 1.06x in FY21 and 1.10x in FY22.

Exhibit 2: Change in adjusted earnings forecasts

	H120	H220e	FY20e	FY21e	FY22e
EPRA earnings	11.6	11.5	23.0	27.5	28.3
Rental income arising from recognising rental premiums & fixed rent uplifts	(3.2)	(1.8)	(5.0)	(5.8)	(5.3)
Rent premium due from exchanged contracts	0.0	0.0	0.0	0.0	0.0
Adjusted earnings	8.4	9.7	18.0	21.7	23.0
Previous forecast		9.2	17.5	21.6	22.8
Change		0.6	0.5	0.1	0.1
% change			2.6%	0.3%	0.6%

Source: Edison Investment Research

In addition to the recent acquisitions discussed above, we have assumed an additional £30m in acquisitions by the end of H121, at a 7.5% yield on consideration (consistent with the historical trend shown and a little below recently achieved yields). Allowing for assumed acquisition costs at 5% (a blend of corporate acquisitions with low land transfer tax and individual properties with higher costs), the implied net initial yield is 7.1%.

We believe that the acquisition assumption is consistent with both the strong pipeline of investment opportunities and the company’s aim to increase gearing from the current modest level. We estimate an end-FY21 gross loan to value ratio (gross LTV) of 25%, well below the company’s 35% upper limit.

Including rent indexation at an assumed 2% pa through FY21 and FY22, we estimate an increase in the annualised contracted rent roll to £33.7m at end-FY21 and £34.4m at end-FY22. We further assume that contracted rents continue to be received in full without deferral or waiver.

We expect revaluation movements will continue to be driven by rental growth and asset management initiatives in combination with ‘buying well’. We allow for existing asset valuations to increase in line with our rental growth assumption, for an uplift on asset management investment and for the yields on acquired assets to migrate towards the portfolio average over time. In FY20 and FY21, this is partly offset by our estimate of acquisition costs written off.

Exhibit 3: Income statement revaluation movement

£m	FY19a	FY20e	FY21e	FY22e
Gross revaluation movement	17.8	13.1	11.9	10.1
Acquisition costs written off	(3.9)	(2.3)	(1.9)	0.0
Net revaluation movement	13.9	10.8	10.0	10.1
IFRS rental smoothing adjustment	(4.9)	(6.3)	(5.8)	(5.3)
Gains/(losses) on revaluation of investment properties as per income statement	9.1	4.5	4.2	4.7
Acquisition costs as % purchase value	5.5%	2.7%	4.6%	N/A
Gross revaluation as % opening portfolio value	7.9%	4.1%	2.8%	2.1%
Gross revaluation gain per share (p)	5.6	4.1	3.7	3.2

Source: Impact Healthcare REIT historical data, Edison Investment Research forecast

Financial flexibility to support further growth

Impact entered the COVID-19 pandemic with low gearing, good liquidity, material borrowing headroom on existing agreed debt facilities and no debt maturities before 2023. It has £125m of committed banking facilities comprising a £25m term loan facility and £100m of more flexible revolving credit facilities (RCF). At the end of Q420, a little over £76m of the debt facilities had been drawn, reflected in the reported gross LTV of 17.8%, with c £49.0m undrawn. Our forecasts assume that £45m of this debt is drawn to fund acquisitions. With gearing headroom between the c 25% LTV that we forecast and the 35% upper limit, there is room to fund additional accretive growth by increasing debt facilities, although given the scale of the market opportunity we would expect the company to seek additional equity funding at some stage in the future.

Exhibit 4: Summary of debt portfolio

Lender	Facility type	Facility (£m)	Maturity	Margin	Interest cover covenant	Propco LTV covenant
Metro Bank	Term loan/RCF	50.0	Jun-23	Base rate +2.65%	200%	35%
Clydesdale Bank	RCF	25.0	Mar-24	Libor +2.25%-2.50%	325%	55%
HSBC	RCF	50.0	Apr-23*	Libor +1.95%	250%	55%
Total facilities		125.0

Source: Impact Healthcare REIT data. Note: *HSBC facility includes option of up to two-year extension subject to HSBC approval.

We estimate the average maturity of the debt facilities at c 2.5 years with an average cost of c 2.5% (based on three-month Libor at 0.3%). To mitigate the interest rate risk of the variable rate borrowing, Impact has hedged £25.0m, until June 2023, with an interest rate cap that protects against a rise in Libor above 1%.

Consistently positive returns

Impact has increased annual aggregate DPS each year since IPO, and since the beginning of 2019 introduced a progressive dividend policy under which it seeks to grow its target dividend in line with inflation-linked rental uplifts. The increased dividend target of 6.41p (+1.9%) for FY21 represents an attractive yield of 5.7%, while the shares trade at a small 3% premium to FY20 NAV. Dividends are a key component of the wider NAV total return target of 9% pa, alongside the potential for capital growth (driven by inflation-linked rental growth and asset management opportunities) enhanced by moderate gearing. Since IPO in March 2017 to the end of FY20, the cumulative total return (adjusted for dividends paid but not assuming reinvestment of dividends) was 33.8%, or an average annualised rate of 7.9%. Dividends accounted for around two-thirds of the total return. We estimate that acquisition costs incurred in growing the portfolio since IPO, subsequently written off, amount to more than c £9m or more than 3p per share and, adjusting for this, the cumulative total return increases and the average annualised return comes close to the 9.0% target.

Exhibit 5: Consistently positive NAV total return

	2017*	2018	2019	2020***	Cumulative
Opening NAV per share (p)	98.0**	100.6	103.2	106.8	97.9
Closing NAV per share (p)	100.6	103.2	106.8	109.6	109.6
Dividends paid (p)	3.0	6.0	6.1	6.3	21.4
NAV total return*	7.2%	8.5%	9.5%	8.5%	33.8%
Compound annual average return					7.9%

Source: Company data, Edison Investment Research. Note: *7 March 2017 to 31 December 2017. **Adjusted for IPO costs. ***FY20 NAV per share unaudited.

Exhibit 6 shows a summary of the performance and valuation of a group of REITs that we consider to be Impact’s closest peers within the broad and diverse commercial property sector. The group is invested in the primary healthcare, supported housing and care home sectors, all targeting stable long-term income growth derived from long lease exposures. The table is based on trailing DPS declared and so does not reflect the increase in Impact’s FY21 DPS target.

Exhibit 6: Peer group comparison

	Price (p)	Market cap. (£m)	P/NAV (x)	Yield (%)	Share price performance
	Price (p)	Market cap. (£m)	P/NAV (x)	Yield (%)	1 month	3 months	12 months	From 12-month high
Assura	73	1750	1.29	3.9	-6%	-5%	-7%	-18%
Civitas Social Housing	108	671	1.00	5.0	3%	4%	9%	-7%
Primary Health Properties	145	1766	1.33	4.1	-5%	1%	-8%	-13%
Target Healthcare	115	444	1.07	5.8	1%	8%	-4%	-7%
Triple Point Social Housing	106	373	1.00	4.9	-5%	0%	7%	-7%
Average			1.14	4.7	-2%	2%	0%	-10%
Impact Healthcare	115	367	1.05	5.4	6%	16%	6%	0%
UK property index	1,588				-2%	12%	-17%	-20%
FTSE All-Share Index	3,796				-1%	16%	-10%	-13%

Source: Historical company data, Refinitiv. Note: *Based on last published EPRA NAV per share. **Based on trailing 12-month DPS declared. Prices as at 29 January 2021.

In terms of share price performance, the peer group has outperformed the overall UK property sector and the FTSE All-Share Index over the past year, and Impact has performed in line with the average. The care home operators, Impact and Target, have the highest yields in the peer group and Impact has P/NAV rating that is below both the average and median. In our view, the potential for a re-rating of Impact shares is strong, based on:

■

The robust operational and financial performance of tenants, with rents paid in full.

■

A clear inflation-linked progressive dividend policy, with DPS well covered by EPRA earnings and by adjusted (‘cash’) earnings from FY21.

■

A long WAULT (20 years before 10-year tenant extension options) with no break clauses and upward-only, triple net rents, linked to RPI.

■

Moderate gearing and available capital to deploy in a sector where care home demand is forecast to grow significantly, driven by an ageing population with increasing care needs.

Exhibit 7: Financial summary

Year to 31 December (£m)	2017	2018	2019	2020e	2021e	2022e
INCOME STATEMENT
Cash rental income	9.5	13.9	19.1	25.6	30.6	32.3
Rental income arising from recognising rental premiums & fixed rent uplifts	(0.1)	3.4	4.9	5.0	5.8	5.3
Net rental income	9.4	17.3	24.0	30.6	36.4	37.7
Administrative & other expenses	(2.3)	(4.3)	(4.6)	(5.4)	(5.5)	(5.7)
Operating profit before change in fair value of investment properties	7.1	13.0	19.4	25.2	30.9	31.9
Change in fair value of investment properties	2.4	4.1	9.1	5.8	4.2	4.7
Gain on disposal	0.0	0.0	0.0	0.1	0.0	0.0
Operating profit	9.5	17.2	28.5	31.1	35.1	36.7
Net finance cost	0.0	(0.7)	(2.1)	(2.3)	(3.4)	(3.6)
Profit before taxation	9.5	16.5	26.3	28.8	31.7	33.0
Tax	(0.0)	0.0	0.0	0.0	0.0	0.0
Profit for the year (IFRS)	9.5	16.5	26.3	28.8	31.7	33.0
Adjust for:
Change in fair value of investment properties	(2.4)	(4.1)	(9.1)	(5.8)	(4.2)	(4.7)
Gain on disposal	0.0	0.0	0.0	(0.1)	0.0	0.0
Change in fair value of interest rate derivatives	0.0	0.1	0.4	0.1	0.0	0.0
EPRA earnings	7.1	12.4	17.6	23.0	27.5	28.3
Rental income arising from recognising rental premiums & fixed rent uplifts	0.1	(3.4)	(4.9)	(5.0)	(5.8)	(5.3)
Rent premium due from exchanged contracts	0.0	0.0	0.0	0.0	0.0	0.0
Non-recurring costs	0.0	0.7	0.2	0.0	0.0	0.0
Adjusted earnings	7.1	9.7	12.9	18.0	21.7	23.0
Average number of shares in issue (m)	162.6	192.2	254.0	319.0	319.0	319.0
Basic & diluted IFRS EPS (p)	5.82	8.57	10.37	9.02	9.93	10.36
Basic & diluted EPRA EPS (p)	4.35	6.47	6.95	7.21	8.61	8.87
Basic & diluted adjusted EPS (p)	4.39	5.07	5.10	5.64	6.80	7.20
Dividend per share (declared)	4.50	6.00	6.17	6.29	6.41	6.54
EPRA earnings dividend cover	97%	108%	113%	115%	134%	136%
Adjusted earnings dividend cover	98%	84%	83%	90%	106%	110%
BALANCE SHEET
Investment properties	156.2	220.5	310.5	405.6	456.6	464.3
Other non-current assets	1.7	5.7	10.1	15.0	20.8	26.1
Non-current assets	157.9	226.2	320.7	420.6	477.3	490.4
Cash and equivalents	38.4	1.5	47.8	6.7	6.8	6.6
Other current assets	0.1	0.6	0.6	0.6	0.6	0.6
Current assets	38.5	2.1	48.3	7.3	7.5	7.3
Borrowings	0.0	(24.7)	(23.5)	(74.2)	(119.8)	(120.4)
Other non-current liabilities	(1.7)	(1.9)	(1.8)	(1.7)	(1.7)	(1.7)
Non-current liabilities	(1.7)	(26.6)	(25.2)	(75.9)	(121.5)	(122.1)
Borrowings	0.0	0.0	0.0	0.0	0.0	0.0
Other current liabilities	(1.2)	(3.3)	(3.1)	(2.4)	(2.4)	(2.4)
Current Liabilities	(1.2)	(3.3)	(3.1)	(2.4)	(2.4)	(2.4)
Net assets	193.5	198.3	340.7	349.5	360.8	373.1
Adjust for derivative financial liability/(asset)	0.0	(0.5)	(0.1)	0.0	0.0	0.0
EPRA net assets	193.5	197.9	340.6	349.5	360.8	373.1
Period end shares (m)	192.2	192.2	319.0	319.0	319.0	319.0
IFRS NAV per ordinary share	100.6	103.2	106.8	109.6	113.1	117.0
EPRA NAV per share	100.6	102.9	106.8	109.6	113.1	117.0
CASH FLOW
Net cash flow from operating activities	8.2	10.0	14.9	19.7	25.1	26.6
Purchase of investment properties (including acquisition costs)	(153.3)	(55.1)	(73.4)	(88.5)	(43.8)	0.0
Capital improvements	(0.5)	(3.9)	(8.2)	(1.8)	(3.0)	(3.0)
Other cash flow from investing activities	0.0	0.0	0.1	1.0	0.0	0.0
Net cash flow from investing activities	(153.8)	(58.9)	(81.5)	(89.3)	(46.8)	(3.0)
Issue of ordinary share capital (net of expenses)	189.3	(0.1)	132.2	0.0	0.0	0.0
(Repayment)/drawdown of loans	0.0	26.0	(0.9)	51.0	45.0	0.0
Dividends paid	(5.3)	(11.6)	(16.1)	(20.0)	(20.3)	(20.8)
Other cash flow from financing activities	0.0	(2.3)	(2.2)	(2.5)	(2.8)	(3.1)
Net cash flow from financing activities	184.0	12.0	112.9	28.6	21.8	(23.8)
Net change in cash and equivalents	38.4	(36.9)	46.3	(41.1)	0.1	(0.2)
Opening cash and equivalents	0.0	38.4	1.5	47.8	6.7	6.8
Closing cash and equivalents	38.4	1.5	47.8	6.7	6.8	6.6
Balance sheet debt	0.0	(24.7)	(23.5)	(74.2)	(119.8)	(120.4)
Unamortised loan arrangement costs	0.0	(1.3)	(1.7)	(1.9)	(1.3)	(0.7)
Net cash/(debt)	38.4	(24.5)	22.7	(69.4)	(114.3)	(114.5)
Gross LTV (net debt as % gross assets)	0.0%	11.4%	6.8%	17.8%	25.0%	24.3%

Source: Impact Healthcare REIT historical data, Edison Investment Research forecasts

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Frankfurt +49 (0)69 78 8076 960

Schumannstrasse 34b

60325 Frankfurt

Germany

London +44 (0)20 3077 5700

280 High Holborn

London, WC1V 7EE

United Kingdom

New York +1 646 653 7026

1185 Avenue of the Americas

3rd Floor, New York, NY 10036

United States of America

Sydney +61 (0)2 8249 8342

Level 4, Office 1205

95 Pitt Street, Sydney

NSW 2000, Australia

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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.

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Frankfurt +49 (0)69 78 8076 960

Schumannstrasse 34b

60325 Frankfurt

Germany

London +44 (0)20 3077 5700

280 High Holborn

London, WC1V 7EE

United Kingdom

New York +1 646 653 7026

1185 Avenue of the Americas

3rd Floor, New York, NY 10036

United States of America

Sydney +61 (0)2 8249 8342

Level 4, Office 1205

95 Pitt Street, Sydney

NSW 2000, Australia

Frankfurt +49 (0)69 78 8076 960

Schumannstrasse 34b

60325 Frankfurt

Germany

London +44 (0)20 3077 5700

280 High Holborn

London, WC1V 7EE

United Kingdom

New York +1 646 653 7026

1185 Avenue of the Americas

3rd Floor, New York, NY 10036

United States of America

Sydney +61 (0)2 8249 8342

Level 4, Office 1205

95 Pitt Street, Sydney

NSW 2000, Australia

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