Primary Health Properties — Ireland enhancing overall growth

PHP recently hosted a capital markets visit to the RoI, providing attendees with an opportunity to view a number of the group’s care centres within its growing Irish portfolio. The presentation that accompanied the visit, with details of each of the Irish assets, and a corporate video providing an overview of the portfolio can be found here:

https://www.phpgroup.co.uk/investors/results-centre

https://www.brrmedia.co.uk/broadcasts/5bd04ebbb01efb6b20c2f611/event

PHP began to invest in the RoI, a market driven by similar fundamentals to the UK, in 2016 and now has eight assets. This includes one forward-funded development that is currently under construction and is expected to complete in the autumn of 2019, in Bray.

PHP has spent €101m acquiring its assets in the RoI, which have a value (including Bray at completion) of €106m, representing c 6% of the current portfolio value of more than £1.5bn, with a rent roll of €6.3m (c 7% of the total). The company sees further good growth opportunities in the RoI, with the share of an otherwise growing portfolio rising to around 10%. The impact of growth in the RoI portfolio on the overall group performance is compounded by the higher yields that are available. PHP estimates Irish net initial yields to be currently c 6%, around 100bp above the yields currently available in the UK. The growing portfolio will also be part-funded with euro-denominated debt, where funding rates can currently be locked in for 10 years at a lower cost than in the UK, further increasing the income contribution after costs. The relative net initial yield and marginal funding rates currently suggest a c 3% net margin over costs for new investment in the RoI compared with around 1.2% in the UK (Exhibits 2 and 3).

There are some differences (discussed below) between lease terms and tenant covenants in the RoI and the UK (which are extremely low risk, with c 90% of rental income backed by the UK government directly or indirectly through GP reimbursement), but we think the difference is minimal. Euro-denominated debt will provide a natural hedge to much of the foreign exchange risk. Further growth in the RoI portfolio should continue to be an important driver of PHP’s growth over the next few years, while we also expect continuing growth in UK assets. Given the tightening in UK yields in recent years, an acceleration in UK open market rental growth (almost three-quarters of the total) would be especially beneficial in increasing income and stimulating new development, having failed to keep pace with the rise in land and building cost inflation. There were positive signs of movement in H118.

The fundamental drivers behind the demand for modern, purpose-built, flexible primary care facilities are similar in the RoI to those in the UK. The rate of population growth in the RoI is one of the fastest growing in the EU and is expected to increase by 20% to c six million by 2051. During this time, the proportion of the population over 65 is expected to increase by 150% by 2051 and the proportion over 80 by 270%. Chronic diseases and complex medical conditions are also increasing, as in the UK.

The mainstay of primary care in Ireland, as in the UK, is the GP, but in Ireland they have been fee charging ‘businesses’ and, as a result, private investment in primary care has been inhibited. To efficiently meet the growing need for healthcare provision, the government has developed various initiatives to modernise delivery, co-locating the provision of a range of care services including physiotherapists, dentists, mental health services, and pharmacies, as well as GPs, at a local level within modern PCCs. The Health Service Executive, the RoI equivalent of the NHS, is seeking to establish around 200 PCCs through the country and while PHP’s analysis indicates that there are currently around half this number, it believes that only a small number of these are modern, purpose-built facilities capable of delivering the planned increasing reliance on community-based primary care.

Reflecting the multi-use nature of the PCCs, the RoI investments made by PHP to date are relatively large, with an average lot size of almost £12m, more than twice the group average. Using this as guide to the scale of investment that may be required to deliver the 75 assets that are under construction or being planned suggests a market-wide pool of potential investment opportunities that could be somewhere between £750m and £1bn. Access to funding is an essential ingredient in delivering the planned developments and the government takes a positive approach to private sector funding.

When reporting the interim results in July 2018, PHP continued to show a strong group-wide pipeline of potential acquisitions, totalling more than £175m, both in the UK and in the RoI. Specifically in the RoI, this included the three assets acquired for €38.6m in September (Navan Road, Celbridge and Newbridge) and a further €24m of assets in negotiation. PHP also expressed confidence in gaining further access to the pool of potential transactions through the strong relationships it has built with owners and developers.

In the UK, around 90% of rent roll is funded directly or indirectly (through cost reimbursement) by the NHS, with much of the rest represented by co-located pharmacies. This is an extremely strong tenant covenant and although the position in the RoI is significantly different, we believe it is still very low risk. In the RoI, the HSE is the anchor tenant and is expected to account for 60–75% of rents. Exhibit 4 shows a breakdown of PHP’s current RoI rent roll, with the HSE representing 67% and the GPs and pharmacies representing much of the balance. Although the GPs are fee charging, lower income households qualify for a medical card, which provides them with free access to GP services, such that around half of all GP fee income is effectively paid by the HSE.

The other main differences between the RoI and the UK are mainly related to lease terms:

We are not changing our estimates following the capital markets day but take considerable comfort in the prospects for continued accretive growth in the RoI. Our forecast for PHP typically include an expectation of c £100m of acquisitions annually, and for FY19 we have allowed for c 40% of this to be within the RoI.

The recent £22.8m UK acquisition of a modern keyworker accommodation property in Northumbria, let to the Northumbria Healthcare NHS Foundation Trust also falls within our property acquisition assumptions for the current year. It adds a large, good quality asset, with a strong covenant, with fixed rental uplifts and the unexpired lease of 29 years will increase the overall average.

Our forecasts also allow for the full conversion of the outstanding convertible bonds by the end of H119, and the recent adjustment to the conversion price (from 97.5p to 96.16p), a technical adjustment linked to cumulative dividends paid, has only a small impact on share count. There is currently £53.4m nominal of the convertible outstanding.

PHP’s long leases and secure covenant (with c 90% of rents derived directly or indirectly from the UK and RoI governments), based off a growing portfolio of good quality, modern, purpose-built primary healthcare assets, with no material linkage to the economic cycle, provide investors with considerably visibility over a growing stream of contracted rental income. PHP is now in its 22nd year of rising dividends, an unbroken record since listing. Moreover, as a result, healthcare property values have shown much less volatility than the broad commercial sector.

PHP has declared and paid four quarterly dividends in respect of FY18, an aggregate 5.40p per share, and with the recent market setback, the shares now offer a yield of 4.9%, and trade at only a modest (c 4%) premium to NAV. Our forecasts for further growth are underpinned by a full period contribution from recent acquisitions, continued deployment of the proceeds of April’s equity issue into a strong pipeline of opportunities, including those in the RoI, an increasingly positive outlook for rental growth and further opportunities to lower average borrowing costs.