Civitas Social Housing — Strong financial and social returns continuing

This report updates on the financial and operational progress of the company since our detailed initiation note published in June 2019 following publication of the FY19 results.

The six months to September 2019 (H120) saw strong year-on-year growth in income and cash flow, driven by the growing portfolio and consumer price inflation (CPI)-linked rental growth. Dividends paid increased by 6% and were 87% covered by EPRA earnings. The company estimates a period-end run rate of 96% and a full-year contribution from recent acquisitions and continuing planned investment should see cover soon reach 100%, consistent with our revised estimates.

Operationally, Civitas has continued to leverage its position as the leading provider of supported social housing, playing a hands-on role in bringing about direct improvements to its counterparties, particularly its housing association partners. It continues to work closely with these counterparties and engage with the regulator of social housing (RSH) to help address the sector risks identified by the RSH to the benefit of all stakeholders.

The company also continues to deliver a strong positive social return, providing much-needed private investment capital to housing associations so they may provide and manage additional care-based quality accommodation to some of the most vulnerable in society, improving tenant life outcomes in a cost-effective manner. Independent analysis indicates that Civitas created £114m of social value in the year to 31 March 2019, including £59m of direct cost savings for the public purse.

The key financial highlights of the interim results were:

Given its greater complexity and granularity and the continuing strong demand for general needs social housing, SSH has not generally been the focus of the longer-established housing associations and sector growth has been led by 40–50 more specialist providers that have been established in the past 10 years or so. These have typically utilised lease-based structures to provide the capital for growth and, in many cases being newer and smaller associations, inevitably have relatively thin capital bases and less sophisticated management and governance structures. Prompted by the financial distress of First Priority Housing Association in early 2018, the RSH has been closely monitoring the sector and has raised a number of concerns. In some specific cases it has issued regulatory judgements, primarily in relation to corporate governance and/or financial viability. Against this backdrop, the company’s investment adviser, Civitas Housing Advisors (CHA), has taken an active role, working in close consultation with its sector partners (housing associations, care providers, local authorities) and with the RSH to promote the delivery of as many improvements as possible. Alongside its ongoing dialogue with the RSH, the actions that have been taken by Civitas include:

We believe current regulatory interventions in the fast-developing SSH segment are primarily aimed at identifying, assessing and making clear the risks so that these may be adequately managed as a means to safeguarding this financial resilience and maintaining the operational standards of the sector. Importantly, we believe the regulator recognises the important role played by private capital in supporting the much-needed growth and sustainable development of the sector. It is important to note that Civitas continues to operate as normal with those of its housing association partners that are subject to regulatory notices and judgements, with no material impacts on its ability to collect rents due, while it engages with them to help effect any changes that may be necessary to allay the regulator’s concerns. Research undertaken by CHA shows the company’s housing association partners are mostly generating increased net financial surpluses from their core activities. Westmoreland Supported Housing and Trinity Housing Association have been loss making but have implemented corrective business plans.

At 30 September 2019 (H120) the Civitas investment portfolio was independently valued at £842m (the balance sheet value of £833m is adjusted for lease incentives). With an annualised rent roll of £46.5m the valuation reflects a net initial yield of 5.28%, similar to end FY19. The portfolio has been assembled at a cumulative cost (excluding acquisition expenses) of £764m with an average acquisition yield of 5.9% (or 5.6% after acquisition costs). The weighted average unexpired lease term was 23.9 years at end-H120, slightly down from 24.4 years at end-FY19, reflecting the passage of time.

The portfolio comprised 599 individual properties, fully let to 15 different registered providers that manage SSH homes for more than 4,000 tenants on behalf of 160 different local authorities.

Civitas has grown its portfolio strongly since IPO and by comparison, the pace of growth in H120 (eight assets and £10.2m of investment including acquisition costs) was relatively modest. The company indicates it was awaiting the completion of new debt facilities before committing to new acquisitions although we suspect the very active role that the investment adviser has played in supporting existing housing association partners to evolve and develop their business models may also have had an impact. With additional debt facilities now in place (see page 7), Civitas expects the pace of investment to pick up.

The portfolio is geographically diversified around major conurbations, with around one-third of the properties purpose built or repurposed and two-thirds well located community properties that have been adapted on a bespoke basis for long-term use by residents. The list of housing associations with which Civitas has chosen to work provides further diversification and has been assembled with the aim of establishing a housing association counterparty in each geographic area and to have several others in reserve to provide for contingencies. In some circumstances this approach facilitates the reassignment of leases from one housing association to another that may be better placed to undertake the management of the assets and meet the needs of tenants.

The spread of housing association counterparties (by share of rent roll) is shown in Exhibit 5. Unrelated to any changes in the composition of the portfolio, during H120 the share of rent roll accounted for by Auckland Home Solutions increased from 11.3% to 20.0% while that of Westmoreland Supported Housing reduced from 19.7% to 10.8%. We believe this change is likely to reflect a re-assignment of leases related to Westmoreland’s ongoing actions to improve its financial performance and corporate governance in response to concerns by the RSH, which in September enforced the appointment of three additional board members to support the process of change. Civitas welcomed the board changes and said that it remained supportive of the Westmoreland board and confident the new appointments would help it in meeting its objectives. It also said Westmoreland had continued to meet its financial obligations to Civitas and produce rental income as expected.

Civitas plans further portfolio growth as it gears up its existing equity resources, targeting a gearing level of up to 35%. It has identified a number of potential investment transactions matched to its current available debt resources and these represent part of a wider pipeline of opportunities for which additional debt facilities are under negotiation.

The £60m NatWest debt facility agreed in September (of which £20m had been drawn at end-H120) has been allocated to:

Aimed at the wider pipeline opportunity, additional borrowing of £80m is under advanced negotiation and the company expects completion during the first three months of 2020. Including the £40m undrawn from the NatWest facility at end-H119 this will take total additional debt funding capacity to £120m with the company targeting 5.5–6.0% yield (excluding acquisition costs).

Our forecasts assume further significant growth in income-earning property assets, although compared with our estimates published in June, the amount of capital committed is lower and occurs at a slower pace. We nevertheless expect a good level of EPRA earnings growth, further DPS growth and for run-rate dividend cover to be achieved in FY20 with increasing dividend cover in FY21. We also anticipate capital growth during the forecast period, driven by CPI-linked rental growth with a partial offset from property acquisition costs and an increasing NAV per share.

Our key forecasting assumptions are:

Our previous forecasts had assumed slightly greater and faster gearing-up of the existing equity base than now seems likely, with £170m of debt funded acquisitions in FY20. With assumed investment of £123m by end-FY21 our revised forecasts indicate a slower build-up of rental income and earnings but the impact on DPS growth is minimal (Exhibit 6). We expect DPS to be covered on a run-rate basis over the next 12 months and on an annual basis for FY22.

Civitas increased its debt facilities by £60m in H120 to £272.5m, of which £228.4m was drawn at the period end. The new £60m facility arranged in September is a five-year term facility with National Westminster Bank that has the potential to be extended by a further £40m. Other debt facilities comprise a £52.5m 10-year fixed-rate facility and two floating-rate revolving credit facilities of a shorter-term nature. The average cost of debt at end-H120 was 2.63%. All covenants on the facilities were comfortably met during the year.

The additional £80m debt facility under negotiation will contribute towards moving gearing on a portfolio basis towards the 35% level targeted by the company (H120: 24%), defined as gross borrowings as a percentage of gross assets on a portfolio basis. To ease comparison across the sector, our calculation of net LTV represents net debt as a percentage of investment property assets measured on an IFRS basis. At H120 this was 21.5% or 27.1% on a gross basis (ie before adjusting gross debt for cash balances). Assuming a similar differential between portfolio gearing and gross LTV on an IFRS basis is maintained, our forecast c 35% gross LTV for end-FY21 suggests the company may still have further borrowing headroom to meet its 35% portfolio gearing target.

Based on targeted quarterly DPS payments amounting to 5.34p for the current year, Civitas offers a yield of 6.1%, while trading at c 20% discount to H120 (IFRS and EPRA) NAV per share.

We calculate an EPRA NAV total return since the 18 November 2017 IPO to 30 September 2019 (H120) of 20.3%, or an average annualised 6.7% pa. This does not allow for reinvestment of dividends. Our forecasts for FY20–FY22 imply an average annualised return of 6.4% pa over the period, with FY20–FY21 returns held back slightly by assumed property acquisition costs. DPS paid represents around three-quarters of our forecast return and capital growth the balance. The capital growth results from our assumption that CPI rental income uplifts will feed through to property values (ie unchanged property yields) with a further benefit from gearing. Given the prospect for continued low interest rates and low investment returns generally, the forecast level of returns from Civitas, substantially income based, appears attractive.

In Exhibit 8 we show a share price performance and valuation comparison with a group of companies that we would consider to be the closest peers to Civitas. The group includes Triple Point Social Housing and Residential Secure Income, which invests in affordable shared ownership, retirement and local authority housing (but not SSH), primary healthcare investors, PHP and Assura, and care home investors, Target Healthcare and Impact Healthcare. The peers are all focused on stable, growing, income returns, with the potential for capital appreciation, from investment in properties let on long leases to tenants whose income is provided, to differing degrees, by government funding. However, the peer group remains quite differentiated in terms of lease terms, which will naturally influence valuation levels. UK primary healthcare leases benefit from the security of being directly or indirectly backed by government, although the majority of rents are subject to open market rent reviews rather than indexed to inflation. For the care home investors, the lease counterparties are the care home operators, and rents are generally linked to RPI.

Civitas shares have a higher yield than the peer group average and its P/NAV remains well below the average. The one year share price performance still shows the effects of the regulatory intervention in the SSH market earlier in 2019, which primarily raised concerns about tenant covenant strength. The share price and the valuation have begun to improve again in recent months but there is still plenty of further potential is investors become more confident about the evolution of the SSH sector, the robustness of the Civitas income stream and its ability to further grow and diversify its portfolio to achieve full dividend cover.