New Zealand Professional Investment Services Firm

Forsyth Barr

We are proud to be a New Zealand owned firm, with 21 offices throughout the country and over 300 employees. We assist personal, institutional and corporate clients providing a full range of investment services.

Forsyth Barr is a foundation New Zealand Exchange firm (NZX) and accredited market participant. We have been confirmed by the Financial Markets Authority as a Qualifying Financial Entity (QFE).

Research is the cornerstone of our advice. We have one of New Zealand's leading teams of analysts. Our global affiliations ensure comprehensive research coverage of all major investment markets.

New Zealand Professional Investment Services Firm, Forsyth Barr

Equity Bottom-Up

<h2>Aged Care Sector<br>Changing the Economics of Care</h2>
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<p>The care landscape in NZ is changing. Three of the four listed aged care operators have pivoted new care development towards care suites (or similar), sold under an Occupational Rights Agreement (ORA). The reason for this pivot is likely to be a combination of poor profitability within standard care, increased expectations with regards to standards from care residents and a wish to differentiate offerings. Oceania Healthcare (OCA) has led the way but Arvida (ARV) is a fast follower. Summerset (SUM) is still very much in its infancy and will deliver its premium care offering through a combination of care suites and memory care (dementia). The shift to care suites sold under an ORA carries with it three main implications; (1) it increases the cash recovery of new build, (2) it improves the profitability of care, but (3) it reduces the cash conversion and predictability of earnings. With this note we upgrade ARV to OUTPERFORM, reiterate our OUTPERFORM rating on OCA, and keep NEUTRAL ratings on SUM and Ryman Healthcare (RYM).&nbsp;</p>
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<h3>What has happened?</h3>
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<p>The earnings and portfolio composition within the aged care sector has undergone significant change over the past decade, with retirement village driven earnings&nbsp;starting to dominate over traditional care related earnings. Care related earnings as a percentage of total earnings have declined&nbsp;as government funding hasn't been able to offset the impacts of increased cost pressures&nbsp;across the aged care sector.&nbsp;While we acknowledge the complementary nature of the two earnings streams, we find ourselves at an interesting juncture with innovation in the form of care suites becoming a common place solution to turning around care profitability.</p>
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<h3>Why is it important? Care ORAs improve the economics of care and development; but it is not a "free&nbsp; lunch"&nbsp;</h3>
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<p>Cash recovery of new development has deteriorated substantially across the aged care sector over the last 5–10 years; from over 90% to around 60–70%. We discussed this dynamic in detail in our report&nbsp;"Different Times Call for Different Measures", published October 15, 2020.&nbsp; The low cash recovery has driven up net debt across the sector over the last few years. The introduction of care&nbsp;ORAs&nbsp;has the potential to restore the aged care operators ability to recycle cash faster. However, with it comes higher volatility in business cash flow and lower cash conversion of annuity earnings.&nbsp;</p>
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<h3>Aged care tour confirms that recent strong demand is continuing</h3>
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<p>We recently visited 11 villages on our Kaimai aged care tour. We walk away with three main impressions that support our overall positive view of the sector and ARV upgrade; (1) demand for retirement villages remains very strong across the board but in particular for high end villages, (2) OCA and ARV are targeting near 100% care suite ORA uptake, above our prior estimates of ~80%, and demand appears strong, and (3) versus our expectations, construction activity is running relatively smoothly. There have been some cost increases but no severe materials or labour shortages were noted.</p>
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<div><strong>Aaron Ibbotson CFA</strong></div>
<div><a href="mailto:aaron.ibbotson@forsythbarr.co.nz" target="_blank" rel="noopener">aaron.ibbotson@forsythbarr.co.<wbr>nz</a></div>
<div>+64 9 368 0024</div>
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<div><strong>Matt Montgomerie</strong></div>
<div><a href="mailto:matt.montgomerie@forsythbarr.co.nz" target="_blank" rel="noopener">matt.montgomerie@forsythbarr.<wbr>co.nz</a></div>
<div>+64 9 368 0124</div>
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Aged Care Sector Changing the Economics of Care


The care landscape in NZ is changing. Three of the four listed aged care operators have pivoted new care development towards care suites (or similar), sold under an Occupational Rights Agreement (ORA). The reason for this pivot is likely to be a combination of poor profitability within standard care, increased expectations with regards to standards from care residents and a wish to differentiate offerings. Oceania Healthcare (OCA) has led the way but Arvida (ARV) is a fast follower. Summerset (SUM) is still very much in its infancy and will deliver its premium care offering through a combination of care suites and memory care (dementia). The shift to care suites sold under an ORA carries with it three main implications; (1) it increases the cash recovery of new build, (2) it improves the profitability of care, but (3) it reduces the cash conversion and predictability of earnings. With this note we upgrade ARV to OUTPERFORM, reiterate our OUTPERFORM rating on OCA, and keep NEUTRAL ratings on SUM and Ryman Healthcare (RYM).&nbsp;


What has happened?


The earnings and portfolio composition within the aged care sector has undergone significant change over the past decade, with retirement village driven earnings&nbsp;starting to dominate over traditional care related earnings. Care related earnings as a percentage of total earnings have declined&nbsp;as government funding hasn't been able to offset the impacts of increased cost pressures&nbsp;across the aged care sector.&nbsp;While we acknowledge the complementary nature of the two earnings streams, we find ourselves at an interesting juncture with innovation in the form of care suites becoming a common place solution to turning around care profitability.


Why is it important? Care ORAs improve the economics of care and development; but it is not a "free&nbsp; lunch"&nbsp;


Cash recovery of new development has deteriorated substantially across the aged care sector over the last 5–10 years; from over 90% to around 60–70%. We discussed this dynamic in detail in our report&nbsp;"Different Times Call for Different Measures", published October 15, 2020.&nbsp; The low cash recovery has driven up net debt across the sector over the last few years. The introduction of care&nbsp;ORAs&nbsp;has the potential to restore the aged care operators ability to recycle cash faster. However, with it comes higher volatility in business cash flow and lower cash conversion of annuity earnings.&nbsp;


Aged care tour confirms that recent strong demand is continuing


We recently visited 11 villages on our Kaimai aged care tour. We walk away with three main impressions that support our overall positive view of the sector and ARV upgrade; (1) demand for retirement villages remains very strong across the board but in particular for high end villages, (2) OCA and ARV are targeting near 100% care suite ORA uptake, above our prior estimates of ~80%, and demand appears strong, and (3) versus our expectations, construction activity is running relatively smoothly. There have been some cost increases but no severe materials or labour shortages were noted.



Aaron Ibbotson CFA
aaron.ibbotson@forsythbarr.co.nz
+64 9 368 0024





Matt Montgomerie
matt.montgomerie@forsythbarr.co.nz
+64 9 368 0124



Aged Care Sector: Changing the Economics of Care