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>Different Times Call for Different Measures</h2>
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<p>The attraction of NZ's aged care sector centres on its near unique business model of recycling capital while building up an annuity stream; for every 100 dollars invested 100 dollars is recouped through the sale of occupational rights agreements (ORAs). What remains is a growing annuity stream and near “infinite” return on actual invested capital, or so the theory goes. In practice this has become increasingly difficult to achieve. Net debt is building up across the sector and cash conversion of earnings is declining. Is the business model broken? We think not, but believe that recycling capital has become harder and scrutiny of underlying earnings more important. We focus on development of annuity earnings and cash recovery of new business when analysing aged care. We downgrade Ryman Healthcare (RYM) and Arvida (ARV) to NEUTRAL, upgrade Oceania Healthcare (OCA) to OUTPERFORM and reiterate our OUTPERFORM rating on Summerset (SUM). ​​​​​​​</p>
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<h3>Quality of earnings; focus on annuity earnings and cash conversion</h3>
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<p>The aged care sector is characterised by an unusually innovative approach to underlying earnings, with, at times, only a tenuous link to reported earnings or cash generation. While non-GAAP earnings are common practice in many industries, the aged care sector stands out with un-audited items making up c. 80–90% of underlying earnings. We believe this increases the importance of careful evaluation of these earnings over time and between companies in order to evaluate relative performance. In this report we take a closer look at the composition of earnings with regards to cash conversion, growth and annuity characteristics. ​​​​​​​</p>
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<h3>Imitation is the sincerest form of flattery — the "RYMification"&nbsp;of the NZ aged care sector increases comparability</h3>
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<p>RYM's focus on continuum of care which is "good enough for mum" and growth through recycling capital has delivered &gt;20% annual Total Shareholder Return (TSR) for over 20 years; the other listed aged care operators have taken note. OCA and ARV are adding a disproportionate amount of Independent Living Units (ILUs) to complement the reliance on care, SUM has increased its care offering and is rather openly following in RYM's footsteps, including over to Victoria. This "RYMification" of the sector reduces the diversity for investors, but also, we believe, increases the earnings comparability. While OCA and ARV are in a different phase, still integrating acquisitions and doing brownfield development, the reliance on traditional care earnings has declined dramatically and the earnings mix is starting to look very similar to RYM.&nbsp;</p>
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<h3>SUM and OCA are our preferred names — for very different reasons</h3>
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<p>SUM has delivered growth in annuity earnings &gt;2x that of the sector over the last 3–5 years and has the best (least bad) cash recovery of expansionary capex. Looking ahead, we see SUM as best positioned to deliver growth from its existing book and, together with OCA, has the highest cash recovery of expansionary capex. Despite this RYM is valued at a ~20% premium to SUM on our preferred valuation metric of EV/Annuity EBITDA and only a modest premium to ARV. OCA, on the other hand, has, by some margin, delivered the worst growth (a decline) in annuity earnings since it listed and has seen cash conversion deteriorate the most. This has been driven by the ongoing transformation from a traditional care operator towards more of a premium continuum of care operator. Looking ahead, we expect 20%+ growth in annuity earnings and cash conversion improving to the sector average; with a starting point as the lowest multiple, we see most upside in OCA — but the path ahead is unlikely to be straight. ​​​​​​​</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 Different Times Call for Different Measures


The attraction of NZ's aged care sector centres on its near unique business model of recycling capital while building up an annuity stream; for every 100 dollars invested 100 dollars is recouped through the sale of occupational rights agreements (ORAs). What remains is a growing annuity stream and near “infinite” return on actual invested capital, or so the theory goes. In practice this has become increasingly difficult to achieve. Net debt is building up across the sector and cash conversion of earnings is declining. Is the business model broken? We think not, but believe that recycling capital has become harder and scrutiny of underlying earnings more important. We focus on development of annuity earnings and cash recovery of new business when analysing aged care. We downgrade Ryman Healthcare (RYM) and Arvida (ARV) to NEUTRAL, upgrade Oceania Healthcare (OCA) to OUTPERFORM and reiterate our OUTPERFORM rating on Summerset (SUM). ​​​​​​​


Quality of earnings; focus on annuity earnings and cash conversion


The aged care sector is characterised by an unusually innovative approach to underlying earnings, with, at times, only a tenuous link to reported earnings or cash generation. While non-GAAP earnings are common practice in many industries, the aged care sector stands out with un-audited items making up c. 80–90% of underlying earnings. We believe this increases the importance of careful evaluation of these earnings over time and between companies in order to evaluate relative performance. In this report we take a closer look at the composition of earnings with regards to cash conversion, growth and annuity characteristics. ​​​​​​​


Imitation is the sincerest form of flattery — the "RYMification"&nbsp;of the NZ aged care sector increases comparability


RYM's focus on continuum of care which is "good enough for mum" and growth through recycling capital has delivered &gt;20% annual Total Shareholder Return (TSR) for over 20 years; the other listed aged care operators have taken note. OCA and ARV are adding a disproportionate amount of Independent Living Units (ILUs) to complement the reliance on care, SUM has increased its care offering and is rather openly following in RYM's footsteps, including over to Victoria. This "RYMification" of the sector reduces the diversity for investors, but also, we believe, increases the earnings comparability. While OCA and ARV are in a different phase, still integrating acquisitions and doing brownfield development, the reliance on traditional care earnings has declined dramatically and the earnings mix is starting to look very similar to RYM.&nbsp;


SUM and OCA are our preferred names — for very different reasons


SUM has delivered growth in annuity earnings &gt;2x that of the sector over the last 3–5 years and has the best (least bad) cash recovery of expansionary capex. Looking ahead, we see SUM as best positioned to deliver growth from its existing book and, together with OCA, has the highest cash recovery of expansionary capex. Despite this RYM is valued at a ~20% premium to SUM on our preferred valuation metric of EV/Annuity EBITDA and only a modest premium to ARV. OCA, on the other hand, has, by some margin, delivered the worst growth (a decline) in annuity earnings since it listed and has seen cash conversion deteriorate the most. This has been driven by the ongoing transformation from a traditional care operator towards more of a premium continuum of care operator. Looking ahead, we expect 20%+ growth in annuity earnings and cash conversion improving to the sector average; with a starting point as the lowest multiple, we see most upside in OCA — but the path ahead is unlikely to be straight. ​​​​​​​



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: Different Times Call for Different Measures