valuation

I am invested in the aged care sector because of the well known relentless increase in customers for the foreseeable decades. Not only are the numbers of aged people increasing every year but they are also richer than ever.

The sector currently has some uncertainty caused by confusing Government policy. On the one hand the Government says it wants to move to a user- pays, deregulated system and on the other hand the Department of Health says aged care operators cannot charge additional fees like asset replacement contributions. Something has to give. If the Department of Health does not back down this matter could end up in court and I am told legal opinion is operators are entitled to enter into private agreements with customers concerning fees such as asset replacement contributions.

The other confusing Government policy surrounds the extent of the budgets cutbacks. The Government claims the changes made to funding will reduce the growth in funding from around 8% pa to 5.1% pa over the next 4 years. But LASA (representing all age service providers) are talking about real cuts not just cuts to growth. Clearly the Department of Health has cut too deep and I understand the Department and the industry are in discussions to amend the legislation.

REGIS.

Regis is the leading listed operator with over 6000 beds. It is the most efficient with the highest Government contribution and the highest margin. It has moderate debt (about $242m) with excellent facilities. Also it has over 1100 net places in greenfield and brownfield development pipelines over next 4 years. This years profit growth will be modest due to higher interest and depreciation charges. I estimate 19.6 cents per share putting the company on a PER of just over 20. In my view this is cheap for a company of this quality in this sector. When the industry has digested the current uncertainty I expect Regis will deserve a PER of 25 or higher – possibly much higher.

ESTIA.

Estia is nearly as big as Regis with over 5800 beds but it has shot itself in the foot with the previous management over promising and under delivering. The previous CEO and CFO came from BUPA, a mutual fund, so perhaps they were not experienced in the financial reporting discipline required from a listed company. Some people have criticised Estia’s high debt peaking now at about $285m. I am not worried about this high debt because it is under control. Estia enjoys large RAD inflows and this coupled with operating cash flow will see the debt reduce as the months go by.

The new CEO has cut the forecast earnings (as new CEO’s always do) to about 22 cents per share but stated this is without any remedial action. We can expect remedial action during this year so probably the earning will exceed the new forecast. The lower profit forecast was caused by lower occupancy (due to bad press) and higher costs. Some cost items are moving from capital account to operating account.

Estia has a very large percentage of the sought after single bed rooms with en-suite. As far as I can make out it has land for about 700 new places over next 4 years. Estia has a large number of facilities recently bought that are still not as efficient as they could be. So Estia has some profit growth from bringing these underperforming assets up to the level of its mature facilities.

At a share price of $2.80 Estia is on a PER of 12.7. This is in my view dirt cheap.

JAPARA.

Japara is the smallest listed operator with a bit under 4000 beds but it does have a target to develop 900 beds by end of financial year 2019. It has a much lower percentage of single bed rooms than Estia and Regis. It has low debt of about $62m. Japara has stated its EBITDA will grow at about 11% this year but I cannot find out how much its depreciation will rise. I am going to guess earnings per share of 12.2 cent this year giving Japara at a share price of $1.92 a PER of about 15.7. Looks like a bargain to me.

I think all 3 companies will do well over coming years. But at these prices I prefer EHE.