PRIMARY HEALTH PROPERTIES PLC (LON:PHP)
21 October 2020
Real Estate Primary Health Properties: Attractive rewards at very low risk 52-WEEK HIGH 167.60p 52-WEEK LOW 114.70p A low-risk income stream delivering outsized gains PRICE 141.80p MARKET CAP MLN £1,901.72 Primary Health Properties (LON:PHP) is a real estate investment trust (REIT) that holds a portfolio of 510 primary health facilities in the UK (92% of the portfolio by value) and Ireland (8%). The business model is to manage the properties for rental income and to grow the portfolio over time. The asset Share Price base has some attractive characteristics for yield-focussed investors: 180 • 90% government-backed rent 170 • 99.5% occupancy rate 160 • Weighted average unexpired lease time (WAULT) of 12.5 years 150
140 This stable rental income base has allowed PHP to pay a steadily growing dividend, with increases every year since listing in 1997. We examine the May Jun Jul Aug Sep Oct underlying drivers in this report. Created by BlueMatrix High returns at low risk Although PHP can be viewed as a ‘safety play’ for investors, there is no adverse trade-off in terms of overall returns. PHP has delivered an 11.5% Major Shareholders annual total shareholder return over the last five years, versus 3.4% for the FTSE 350 and negative 3.5% for the UK REIT sector. In this report, we examine Blackrock inc 7.2% PHP's strong financial returns in terms of: Investec Wealth & Investment 5.0% • Solid rental income yield on property CCLA Investment Management 4.9% • Low-cost ratio Shares in issue 1,315,158,283 Avg Three-month trading 3,514,788 We also examine PHP relative to sector peers on other characteristics such volume as lease terms and rental escalations. Primary Index MAIN Next Key Announcement AGM June 11 Conclusion We believe that the conditions remain in place for PHP to continue generating strong returns in the next few years, and to continue its unbroken run of dividend Company Information increases.
Address: Greener House, Haymarket, London Furthermore, we believe that government policy in the UK has become more SW1Y 4RF supportive of primary healthcare infrastructure investment. This supports Website: www.phpgroup.co.uk PHP’s ability to continue to find new development and asset management opportunities. These in turn support our forecast for continued growth in Analyst Details earnings in addition to sustained cash generation and dividend distribution.
Ed Stacey The table below summarises our financial forecasts for PHP. Detailed models are [email protected] included on p12-14.
Year end Dec 31 2018 2019 Current 2021
Portfolio value (£mln) 1,502.9 2,413.0 2,538.0 2,690.0 Net rental income (£mln) 76.4 115.7 130.5 138.6 EPRA earnings (£mln) 36.8 59.7 72.5 76.3 EPRA EPS (GBp) 5.2 5.4 5.7 5.8 DPS (GBp) 5.40 5.60 5.90 6.10 EPRA NTA / share (GPp) 105.1 107.9 111.9 113.6 Gearing (LTV%) 44.8 44.2 41.1 43.2
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Investment summary Harry Hyman, managing director. Hyman has extensive experience in investing in the primary healthcare sector, having developed PHP’s business from inception more than 20 years
Total shareholder returns ago. He is a graduate of Cambridge University and a fellow of the Institute of Chartered 200 Accountants in England & Wales. 190 180 170 160 150 Richard Howell, finance director. Howell is 140 a chartered accountant and has more than 20 130 years’ experience working with London-listed 120 commercial property companies, including 110 Brixton PLC and LondonMetric Property PLC. 100 90 80
Indexed to start at 100 at start to Indexed 70
60
Jun-16 Jun-17 Jun-18 Jun-19 Jun-20
Oct-15 Oct-16 Oct-17 Oct-18 Oct-19 Oct-20
Feb-16 Feb-17 Feb-19 Feb-20 Feb-18
PHP FTSE 350 UK REITs
Source: LSE data Strong total shareholder return driven by The chart above shows the five-year record of PHP in terms of total shareholder growing dividend return (dividend income + share price increase). This shows an annualised return for PHP of 11.5%, compared with 3.4% for the FTSE 350, and -3.5% for the UK REIT sector.
The average dividend return (dividend paid / starting share price) for PHP over this period was 5.2% with the rest of the 11.5% total return coming from share price growth. The dividend is an important part of the overall investment thesis. PHP has increased its dividend every year since listing in 1997. Very few stocks in the UK market have this kind of track record.
Dividend history
Delivered Forecast
7.0 6.0 5.0
4.0 GBp 3.0 2.0 1.0 0.0
Source: Proactive Research
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Primary health assets produce very steady Portfolio - primary healthcare facilities cash returns PHP’s growing dividend stream is underpinned by one of the safest asset bases in the UK real estate sector — primary healthcare facilities. These are local health centres usually encompassing general practitioner (GP) surgeries, sometimes alongside other NHS services, pharmacies and dentists. The focus is on area ‘hub’ facilities rather than very small neighbourhood GP practices, as these ‘hubs’ are a core feature of local health infrastructure that do not tend to shut down or relocate.
In both the UK and Ireland the national health authorities have a committed policy of strengthening primary health care. This reflects the need to reduce pressure on hospital-based services, and to meet the needs of an ageing population.
In the UK PHP owns 493 properties, representing 8% of the addressable market, leaving plenty of headroom for further growth.
The following image shows a typical PHP property.
Typical property - Oakwood medical centre, Leeds
Source: Primary Health Properties Primary healthcare facilities have some attractive qualities as a tenant base: • Occupancy rates are high, and tenant turnover is low • Properties are typically let under long lease terms. PHP has a weighted average unexpired lease term (WAULT) of 12.5 years • Government is the direct payer for 90% of rents. This leads to a dependable and timely payment of rents
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How does PHP generate returns for shareholders? Strong returns on the portfolio have Over the past five years, PHP has delivered a total shareholder return (TSR) of driven outperformance in TSR 73% (to May 12, 2020) or 11.5% per annum over the five years. Total shareholder return is defined at dividends + capital gains.
The total shareholder return closely reflects the underlying performance of the asset portfolio. We can view this in terms of two measures of portfolio performance:
The portfolio return is the investment return on the weighted average gross assets, in terms of both rental income and capital gains.
NAV return is the percentage annual increase in net asset value (NAV) per share together with the dividends paid as a percentage of NAV. If the share price were always valued at 1x (i.e, one multiplied by) the NAV per share, then NAV return would be the same as total shareholder return.
Returns on the portfolio drive returns to shareholders
Source: Proactive Research The chart shows average annual performance over the last five years.
Average NAV return of 10% is very strong
PHP five-year average return - Portfolio return and NAV return compared with the low risk profile of the assets 14.0
12.0
10.0 Dividends
8.0 Share price appreciation % 6.0 Dividends
4.0 NAV per share growth Income return 2.0 Capital return 0.0 Portfolio NAV return Total return shareholder return
Source: Proactive Research Going forward we believe it is realistic to expect a continuation of similar portfolio performance — broadly 5% income return and 3% capital gain, driving the continued growth in the dividend.
In the current financial markets, we believe that investors may find it increasingly hard to find investments that offer a secure income with growth and an attractive income yield as a starting point. As investors seek secure yields, this could drive the PHP valuation multiples higher.
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The primary healthcare investment environment In recent years it's clear that the UK government and opposition parties have begun to place a higher priority on healthcare as a focus of public spending. We believe that the COVID-19 crisis has likely served to further reinforce this.
Primary healthcare infrastructure in particular has an important role to play in delivering high quality and cost-effective healthcare. Modern purpose-built general practice centres can provide improved hygiene and higher patient satisfaction, and allow more consultations and procedures to take place outside of a hospital environment, leading to cost savings.
Ireland has many of the same dynamics as the UK — ageing population demographics, public opinion supportive of healthcare spending, and a clear efficiency benefit available from improving primary healthcare infrastructure.
In terms of the cost-saving aspect, the following chart illustrates the difference in cost between a general practitioner visit as compared to an accident & emergency (A&E) visit. This has been a particular issue in the UK, where local health authorities have often reported an excessive burden on A&E departments coming from cases that should really be dealt with by a general practitioner.
Costs per visit - A&E versus General Practise Unnecessary visits to A&E represent a major demand on the healthcare budget 180 160 140 120 100 £ 80 60 40 20 0 A&E visit Minor A&E visit General practise visit
Source: The Health Foundation These drivers have already been leading to increases in spending on primary healthcare in the UK. The following chart illustrates.
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Spending on primary healthcare (forecasts pre-COVID) UK spending on primary healthcare has already been increasing. We expect this to 11.5 continue Government 11 forecast 10.5 10
9.5
bn -
£ £ 9 8.5 8 7.5 7 Apr Apr Apr Apr Apr Apr Apr Apr Apr Apr Apr Apr 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020 2021
Source: NHS England In terms of the benefit to PHP we note that capital investments made by the company are usually accretive to earnings per share and strongly net present value (NPV) positive. New capital investment opportunities arise when the health authorities in the UK or Ireland decide to commission a new primary healthcare facility or an upgrade programme project on an existing PHP-owned facility. Upgrade work triggers a rent review and this in turn typically provides a capital gain for PHP.
PHP currently has a pipeline of £138mln of new development projects and upgrades. We believe that the budgetary priorities of the UK and Irish governments provide a supportive environment for PHP to acquire further investment opportunities during the coming years. Comparing PHP with the REIT sector - metrics Next, we consider some metrics that support the view that PHP’s cashflow stream offers a high degree of dependability.
The following chart shows the annual rent escalations that PHP has realised over the last 12 years.
Annual rent increases
3.5%
3.0%
2.5%
2.0%
1.5%
1.0%
0.5%
0.0% 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020*
Source: Primary Health Properties
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Rent escalations have been consistently If we compare PHP’s rent escalation history with the wider REIT segment, the positive - in contrast to the wider REIT important feature is that PHP has not suffered decreases in rent during the last space decade. The commercial property sector suffered rent declines in 2009 and 2010, we believe this is also likely in 2020/21. The stability in health care is a clear positive for PHP.
The rent review mechanisms in the primary healthcare space contribute to stability: • Within PHP’s expanded portfolio, 31% of rents reviews are on a fixed escalations or an inflation-linked (retail price index) basis, while 69% are based on an open market review. • Open market review rents are effectively “up only”, with reductions only possible if both parties choose to agree to it. We believe that the slowdown in rent escalations in 2015-2016 began to make the primary healthcare market appear less attractive to private capital. The pick- up in 2017-2019 suggests, in our view, that the NHS recognises the need to attract investment. We expect the pace of rent escalations to remain positive in 2021-2022. Occupancy PHP has an occupancy rate of 99.5% and primary healthcare assets tend to achieve high levels of occupancy, due to the low turnover of tenants and controlled nature of the market. The following chart compares PHP with various UK REIT peers based on occupancy rates.
We have divided the peer group into two categories:
General: These are primarily focussed on office and retail, which account for the majority of the overall UK REIT space. The names we have chosen are some of the big names in the sector: British Land (LON:BLND), Derwent London (LON:DLN), Land Securities (LON:LAND), and Shaftesbury (LON:SHB).
Niche: We have chosen niche players that share some similar characteristics with PHP – Civitas (LON:CSH) is in social housing, Unite Group (LON:UTG) in student accomodation, Impact Healthcare (LON:IHG) in care homes, and Assura (LON:AGR) in primary healthcare.
PHP's occupancy rate is up among the best
Occupancy rate of the "niche" players in the REIT space 100.0%
95.0%
90.0%
85.0%
80.0%
General Niche
Source: Proactive Research * Unite Group figure is for properties leased to universities
The chart shows that PHP, along with Impact Healthcare and Civitas, has close to 100% occupancy. Among the niche players, Unite Group is the only one with
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occupancy below 95%, this being due to student accommodation falling vacant due to COVID-19. The figures for the generalists do not necessarily yet reflect the full impact of COVID-19 as we believe that some properties, particularly in the retail sector, may still be considered ‘occupied’ even if the tenant is unlikely to ever resume paying rent. In this sense, the chart understates the difference between the less secure plays in the sector versus more secure names like PHP. Cost Ratio We next compare PHP with its peers based on cost ratio. For this purpose, we use the cost ratio defined by the European Public Real Estate Association (EPRA). It is calculated by expressing the sum of property expenses (net of service charge recoveries and third-party asset management fees) and administration expenses (excluding exceptional items) as a percentage of gross rental income.
The following chart compares our peer group sample using the EPRA cost ratio. Most of these companies explicitly publish an EPRA cost ratio, and the figure is taken from their publications. In the cases of Unite and Civitas, we have constructed the ratio based on raw data from their accounts.
PHP leading the peer group on cost ratio
Cost ratio
35% 30% 25% 20% 15% 10% 5% 0%
General Niche
Source: Proactive Research On the cost ratio measure there are two stand-out names among the group – PHP and also Assura, which is the other healthcare REIT within the group. A low-cost ratio is an important characteristic of PHP, from an investor’s perspective, as low costs mean that a larger proportion of rent drops through to net profit and to dividend payments. Financials Conditions remain in place for continued PHP has established a strong track record of delivering a resilient and growing financial performance stream of earnings and cash flow to support a dependable and growing quarterly dividend to shareholders.
From the perspective of supporting dividend growth, the profit metric we focus on is the ‘EPRA EPS’. This is the earnings per share (EPS) as defined by European Public Real-Estate Association. It is the industry-standard measure of profit per share based on rental income (not capital gains). This is important because the EPRA EPS represents the profit per share available for paying dividends.
Growth in EPRA EPS, for PHP, is primarily attributable to two drivers: • Rent reviews on existing properties • Additional capital investment, in new properties or upgrades to existing properties
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Additional capital investments are typically earnings-enhancing for PHP from the first full year of inclusion. New investments are financed using a combination of retained cash flow and new debt issuance.
PHP completed an equity raise in July 2020, for £140mln. This has left the company with a degree of additional balance sheet firepower to support investments over the next 12-18 months. The following chart shows PHP’s balance sheet leverage as measured by the loan-to-value (LTV) ratio.
Loan-to-value ratio
55.0%
50.0%
45.0%
40.0%
35.0%
30.0%
Source: Primary Health Properties Following the equity issue, PHP reported an LTV ratio of 40.3%, which leaves significant headroom for financing investments. At the time of the equity issue, the company also announced that it was reducing its targeted maximum LTV ratio from 55% to 50%, so we do not expect balance sheet leverage to return to its previous levels in the medium term.
The company has a strong pipeline of existing opportunities for additional investments, summarised in the following table. These include the pipeline of new facilities to be acquired or developed, as well as asset management projects meaning upgrades to existing PHP properties.
Investment pipeline A strong pipeline of opportunities for 2020-2021
Source: Proactive Research
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Based on a solid pipeline of earnings accretive investment opportunities, and a supportive environment in terms of rent reviews (see p6), we believe in a positive outlook for PHP earnings growth in the next few years. The following chart summarises our earnings forecasts.
EPRA EPS - Our forecasts
5.8
5.6
5.4
5.2 GBp
5.0
4.8
4.6 2017 2018 2019 2020e 2021e
Source: Proactive Research
Conclusion We argue that Primary Health Properties offers a number of compelling investment characteristics for the shareholder — an acyclical business model, delivering strong returns and consistent cash generation. This is underpinned by the nature of the underlying property portfolio: • 90% government-backed rent • 99.5% occupancy rate • Weighted average unexpired lease time 12.5 years The current outlook for primary healthcare infrastructure spending in the UK and Ireland is supportive for PHP in terms of development and asset management opportunities, in our view. The company has a strong existing pipeline of opportunities and has the balance sheet strength to execute on these. We believe that this leaves PHP well positioned to deliver further value creation within the portfolio while continuing to deliver a growing dividend stream.
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Forecasts
Income statement Yr to December (£-mln) 2018 2019 2020 E 2021 E
Rental income 79.6 121.3 136.5 145.0 Direct property expense (3.2) -5.6 -6.0 -6.4 Net rental income 76.4 115.7 130.5 138.6
Admin and operating expenses (9.9) (12.3) (12.5) (12.8) Operating profit before revaluations 66.5 103.4 118.0 125.8 Finance income 0.1 1.4 - - Finance cost (29.8) (45.1) (45.5) (49.5) EPRA earnings 36.8 59.7 72.5 76.3 Other financial 1.4 (33.6) - - Profit on disposal/Other 0.1 1.4 - 0 Tax - (1.1) - - Adjustments for MedX acqn (146.1) Net result on property portfolio 36.0 48.4 35.0 27.0 Operating profit 102.5 5.7 153.0 152.8
IFRS net 74.3 (71.3) 107.5 103.3 Other comprehensive income 4.1 (0.2) IFRS Comprehensive income 78.4 (71.5) 107.5 103.3 EPS - Fully Diluted (GBp) 9.8 (6.3) 8.5 7.9 YoY Growth % EPRA EPS (GBp) 5.2 5.4 5.7 5.8 Dividend per Share (GBp) 5.4 5.60 5.90 6.10
Source: Proactive Research
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Balance sheet Yr to Dec (£-mln) 2018 2019 2020 E 2021 E
Cash and marketable securities 6 143 193 183 Receivables/other 5 17 18 19 Current Assets 11 160 211 202
Property 1,503 2,413 2,548 2,700 Other non-current 1 1 Total Assets 1,514 2,573 2,759 2,902
Short-term debt 102 6 6 6 Payables/other 16 35 30 30 Deferred income 16 25 25 25
Long-term debt 574 1,258 1,278 1,398 Other non-current liabilities 18 21 18 18 Deferred share payments - - - - Total Liabilities 726 1,345 1,357 1,477
Share capital 96 152 152 152 Premium 221 338 338 338 Retained earnings 370 299 277 300 Reserves 102 440 635 635
Shareholders' equity 788 1,229 1,402 1,425
Source: Proactive Research
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Cash flow Yr to Dec (£-mln) 2018 2019 2020 E 2021 E
Operating profit 102.5 5.7 153.0 152.8 Fair value adjustments and capital gains/losses (36.0) (48.4) (35.0) (27.0) Other non-cash (1.6) 134.1 - - Taxes paid - - - - Operating cash before WC and interest 64.9 91.4 118.0 125.8 Movement in receivables 2.2 (5.2) (0.9) (1.1) Movement in payables 1.4 7.8 (4.9) - Cash from operations 68.5 94.0 112.2 124.7
Property investment (101.9) (49.9) (100.0) (125.0) M&A - debt acqd and transaction cost (5.9) Cash flow from investing (101.9) (55.8) (100.0) (125.0)
Share issue 115.0 100.0 140.0 - Cost of share issue (4.0) (2.4) (2.1) - Other financing (10.7) (16.3) Interest paid (25.2) (36.7) (45.5) (49.5) Debt increment (5.6) 110.5 20.0 120.0 Dividends (34.7) (54.4) (74.7) (80.2) Cash flow from financing 34.8 100.7 37.7 (9.7)
Source: Proactive Research
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