Description

I had been intending to do a writeup on Ryman before Jumpman posted his own writeup back in August. On top of beating me to the punch, Jumpman also had the nerve to do an excellent job. Still I haven’t been able to get Ryman out of my mind. That’s because Ryman, a market leader in retirement communities with 30% ROEs, offers the exact opposite of what the investing universe does today. It offers high returns, a high chance of success and a robust risk profile. We view it as a kind of Berkshire Hathaway in that it’s a compounder offering above-market returns with below-market risk. 

Something interesting I read recently was how Allan Mecham managed to have an up year in 2008. He didn't hedge or anything. Instead he stuck to his philosophy of buying "cockroach" businesses that could thrive in any macro environment. I decided to do this writeup because I think Ryman is one of those rare "cockroach" businesses. And even beyond being "merely" robust, there is a strong counter-current here because Ryman is levered to the rapidly growing elderly population. While Western economies will be harmed by demographic decline, Ryman will actively benefit. This observation doesn't involve some remote, far-off future. It's already happened, and the rate of change is accelerating. Ryman, as a result, has been growing for some time, and it's reaching an inflection point. I believe the intrinsic value of the business could double over the next 4 years.

What does Ryman do?

Ryman builds and operates retirement communities and aged care facilities in New Zealand. And they do it particularly well. They raised $25 million in their IPO in 1999, and since then they’ve invested $2.8 billion in their asset base without issuing any more equity. Meanwhile they’ve paid out $630 million in dividends. 

So how does Ryman self-fund so much growth? They’re the highest quality retirement community provider in New Zealand. Everything keys off that. When Robert Vinall, an investor some of you know, toured retirement communities in New Zealand, even Ryman’s competitors admitted that Ryman had already bought up most of the best locations in the country. That’s number one. Number two, however, is far more important.

Ryman is committed as a company, at a moral level, to provide people at the end of their lives a dignified experience. The company was started when one of the co-founders visited a retirement home and was appalled by what he saw. Those beginnings are still a part of the company today. The executives speak movingly about what they do, and they speak with a sense of purpose. The reviews by ex-employees on indeed.com praise the culture and care given to the residents. The only real complaints are about the nature of care-taking work itself, which requires huge amounts of kindness and hard work, yet offers little pay. 

Moving down the ladder of abstraction, Ryman also offers something almost no one else has: the continuum of care. Ryman has a roughly equal number of retirement communities for younger retirees and aged care facilities for older retirees. What this means is that when you check into a Ryman location, you can there until the end of your life.

As you can see, Ryman blows everyone else out of the water. This matters because it means spouses won’t be split up. Residents won’t have to start over somewhere new, which is something I find daunting and unpleasant as a man in his thirties. I could only imagine how I’d feel in forty years when I’m even more crotchety and suspicious of everything.

The quality of these facilities is also best in class. The gold standard of any retirement village is the receipt of a four-year certification from New Zealand’s Ministry of Health. Here again Ryman leads the competition in terms of resident standard of care.

Those are the advantages Ryman offers. Below are the advantages it reaps.

Returning to how Ryman self-funds, typically property developers must shoulder mountainous debts. But Ryman’s brand is so strong that its customers are willing to fund the construction of their units themselves. They pay years in advance for their units, thus providing Ryman with an interest-free loan to fund construction. 

This is an advantage in and of itself, reducing financing costs and credit risk, but it also speaks to the existence of another important advantage: pricing power. People are flat-out motivated to get into Ryman facilities. They not only have to commit capital years in advance, but they have to sit on wait lists to get in. Occupancy at Ryman facilities runs at 97% compared to 87% for the rest of the industry. The founder’s goal, to create a place “good enough for mum,” has come true.

The best businesses typically have an advantage either on the demand side (pricing power, embeddedness with the customer) or on the supply side (they're the lowest cost producer). It's extremely rare to find a business that has both. See's Candies is one example. It had both pricing power and essentially nonexistent capital needs, both of which combined to make it the investment Buffett most often refers to as his "ideal."

Ryman's advantages, to be clear, don't exist to the same rarified degree as those of See's. Nonetheless Ryman does still possess advantages on both the demand side and the supply side. It has a premium, truly value-adding product for which there is a very massive, very passionate market. As Marc Andreesen would say, that's the only thing that matters. But on top of that, Ryman is also able to supply this product more cheaply and safely than the competition. As a result, Ryman has two advantages moving at the same time, in the same direction. This company could really become something special over the next 10 years. 

The economics

The business is hard to analyze because of the growth economics and because accounting rules require Ryman to mark everything to market, even PP&E. Nonetheless to get an idea of Ryman’s returns on its own money, we need to deflate the numbers to cost. When we did that, we found the business has put up impressive 30% ROEs over the last decade. Since it pays out half of earnings in dividends, this suggests the sustainable growth rate of the business is 15%. Also impressive. That said, as we'll discuss later, there are reasons why Ryman may be able to growth intrinsic value even faster. 

Assets have grown at 19% a year over the last nine years, and over the next five years resident-provided funding is expected to double from $2.6 billion today to $5.4 billion in 2022. Their productive asset base is growing rapidly.

Profit per bed/unit has grown at 3% a year for the last ten years. The rate of inflation over the same period was 2%. This isn’t See’s Candies growing profit per unit by 3% a year over inflation, but still this is positive, and it’s another demonstration of Ryman’s pricing power. 

Why now?

As we all know, world-wide, profit margins are high. Valuations are titanic. There is a chance that the forces powering historical corporate profitability will end. For Ryman, however, it is the opposite. The risks inherent in this business are in the process of going down, not up. Their business depends on retirees. The more, the better. And since the world is at the beginning of the greatest retirement wave in human history, there’s about to be a whole lot more.

The hockey stick is just beginning to curve. Mark your calendars. On August 1, 2018, there will be a zombie apocalypse, and the dead shall walk the earth. No, but in all seriousness the population over 75 will increase 4x over the next decade. Everything the company has done up until now has been gearing up for, in the company’s own words, “the main event.”

Capex at the company has gone into overdrive.

They’re ramping up to meet future demand. And incremental returns on equity (at cost) have continued to stay above 30%. In other words, this is a company that has one of the most valuable features a business can: it has the opportunity to redeploy capital at wonderful rates. And not only is that rate high--30%--but ever-greater amounts of capital are being funneled into it. This is one of those rare situations where you actually want CAPEX to be growing at 30% a year.  

The demographic trend is also relevant because it neutralizes the greatest risk Ryman faces: its exposure to real estate. Real estate prices in New Zealand have gone up 4.7% a year for the last decade—more than double the rate of CPI. This is the gating issue here, and if Ryman doesn't work out as an investment, it is highly likely that real estate prices are the reason why. Rising real estate prices have been a tailwind to Ryman’s past earnings, and we can't assume they're going to continue. As a result, we have to ask ourselves if those earnings are really sustainable. I think they are because while real estate is unlikely to provide its past lift, another force is just coming into play to pick up the slack. 

Not only is the number of prospective customers about to shoot up, but so is the average age of a resident entering Ryman’s facilities. This is huge. The older a resident is upon entry, the more profitable it is to serve them. This isn’t something Ryman can trumpet because it speaks to the more unpleasant aspects of its business. Nonetheless, buried in the footnotes, the company acknowledges this as one of two drivers of profitability.

The two major inputs in valuing investment properties are (1) housing prices and (2) average age of residents upon entry. And what’s true for the investment properties is true for the business overall. For the last decade, Ryman has benefited from the first one, housing price appreciation. Now it’s about to benefit from the second, a rapidly aging population. In fact it’s already happening.

And it’s about to ramp up in earnest.

Also offsetting the real estate risk is the fact that in Melbourne and Auckland, for example, when residents move into Ryman, they typically free up capital. Why? Ryman’s units are priced well below the price of the average home, which means the residents can pocket the difference.

Housing could remain stagnant or even correct, and residents would still be able to afford Ryman’s units.

Finally there’s one other driver of profitability that’s coming into play as well. Ryman’s communities get more profitable as they mature. Ryman has had a lot of new facilities come online over the last years. As these facilities reach their true profitability, that will provide another boost to Ryman’s bottom line. 

Valuation

Ryman isn’t a traditional value stock. When we exclude unrealized gains and look only at underlying net profit, it trades at 26.5 times next year’s earnings. However, you’re buying something that’s growing its assets at 20% a year and is poised to grow shareholders’ equity at 15% a year. Meanwhile if the ramp-up in Capex continues, then the intrinsic value of the business will grow even faster. 

I think the value of the business could double over the next 4 years, implying a 19% IRR. And if I'm wrong, then I would bet that the intrinsic value still grows 15% a year--in line with a conservative estimate of growth in shareholders' equity.

Ultimately, though, what’s so appealing about Ryman, and what sets it apart, is how it looks when you frame the investment negatively. The risk of something catastrophic happening is unusually low. Even the risk of the business reverting, as many businesses do, back to mediocrity is low. This is a high-probability, low-risk investment where a long-term investor could earn 15-20% a year.

Even if the P/E for the company fell to 16x, the long-term average for stocks, then you'd likely still earn 9% a year in this investment. For a company of this quality, I think that's the floor for long-term returns. And in the grand scheme of things, that’s a pretty nice floor to have.

I'd like to make one last point that perhaps may be obvious to some. The biggest function of almost any equity's value is its terminal value. Some businesses might experience strong growth for five years and then, more less, revert to the mean. At the right price, that still makes them appealing. The real compounding machines, though, have much longer runways than five years. This matters because compounding is not just a function of the growth rate. It's also a function of time. In Ryman's case, it will never compound like a Google or a Microsoft, not even close. But due to the massive retirement wave in the Western world, there is a possibility that it could compound for the next 20 years. Obviously not at 30% ROEs. But nonetheless at something well above its cost of capital. I bring up terminal value here because, yes, price factors into margin of safety, but then so does a business's ability to survive. This could be one of those rare businesses that will be worth multiples of what they are now in 10 years. 

Disclaimer: Nothing the author writes should be construed as investment advice or a recommendation to buy or sell specific securities. Please do your own research. While everything the author writes is factually correct to the best of the author’s knowledge, a lot of this is guesswork and is far more subjective and far more prone to error than it may seem. You are encouraged to notify the author of any mistakes or oversights in the comments section, but the author assumes no liability whatsoever for the accuracy of the information herein. Moreover the author undertakes no duty to update the information contained in this write-up. 

Catalyst

The catalyst here is a soft catalyst. Management describes everything it's done so far as gearing up for the main event, the main event being New Zealand's retirement wave. That wave is just beginning to get underway.