|Shares Out. (in M):||500||P/E||0||0|
|Market Cap (in $M):||4,560||P/FCF||0||0|
|Net Debt (in $M):||837||EBIT||0||0|
|TEV (in $M):||5,397||TEV/EBIT||0||0|
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Ryman Healthcare is a high-quality compounder, with a long runway for growth. The company is uniquely positioned to benefit from a very favorable demographic shift and has also expanded into the Australian market, where it has shown early signs of success. Whilst the valuation is not statistically cheap (~25x underlying earnings), we believe it is reasonable when factoring in Ryman’s strong track record of development, unique competitive advantages and long growth runway.
Ryman Healthcare is an NZX-listed company, and one of New Zealand’s leading retirement village/aged-care operators. The company designs, develops and operates retirement villages with co-located aged care facilities and targets the 75+ demographic (more needs-based as opposed to the lifestyle-based villages that target younger retirees).
The accommodation provided by Ryman Healthcare spans the ‘continuum of care’ (in industry lingo), from retirement village units where residents live independently to service apartment with low-level aged care services provided, through to rest-home care, where there is some assisted living and finally all the way to hospital-level care and specialist care for dementia sufferers, that are very care-intensive.
Ryman currently operates thirty-one retirements villages, and all but one of these are based in New Zealand, where it is the among the market leaders. The company however has recently been making a push into the Australian market, with its first village being extremely well received. The current portfolio consists of almost 6,000 retirement units/serviced apartments and 3,281 aged care beds. Ryman’s current landbank is capable of developing a combined 5,500 retirement units and aged care beds.
Ryman is considered a success story amongst New Zealand companies. It has grown its property portfolio in retirement units and aged care beds at a 14% and 10% CAGR, respectively in the past decade, whilst underlying operating profit has increased by ~15% CAGR over the same period. The company has built an excellent development track record and there is very high market demand to live in Ryman Villages (in most recent annual report, only 0.5% of existing retirement units are currently available for resale, whilst Ryman typically attracts strong waiting lists for new developments).
Ryman has also benefited from a very stable management team. Simon Challies (the CEO until very recently), presided over much of the aforementioned growth in Ryman’s village development and operating profit until recently stepping down to due Parkinson’s Disease. Current CEO, Gordon MacLeod, was formerly the CFO of Ryman and joined the company in 2007, having been recruited for the job by Challies. Furthermore, Kevin Hickman, one of Ryman’s co-founders, remains a substantial shareholder and sits on the Board.
Secular Outlook/Development plans
“You could say that we have spent the past 18 years since we listed warming up for the main event – and it is about to begin. I’d like to explain why. The clear majority of our residents were born in the 1920s and 1930s, in a period when the birth rate was declining post World War I and into the depression. We are entering a period where the birth rate starts to gradually climb before almost tripling at the height of the baby boom. That’s why we’re starting to see an increase in demand for independent units, and we expect to see that demand starting to flow through to our serviced units and our care centres over the next two to three years. Our established care centres are already running at 97% occupancy, and we are going to need all the resources we can muster to cope with the demand ahead. “ Simon Challies (Former CEO) 2017 Annual Report
Source: 2013 Investor Presentation (Blue column is NZ, Red column is Australian State, Victoria)
Source: 2016 Ryman Investor Presentation
We think the above two graphs are fairly self-explanatory. Basically the coming demographic shift is very favourable to Ryman’s business model of developing villages for the 75+ market, and it is ramping up its development plans, most notably in the Australian state of Victoria. The Weary Dunlop Retirement Village in Wheelers Hill (Ryman’s first Victorian village), was extremely well received, with Ryman reporting that sales of the units were the fastest they had ever experienced. Town houses were first sold at $400,000, a slight discount to enter the market, but 12 months later sold for $570-$580,000. The integrated approach to retirement villages and aged care are not common in the Australian market, however based on the success of Weary Dunlop and strong waiting list for Brandon Park (an upcoming Victorian village set to open in 2018), it appears to Ryman’s unique offering is an excellent fit for the market.
Unit economics of a retirement village unit
Before discussing Ryman’s revenue streams, it is probably worth illustrating the unit economics of a Ryman Village (the numbers in the example is taken from Ryman’s 2011 Investor presentation, but I’ve added additional colour).
In order to live in a village unit, a prospective tenant needs to purchase an Occupancy Right Agreement (ORA). These payments are ultimately used to fund the construction of the village (although bank debt can act as a bridge during development/construction of the village).
Let’s say a single retirement unit in a new development costs $200k to build. Ryman will seek to sell the ORA for this unit at a mark-up. So if Ryman sells the ORA to a resident for $250k, it has achieved a 25% development margin and the $50k surplus is immediately booked as revenue under Realised Fair Value Movement – New Village.
The $250k is also recorded as a liability under gross occupancy advances, as Ryman will refund the tenant the face value of the ORA (less a deferred management fee – to be discussed later). This liability by Ryman does not accrue any interest, essentially allowing Ryman to borrow interest free for long duration, in order to fund the construction of villages.
When a tenant leaves the village, the occupancy advance is refunded at face value (NOT resale price) less a deferred management fee (DMF). This means that any capital gains or loss from resale are borne by Ryman and not the previous tenant. The DMF is essentially the tenant’s contribution towards the shared facilities provided by the village (resort-style facilities, pool, rec rooms, etc). The DMF is accrued on an annual basis and capped at a certain level (in Ryman’s case the cap is 20%, which appears to be on the lower end of industry norm of between 20-30%).
So if it is assumed the tenant lives in the retirement unit for five years and the annual management fee is 4%, then the existing tenant would receive the face value of the ORA less the DMF (which in this case would be $200,000 - $250,000 FV ORA minus $50,000 DMF (5 years * 4% of $250k)). Whilst the DMF is paid at the end of the tenancy, the annual accrual is recognized as management fee revenues.
Ryman would also receive an ORA payment from the new tenant, which would sell at prevailing market rates. So in this example, if the market value have risen 20% during this five-year time period, then Ryman would be able to resell the ORA for $300,000 to the new tenant. The rise in market value ($50,000 or $300,000 New Price ORA - $250,000 Original price ORA), would be recorded as revenue under Realised Fair Value Movement – Existing Village Unit.
Also remember, that these ORA payments cover the construction costs of communal facilities and large aged care facilities. So on an on-going basis, Ryman benefits from charging larger care fees for those residents that require greater assistance in living.
Ryman’s competitive advantage
I believe Ryman’s competitive advantage is largely a function of two factors – i) its past track record in successfully executing its development plan, which provides a funding model advantage and ii) combining the disparate expertise of developing/constructing retirement villages and running a large aged care facility.
Past track record in development/funding model
Ryman has an excellent multi-decade track record of selling ORAs on new developments, which is largely a function of their excellent market reputation, resulting in strong demand to live in Ryman villages. This plays an important role in Ryman’s funding model advantage. Firstly, occupancy advances from residents of new villages ultimately fund the construction of new villages + aged care/common facilities. Secondly, bank debt is used to fund land acquisitions and construction WIP. However, the bank debt is essentially a bridge to being taken out by an incoming residents ORA. Therefore, the developer’s track record is a very important consideration when extending credit. Secondly, Ryman uses the aged facility + shared facilities of existing villages as collateral for bank debt facilities in order to fund new villages, so as Ryman continues to build more villages, it also increases its borrowing capacity (this is also benefitted by the more defensive earnings from care fees on existing aged care facilities). Finally, in an environment where ORA price has risen (which has been historical case), re-sales on existing village units provide further capital to execute Ryman’s ambitious build plans. Similar to insurance float, ORAs provides an excellent source of capital given i) they are non-interest bearing, ii) they have long duration (typical occupancy on an ILU is seven years) and iii) there is minimal refi risk, as Ryman only refunds ORA to previous tenant when it has found a new buyer (although according to Ryman, an available resale unit has never taken more than six months to sell).
Combining disparate expertise of development/construction and operating aged care facilities
Given Ryman does not outsource the development/construction of its villages, it has developed a substantial institutional knowledge of executing integrated retirement villages with aged care facilities. Furthermore, the company also has developed a strong culture of care in its DNA, having operated aged care facilities for a long period of time – a business with higher barriers to entry than retirement villages alone (given the far greater regulations around aged care), yet also one that is not does possess attractive economics on a stand-alone basis without the cross-subsidy of the retirement villages. In fact more recently in the New Zealand market, Ryman has been responsible for adding the majority of marginal capacity in aged care beds in the past few years, whilst existing operators with a primary focus on aged-care, like Oceania, have been focusing on increasing their exposure to the development-side of the market (albeit at far smaller volume without Ryman’s outstanding track record).
The large aged-care facilities are a major attraction to residents staying in ILUs as:
i) even though current residents may live independently, they are attracted by the co-location of aged care facilities, in anticipating health issues down the road
ii) residents of Ryman ILUs get priority access to Ryman’s aged care facilities, should they move to a living arrangement with higher assistance and giving greater peace of mind
iii) for an old couple, where both parties on on different levels of continuum of care, this allows them to still be co-located
Also, as previously mentioned in the unit economics at the village level, Ryman is ultimately using the ORAs from the ILUs/SAs in order to construct the large aged care facilities. This would involve a degree of scale with regards to village size, which when combined with Ryman’s excellent development track record/funding model creates some moat-like characteristics in the business.
Ryman’s Revenue streams
So based on the above unit economics, we can break down Ryman’s earnings into five categories: 1) Care Fees, 2) Realised Gains on new properties (development margin), 3) Realised Gains on Existing properties (resale margin), 4) Management Fees, 5) Unrealized gains/losses on investment properties.
1) Care Fees: These are the fees that are charged for providing healthcare services to residents across with ‘continuum of care’, with greater revenues (and costs) associated for those residents requiring a higher level of care (hospital/dementia) relative to the very low level of care for retirees living independently in ILUs. The majority of care fee revenues are daily fees that are paid for and set by the NZ government, depending on the level of care required. However Ryman does have the ability to earn additional margin directly from residents, as their facilities are above minimum government specifications (eg, larger rooms, en-suites).
Underlying drivers: 1) Daily rates set by government, 2) Size of Ryman’s property portfolio (emphasis on growth in aged care beds)
2) Development Margin: The development margin represents the difference between the construction cost of ILU/SA and the price that ORA is sold for (as described in unit economics above). Historically this development margin has been in mid-high 20s range.
Underlying drivers: 1) Size of new developments, 2) house price movements (during development phase), 3) underlying demand for living in new Ryman villages.
3) Resale Margin: The resale margin represents the difference between the carrying value of the ILU/SA versus new resale price. Historically the resale margin has been in the low 20s range.
Underlying drivers: 1) house price movements, 2) size of Ryman’s investment property portfolio (more properties = more resales).
4) Management Fees: As stated in the revenue recognition in the financials – “- Management fees … are recognised on a straight line basis over the period of service, being the greater of the expected period of tenure, or the contractual right to revenue. The expected periods of tenure, based on historical experience across our villages, are estimated to be seven years for independent units and three to four years for serviced units.”
Underlying drivers: 1) the growth in Ryman’s investment property portfolio (more properties = more management fees) and 2) house price movements (fee is calculated as % of ORA price)
5) Unrealized gains/losses on investment properties: Ryman’s existing investment portfolio is mark-to-market using an independent DCF valuation by CBRE.
Underlying drivers: 1) size of Ryman’s investment property portfolio (more properties = more scope for gains/losses) and 2) house price movements.
One of the challenges in normalizing Ryman’s earnings is trying to determine which of the earnings streams are truly recurring versus the lower quality earnings streams that have benefitted from the broader trend of house price appreciation and are more speculative in nature.
Whilst I don’t want any thesis to rely on some forecast of NZ/Australian house prices, I thought it would be an interesting thought exercise assume zero growth in ORA prices going forward to see how this would impact each of Ryman’s five key revenue streams (as described above), once we try to neutralize this tailwind.
In order of least affected to most affected (or highest quality to lowest quality if you will), this is what I believe the impact would:
- Care Fees: Existing Care Fees shouldn’t be adversely impacted at all by any movement in house prices, given the service nature of the revenue stream. New care fees will continue to increase as developments take place.
- Management Fees: Fees from existing portfolio should initially increase, until full churn in portfolio, when fees would ultimately flat-line. Like care fees, new management fees will be earned on future development, however even in a zero growth environment, management fees on new villages should be higher than existing portfolio on a per unit basis, given the historical rise in ORAs.
- Realised gains (new): The development margin would be lower in a zero growth price environment, but we would expect that Ryman would still be able to achieve a respectable margin. Combined with a higher build-rate, we would expect overall realised gains on new units going forward to still be higher than current levels.
- Realised gains (existing): Given historically resale margin is low 20s range we would initial expect some realizes gains, as the current portfolio is likely undervalued even after factoring unrealized gains. However this earnings stream would trends to zero.
- Unrealised gains (existing): Should in theory be zero. Is not included in management’s underlying operating profit measure.
In 2017, underlying operating profit (which excludes unrealized gains) was ~$178mn. This has grown at CAGR of over 15% in the past decade, although as we’ve explained it is probably not reasonable to extrapolate this rate, given the beneficial tailwind of higher housing prices in NZ, which directly benefit every revenue stream materially. However, as we’ve demonstrated, the majority of the Ryman’s revenue drivers, should still grow even in an environment of minimal price growth.
Whilst not cheap, we believe that Ryman’s current valuation (~25x P/E multiple, based on underlying operating profit) to be very reasonable for a high quality compounder whose unique competitive advantages are well placed to benefit from the extremely favorable long-term demographic.
- Lower housing prices in NZ: Given Ryman bears the price risk on investment properties in its portfolios, the obvious risk would be a housing crisis in New Zealand. However we believe there are a few mitigating factors in this scenario:
o Ryman’s accommodation is more needs-based, rather than lifestyle-based, so it should be more insulated from potential market down-swing, especially when factoring in the large favorable demographic shift
o Only a small portion of Ryman’s total investment property portfolio is churned on an annual basis, whilst the average tenancies on ILUs are quite long (seven years). This limits the numbers of Ryman’s existing units being available for re-sale.
o When looking at both inventory levels and resale margins for Ryman village units, we believe they are leaving money on the table, which should provide further margin of safety
o Land for future developments should be able to be acquired more cheaply, providing a lower price-base for future growth.
- Development risk: Whilst their first village was a success, Ryman is a new entrant to Australian market, which may increase development risk. Also risk in terms of finding future sites and either paying over the odds and sacrificing development margin, or slowing development plans.
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