Description

Retirement homes in New Zealand!  Sure, it doesn’t sound sexy, but just check out the numbers.  Even though COVID-19 is well under control in NZ, the shares have cratered regardless, giving us the opportunity to buy in at historically trough valuations just a year before demand surges due to the baby boomers starting to turn 75.

Here’s the pitch in a few charts:

The 2 leading retirement village operators in NZ - Summerset and Ryman - benefit from a fairly unique business model in which customer money builds up as float, which allows them to fund most of their growth interest-free.  Add to that the advantages of scale and you have rapid yet steady, “compounder” like increases in value.

(Note that this price chart gives no credit to $0.605 per share in cumulative dividends.)

In January of 2018, VIC member rajpgokul posted a writeup that does an excellent job of describing the business model and accounting quirks in detail.  I can’t say it better so I won’t try, but I will attempt a very brief overview for those new to SUM and RYM.

The attractions of these retirement villages (RVs) are community, predictable costs, and continuum of care - i.e. RVs often have facilities covering the range of independence for the 75+ crowd.  So, you won’t have to leave the community if your needs change.

RVs don’t actually sell property, but rather sell “occupation rights” that allow retirees to occupy their apt until death.  Retirees pay an upfront price along with nominal weekly fees. Each year, a “deferred management fee” is assessed until cumulative DMFs reach some set % of the initial price (25% for Summerset).  So, upon moving or death, the operator returns the initial purchase price less accrued DMFs. This is where the float comes from.

DMFs plus the nominal weekly fees mostly cover the cost of operating the RVs plus corporate overhead.  Summerset basically makes money by 1) building RVs at a profit (called the “development margin”), and 2) capturing property value appreciation when reselling occupation rights every 5 years or so when residents leave or die.  

And there’s been quite a lot of appreciation - roughly 6% per annum in NZ over the past several decades.  That said, the split is roughly 70% development margin 30% gains on resales, so I don’t worry too much about the housing market.  Also, the RV industry has avoided overbuilding throughout its ~30 year history and there’s no sign of that happening now. The 6 largest developers are responsible for about 55% of new builds, and that figure rises over time.  Also, demand is about to jump higher.

Outlook:

FY20 (ends Dec 31st) will be a rare year of growth in underlying profits.  (Note that due to accounting quirks, the income statement is of limited use and the industry has thus adopted “underlying profit”, which gets to the true economic profit - please see rajpgokuls’s explanation.)  This will be due to:

• Particularly high selling prices due to an unusually high % of apts from the Auckland area in FY18-19.

• Elevated development margins in FY18-19 returning to normal 20-25% range (many apts sold in those years had unusually low cost basis as the land was bought prior to the Auckland housing price boom)

• Extra $5M in pay for nurses (there is a nursing shortage in NZ)

• Extra overhead for expansion into Australia (should begin sales in Australia in late FY21)

• Reduced apt deliveries of 300-325 assuming 3 months of no construction due to COVID-19

By the way, NZ seems to have COVID-19 largely under control:

At 969 cases, NZ has 251 per million residents versus 1,300 in the US, despite more extensive testing.

So why not Ryman?

Summerset and Ryman the two largest of 5 publicly traded RV companies in NZ, and scale has its advantages, especially on development margins. Skip the rest.

Look, Ryman is great.  They’re the pioneer and probably have the best mgmt (though the folks at Summerset are pretty good too).  That said, Summerset typically trades at lower multiples despite faster growth. Currently, Summerset is trading at 12.6x and 11.7x underlying profit per share for FY20 and FY21, respectively.  Ryman meanwhile is at 21.9x and 19.6x. Note that for Summerset, ~12.5x forward is pretty much as cheap as it has historically traded.

While the sellside tends to focus on price to net tangible assets (NTA), I prefer valuation multiples based on underlying profit, since the business is steady and rules for calculating assets are screwy and understate true economic equity to different degrees depending on the age profile of units (rajpgokul can explain!).  About half of Summersets portfolio is less than 5 years old, and thus hasn’t really impacted resale gains yet.

Catalyst

COVID-19 goes away in NZ

Panic abates

Baby boomers turn 75!