Doctors' surgeries make fundamentally attractive investments. They yield about 5.7 per cent in rent, and that income - paid by the NHS - comes with little risk. But Primary Health Properties (PHP), the largest of the three listed landlords, has lost its way trying to consolidate the market even as its debt costs have risen and rental growth has slowed. We reckon investors should sell up while the market is still minded to give the company the benefit of the doubt.
- Low-risk market
- Scope for growth in the longer term
- Uncovered dividends
- Falling earnings per share
- Shares trade at a premium
- Little rental growth
PHP emerged from the financial crisis in good shape, with a written-down portfolio but a rock-solid income profile. But its rental earnings per share have since plunged, from a peak of 18.4p per share in 2009 to just 10.2p last year. There are three reasons for this. The first is relentless equity issuance. The number of shares in issue have increased by nearly 140 per cent from 40.6m in 2009 to 97.8m now. It has used the funds to buy new medical centres, but never fast enough to generate earnings for all the new shares.
The second reason is higher debt-servicing costs. PHP completed the refinancing of its pre-crisis debt packages in April 2012, extending maturities but paying higher margins. Its rental income was 8 per cent higher last year than in 2011, but its finance costs were 31 per cent higher.
Finally, organic rental growth has stalled. Historically, rents from newly built surgeries became the new market level that informed rent reviews, but the radical reorganisation of the NHS has led to a hiatus in development, weakening the old link with inflation. The average annual increase in PHP's portfolio fell to 2.3 per cent in the first half of 2013, from an historic norm of over 3 per cent. In time, rental growth may return. But there is no sign of a return to the boom days just yet. In the medium term, rental growth is more likely to drift lower than to pick up.
PRIMARY HEALTH PROPERTIES (PHP) | ||||
|---|---|---|---|---|
| ORD PRICE: | 326p | MARKET VALUE: | £319m | |
| TOUCH: | 324-328p | 12M HIGH / LOW: | 364p | 313p |
| FWD DIVIDEND YIELD: | 6.0% | TRADING PROP: | nil | |
| PREMIUM TO FW NAV: | 5.5% | |||
| INVESTMENT PROP: | £647m | NET DEBT: | 131% | |
| Year to 31 Dec | Net asset value (p)* | Pre-tax profit (£m)* | Earnings per share (p)* | Dividend per share (p) |
|---|---|---|---|---|
| 2010 | 312 | 9.15 | 14.7 | 17.5 |
| 2011 | 319 | 9.70 | 14.5 | 18.0 |
| 2012 | 305 | 7.38 | 10.2 | 18.5 |
| 2013* | 306 | 10.0 | 10.9 | 19.0 |
| 2014* | 309 | 14.9 | 15.2 | 19.5 |
| % change | 0% | 35% | 7% | 3% |
NMS: 800 Matched bargain trading Beta: 0.1 *Investec forecasts, underlying NAV, PTP and EPS figures | ||||
The combination of share issuance, refinancing and sluggish rental growth has substantially reduced PHP's profitability. But the company has continued to pay dividends as if nothing had changed, with a half-pence increase each year. Underlying earnings per share stopped covering the dividend in 2010, and with dividends rising and EPS falling ever since, in 2012 the 18.5p payout was only 55 per cent covered by earnings of 10.2p per share.
Half-year cover of 52 per cent did show an improvement on cover of just 45 per cent in the preceding six months as acquisitions boosted earnings - and managing director Harry Hyman insists it will improve further. But restoring full cover will require a doubling of earnings per share, which looks a very distant prospect indeed, even based on brokers' bullish assumptions.
Meanwhile, capital, which could otherwise be used to increase future earnings and NAV, needs to be handed out to shareholders to maintain the company's 17-year record of unbroken dividend growth. This is why PHP's adjusted book value has been falling, from a peak of 319p at the end of 2011 to 301p at the end of June. Some brokers expect book value to pick up again now, but this will require an improvement in portfolio growth.
