Under the terms of the agreement, the freehold to 41 CareTech properties have been transferred to Alpha Real Capital's managed funds in exchange for a cash sum of £30m and security of tenure with a 150-year term. The commencing annual rent is £1.07m, which will rise with the retail price index (RPI) on a five-yearly compound basis at between 0 per cent and 5 cent a year.
Farouq Sheikh, CareTech's executive chairman, says that the board has "already identified a number of potential earnings-enhancing acquisition opportunities, which we believe will meet the evolving requirements of care commissioners along with our own growth criteria". Having raised £21m in a placing last year, and invested all the proceeds in three earnings-enhancing bolt-on acquisitions between July and December 2015, the company has now negotiated an additional £30m credit line on top of its existing bank debt facilities to augment the £30m of cash raised through the non-dilutive ground rent fundraising.
It's worth noting that as part of the transaction, CareTech's entire property portfolio has been revalued upwards at £282m, implying it now has pro-forma net borrowings of £137m net of the £30m proceeds from the ground rent fundraise and after factoring in the recent acquisition of ROC, a north west-based provider of residential care and education services for young people with complex needs, after its September 2015 financial year-end. This suggests a comfortable loan-to-value ratio just below 50 per cent, and a net debt to cash profit ratio of less than four times.
The ROC acquisition, announced in early December last year, highlights the type of opportunities available for deploying CareTech's £60m warchest. The company agreed to pay up to £11.4m for ROC, comprising a net initial cash payment of £8.7m and an earn-out of up to £2.7m. ROC provides residential care and education for challenging and vulnerable young people with complex needs. It has established a model of therapeutic care and education which has generated over the past few years a history of high regulatory grades across its services. The business has a capacity of 41 residential places in seven residential homes in Lancashire and 25 education places in its school in Preston. In the year to July 2014, ROC reported revenue of £5m and profit before rent and tax of £802,000, and this will have increased again last year, so the acquisition is immediately earnings enhancing for CareTech's shareholders.
Significant earnings upside potential
To put the earnings upside into some perspective, analyst John Cummins at broker WH Ireland believes that if the £60m is deployed in full, then the company has the potential to deliver cash profit approaching £50m in the 2018 financial year (September year-end). That doesn't seem unreasonable to me as analysts forecast a 10 per cent rise in CareTech's cash profit to £36m in the 12 months to the end of September 2016 after factoring in the contribution from the three acquisitions made last year funded from the £21m proceeds from the share placing last March. In effect, excluding any growth from its existing operations, CareTech would need to deliver an additional £14m of cash profit from £60m of acquisitions to boost annual cash profit to £50m.
That looks achievable considering the company acquired Spark of Genius, a Scotland-based provider of residential care and education services for young people with complex needs, last summer on a multiple of five times cash profit based on the initial consideration of £7.48m and excluding the earn-out of £1.75m. In the year ended 31 March 2015, Spark reported revenue of £10.9m and profit before tax of £1.2m.
The important point being that any earnings upside from future acquisitions is not reflected in CareTech's valuation. In fact, the shares only trade on 7.5 times earnings estimates for the financial year to end-September 2016, and that's before adding in the contribution from any of the earnings-enhancing acquisitions the board is currently targeting. The shares also offer an attractive forward dividend yield of 3.5 per cent. And with all those freehold interests on the balance sheet, there is substantial asset backing, too: net asset value of £133.7m at the last financial year-end is the equivalent of 215p a share, so the shares are being rated on a price-to-book value ratio of 1.14 times. But even that underscores the true value on offer.
Hidden value on the balance sheet
At the time of CareTech's last results the property portfolio was valued at £294m, well above the carrying value of £256.5m in its 2015 accounts. The £37.5m difference is worth 60p a share and implies an adjusted net asset value of 275p at the end of September 2015. Those properties have clearly been revalued upwards again because after the £30m sale of the freehold ground rents, the remaining portfolio has been valued at £282m, representing a fall of only £12m on the October 2015 valuation prior to the sale. So, even after accounting for the acquisition of ROC in December, I believe that the portfolio has risen by at least 4 per cent since the last balance sheet date, adding a further £12m, or 19p a share to Caretech's adjusted net assets. Or, to put it another way, I believe that if you mark-to-market the portfolio, the company has a spot net asset value of around 294p a share, or 20 per cent above the current share price.
In my view, CareTech's heavy asset backing, solid cash-flow generation, rising cash profitability, ability to adopt a progressive dividend policy, and potential to make further earnings-accretive acquisitions make for a pretty strong investment case. True, the shares have only risen by 6.5 per cent since I commenced coverage at 230p ('Time to take care', 16 Mar 2015), but that's far better than the 5 per cent decline in the FTSE Aim index in the same period. And although they are trading in line with my last recommendation ('Hitting the right numbers', 30 Jul 2015), they have outperformed a falling market by 8 per cent in the past seven months. I can certainly see this positive trend continuing.
So, with the prospect of more earnings-enhancing acquisitions likely, I rate CareTech's Aim-traded shares a decent buy on a bid-offer spread of 240p to 245p and have a target price of 300p.
Please note that I have published three columns today, all of which are available on my IC homepage and are also listed below.
MORE FROM SIMON THOMPSON...
I have written articles on the following 77 companies since the start of this year:
■ Grainger: Buy at 243.5p, target 280p; Dart: Take profits at 580p; Crystal Amber: Hold at 159p; Redde: Take profits at 203p; Burford Capital: Run profits at 196.5p; Renew: Run profits at 404p; Plethora Solutions: Speculative buy at 4.5p ('Stock check', 5 Jan 2016)
■ Elegant Hotels: Buy at 118p, target price 130p to 135p ('Check in for a profitable stay', 6 Jan 2016)
■ Safestyle: Run profits at 272p ahead of pre-close statement on 25 Jan 2016 ('Clear cut gains', 6 Jan 2016)
■ Epwin: Run profits at 143p, new target 170p ('Epwin on the acquisition trail', 6 Jan 2016)
■ GLI Finance: Recovery buy at 37.5p ('GLI shelves fundraise and its chief executive', 6 Jan 2016)
■ LXB Retail Properties: Buy at 97.5p, new six-month target 120p; Urban&Civic: Buy at 286.5p, target 325p; Conygar: Buy at 172p, target 200p ('Hot property, 7 Jan 2015)
■ Somero Enterprises: Buy at 139p, target 185p; 1pm: Buy at 70p, target 82p; First Property: Run profits at 53p; Avation: Buy at 145p, target 200p ('Small-cap value plays', 11 Jan 2016)
■ 32Red: Run profits at 147p; Netplay TV: Buy at 7p ('Chipping in', 12 Jan 2016)
■ Cambria Automobiles: Buy at 87p, new target 95p; Vertu Motors: Buy at 76p, target range 85p to 90p ('Motoring ahead', 12 Jan 2016)
■ Global Energy Development: Hold at 24p ('Cash rich, but unloved', 12 Jan 2016)
■ KBC Advanced Technologies: Bank profits and sell in the market at 183p ('Tech watch, 13 Jan 2015)
■ Sanderson: Buy at 75p, target range 85p to 90p ('Tech watch, 13 Jan 2015)
■ Trakm8: Buy at 300p, new target 400p ('Tech watch, 13 Jan 2015)
■ Amino Technologies: Buy at 120p, new target range 155p to 160p ('Amino has the ammunition', 14 Jan 2015)
■ easyHotels: Buy at 89p, initial target 100p ('easyHotels ramps up expansion', 14 Jan 2015)
■ Stanley Gibbons: Hold at 58p ('Stanley Gibbons fundraise', 14 Jan 2015)
■ Miton: Buy at 28p, target 35p; Moss Bros: Buy at 97p, target 120p to 130p; Bioquell: Buy at 140p, minimum target 170p; UTV Media: Trading buy at 184p ('An awesome foursome', 18 Jan 2015)
■ Equity market strategy ('Bear Market signals', 25 Jan 2015)
■ STM: Buy at 47p, target 80p; Stadium: Trading buy at 103p; Fairpoint: Run profits at 150p, target range 200p to 220p ('Exploiting market anomalies', 1 Feb 2015)
■ Character: Buy at 505p, target 600p; 1pm: Buy at 67p, target 82p; and Entu: Hold at 68p ('A trio of small cap plays', 2 Feb 2016)
■ Inland: Buy at 83p; Henry Boot: Buy at 220p, target 260p; FTSE 350 housebuilding sector: Trading buy ('Playing the housing market', 3 Feb 2016)
■ Flowtech Fluidpower: Buy at 109p ('Undervalued and ripe for a re-rating', 4 Feb 2016)
■ Safestyle: Run profits at 253p ('Awaiting news on a cash return', 4 Feb 2016)
■ Bowleven; Volvere; French Connection; Bioquell; Juridica; Mind + Machines; Oakley Capital; Gresham House; Gresham House Strategic; Walker Crips ('Bargain shares', 4 Feb 2016)
■ AB Dynamics; Inspired Capital; H&T; Netplay TV; Mountview Estates; Crystal Amber; Arbuthnot Banking; Record; Pittards; Stanley Gibbons ('How the 2015 Bargain share portfolio fared', 4 Feb 2016)
■ IS Solutions: Buy at 120p, target 150p ('Big data, big profits', 8 February 2016)
■ 32Red: Run profits at 133p, easyHotel: Run profits at 99p; Burford Capital: Run profits at 230p; Bilby: Buy at 136.5p ('Hitting record highs', 9 February 2016)
■ BP Marsh & Partners : Buy at 157p, new target 190p ('Primed for investment gains', 10 February 2016)
■ Gama Aviation: Hold at 270p ('Gama hits guidance', 10 February 2016)
■ Bloomsbury Publishing: Buy at 150p, target range 175p to 185p ('Book into a trading play', 11 February 2016)
■ PV Crystalox Solar: Speculative buy at 8.2p ('Lights brighten at PV Crystalox Solar', 11 February 2016)
■ Alpha Real Trust: Buy at 80p, target 105p ('High yield property play', 15 February 2016)
■ LMS Capital: Buy at 68p; Leaf Clean Energy: Await news on Invenergy; Eurovestech: Sell at 7p ('Investment company watch', 16 February 2016)
■ GLI Finance: Buy at 31p ('GLI Finance review offers potential for gains', 17 February 2016)
■ Trifast: Buy at 112p, target 140p ('Engineered for a higher rating', 17 February 2016)
■ 600 Group: Sell at 10p ('600 Group warns', 17 February 2016)
■ Marwyn Value Investors: Buy at 190p ('Undervalued, cash rich investment, 18 February 2016)
■ Henry Boot: Buy at 220p; Moss Bros: Buy at 102p, target range 120p to 130p; Creston: Sell at 103p; Mind + Machines: Buy at 8.5p ('Changing places', 22 February 2016)
■ CareTech: By at 245p, target price 300p ('Asset backed, lowly rated property play', 23 February 2016)
■ WH Ireland: Buy at 90p, medium-term targte 120p ('WH Ireland hit by FCA fine', 23 February 2016)
■ Stanley Gibbons: Sell at 42p ('Stanley Gibbons rescue equity raise', 23 February 2016)
■ Simon Thompson's book Stock Picking for Profit can be purchased online at www.ypdbooks.com, or by telephoning YPDBooks on 01904 431 213 and is being sold through no other source. It is priced at £14.99, plus £2.95 postage and packaging. Simon has published an article outlining the content: 'Secrets to successful stockpicking
