- The pandemic has put care operators under increased strain, heightening risk for senior living landlords
- Target Healthcare’s rent collection has remained resilient throughout the crisis
- The target dividend for 2021 has been increased to 6.72p a share, resulting in the shares offering a healthy yield
Inflation-linked rental income
Rising asset values
Generous dividend payments
Financial strain on care operators
Dividend uncovered by earnings
The Covid-19 pandemic has arguably tested the mettle of the care sector like never before. In addition to the human tragedy that developed in homes, care operators have been placed under heightened financial strain as lockdown restrictions reduced occupancy levels. That has presented increased challenges for the specialist real estate investment trusts (Reits) that lease facilities to these operators. However, with staff and residents at every eligible care home across England – and most of those in Wales and Scotland – having now been offered the coronavirus vaccine, there is hope that the worst is behind the sector.
Investor sentiment towards senior living Reits has strengthened further since plans for the vaccine rollout were announced in November. Nevertheless, shares in the sector’s largest Reit, Target Healthcare (THRL), still trade at a marginal discount to forecast book value over the next 12 months. There should be potential for the shares to rerate further, given improving enquiry levels reported by tenants, financial firepower to continue expanding the portfolio, an attractive dividend and the premium to NAV the shares traded at prior to the pandemic.
Managing the pandemic
Target Healthcare acquires and operates care homes across the UK, renting properties on inflation-linked, 20-year-plus leases to 27 private care operators. It targets the premium end of the market, providing modern care homes with en-suite wet-room facilities in 95 per cent of rooms. Its tenants’ aggregate revenue sources are 66 per cent from privately-paid fees and the remainder from the government.
Costs associated with managing the spread of the virus, including the provision of personal protective equipment and reduced occupancy have placed increased financial strain on care operators across the sector. For Target Healthcare, restrictions around admissions and care home visits during lockdown have resulted in a decline in occupancy rates for the Reit’s tenants. At the end of September, the occupancy rate had declined to 85 per cent, compared with90 per cent at the end of 2019.
The Reit made £2.1m in provisions relating to arrears from two tenants during the 12 months to June. Those provisions, combined with a pause in acquisitions from March to June, resulted in a 3 per cent decline in adjusted EPRA EPS. However, progress has since been made in replacing one tenant operating two homes, while occupancy is improving at the two, less mature, homes operated by the other tenant.
Rent cover was maintained at a multiple of 1.6 over the 12 months to June, slightly above a three-year average multiple of 1.5. Overall rent collection has remained resilient – 94 per cent of rent due between 11 March – when Covid-19 was declared a global pandemic by the World Health Organisation – and the end of 2020 was collected.
Yet it seems likely that there will continue to be a shortfall in rent collection in March, following the latest national lockdown. Ahead of the formal tenant performance figures for December being received, management said it expects to see a decline in underlying occupancy and profitability due to the ongoing restrictions. That could lead to further requests for rent concessions. One tenant, representing 4 per cent of the group’s total rent, has already requested a rental deferral for the next quarterly payment.
Is the worst over?
The prevalence of the virus in homes owned by Target Healthcare has subsided. At the start of February, there were confirmed coronavirus cases in 2.1 per cent of total portfolio beds across 11 care homes, down from an April peak of 3.2 per cent suspected or confirmed cases across 32 care homes.
The successful roll-out of the vaccine has provided fresh hope that the prevalence of the virus will be quashed further. By the start of February, vaccinations had been made available to residents and staff in all of the group’s care homes, with substantial uptake across both groups. This should allow for increased admissions and, eventually, safer visits and a greater variety of social activities for residents to resume, ultimately enabling occupancy recovery. According to the Reit’s investment adviser, a number of tenants have recently reported high levels of enquiries, with one of the Reit’s largest tenants experiencing record levels of new enquiries in January.
Part of the driving force behind rental income growth comes from upward-only contractual rent reviews, which pushed like-for-like rental income up 1.5 per cent during the 12 months to June. Expanding the portfolio through acquisitions and developments provides another opportunity to boost rental income. During the same year, newly acquired or completed homes contributed the lion’s share of the 29 per cent in annual rental growth.
In February, the group raised gross proceeds of £60m via a share placing at 111p to help fund acquisitions. The issue size was increased from £50m thanks to sufficient investor interest. The capital will be put towards funding an already identified pipeline of acquisitions worth £224m.
Management has signalled that it will return to the market to fund acquisitions this year. However, this also brings with it the prospect of further dilution of existing shareholders. Following the February fundraising, the Reit intends to implement a placing programme to enable the group to raise additional equity capital through the issue of up to 150m new shares in the 12-month period from 4 March 2021 to 11 February 2022. That is equivalent to almost a third of the shares currently in issue.
Prior to the recent share placing, the balance sheet was in robust shape. The loan-to-value ratio stood at 22 per cent and it had £76m in cash and undrawn debt facilities. During the final quarter of last year, the terms of two debt facilities were extended, increasing the weighted average term to expiry to 5.3 years, from four years at the end of September.
Can healthy dividends continue?
The target annual dividend for the 2021 financial year, which is paid in quarterly instalments, stands at 6.72p a share, up from 6.68p for 2020. At the current share price, that equates to a potential yield of just over 6 per cent. However, the security of those payments has become less certain following the pandemic.
Provisions for rent arrears made during the last financial year meant coverage of the dividend by EPRA earnings dropped to 76 per cent, down on 82 per cent during the prior two years. However, if occupancy levels recover as we emerge from lockdown, then there is every chance that dividend cover will improve.
Over the longer term, there is reason to be bullish towards the shares. The value of the assets in Target Healthcare’s portfolio have continued to rise, which, together with annual contracted rent increases, have resulted in the Reit’s net asset value (NAV) moving marginally upwards to around 108p a share at the end of December. Demographic changes are also supportive of increased need for elderly care accommodation, with the number of people aged 85-plus forecast to double over the next 20 years, according to the Office for National Statistics.
The shares trade broadly in line with forecast NAV at the end of June and at a5 per cent discount to a forecast 117p at the same time in 2022. That seems an undemanding valuation when the strength of the balance sheet, strong rental growth track record and rising asset valuations are considered. Indeed, in the year prior to the pandemic the shares commanded an average premium to forecast next-12-month NAV of 4 per cent.
Last IC view: Buy, 105p, 21 Apr 2020
|TARGET HEALTHCARE REIT (THRL)|
|ORD PRICE:||111p||MARKET VALUE:||£508m|
|TOUCH:||111-111.4p||12-MONTH HIGH:||121p||LOW: 66p|
|FORWARD DIVIDEND YIELD:||6.2%||TRADING PROPERTIES:||£7.5m|
|FORWARD DISCOUNT TO NAV:||5%||NET DEBT:||23%|
|Year to 30 Jun||Net asset value (p)||Pre-tax profit (£m)||Earnings per share (p)||Dividend per share (p)|
|Normal market size:|
|*Berenberg forecasts, adjusted NAV, PTP and EPS figures|