When care home owner CareTech (CTH) first confirmed its intention to buy its only listed peer, Cambian, in an attempt to broaden its geographic spread and double the number of homes under its control, we were concerned. The initial cash-and-shares offer was generous and Cambian was only just emerging from a period of intense margin erosion.
History of making good acquisitionsl
Market-leading staff recruitment and quality ratings
Good cash generation
Well-covered dividend
Government care funding issues
Elevated net debt
But since then, we have been given several reasons to back-track on our initial hesitancy. For a start, CareTech managed to negotiate a better deal than originally expected and ended up paying just £372m, split half and half between cash and 33.2m new shares. The group refinanced its £322m debt facility and has put a £25m short-term facility in place. Based on forecasts from broker Panmure Gordon, following completion of the deal last month, net debt is expected to stand at £328m, equivalent to 4.5 times forecast 2019 adjusted cash profits (Ebitda). However, management “remains committed to maintain leverage” at between three and four times Ebitda and the company is expected to be comfortably within that range by September 2021. Meanwhile, following a revaluation of the combined property portfolios at £774m, the loan-to-value ratio stands at 43 per cent.
Key to making a success of the Cambian acquisition is improving operating performance. There were some green shoots at the time of Cambian's half-year results, with Ebitda margins rising to 11.2 per cent from 8.3 per cent. Revenues also ticked up slightly.
CareTech has impressive credentials as a care home operator. It has a good track record in negotiating higher fees from local authorities – an important consideration when rising wages have increased costs. It helps that it boasts a strong track record with quality commissioners, with the proportion of outstanding and good ratings rising to 82 per cent in 2018, from 79 per cent. The group also has better staff retention than many peers, which has helped support margins. Indeed, post-tax profit margins of 14.7 per cent compare with an industry average of 9.2 per cent.
True, taking on the challenge of improving Cambian will initially mean a profitability hit for the combined group, with Panmure forecasting that operating margins will drop from 21.0 per cent in 2018 to 15.3 per cent in 2019. However, with the help of expected annual synergies of £6m, the broker believes the enlarged group's operating margins will get back to 18.6 per cent by 2021. This should drive rapid earnings growth, with a forecast compound annual earnings per share (EPS) growth rate of 23.5 per cent over the two years.
The deal makes the new larger group the third-largest care home owner in the UK and CareTech’s reach will be extended in the south-west and north-east, while it will also now have enhanced its offering in children’s specialist care, where demand in the UK continues to rise. But still the group’s 435 homes only account for a low single-digit percentage of the UK care home market, meaning there remains plenty of scope for further consolidation. CareTech’s cash generation – operating cash conversion is expected to average 117 per cent between 2018 and 2021 – means it has the ability to consider further acquisitions and still pay a decent dividend.
CARETECH (CTH) | ||||
ORD PRICE: | 367p | MARKET VALUE: | £400m | |
TOUCH: | 367-370p | 12-MONTH HIGH: | 442p | 340p |
FORWARD DIVIDEND YIELD: | 2.8% | FORWARD PE RATIO: | 10 | |
NET ASSET VALUE: | 52p* | NET DEBT: | 71%* |
Year to 30 Sep | Turnover (£m) | Pre-tax profit (£m) | Earnings per share (p) | Dividend per share (p) |
2015 | 124 | 22.0 | 31.6 | 8.4 |
2016 | 149 | 26.2 | 38.4 | 9.2 |
2017 | 166 | 29.4 | 38.0 | 9.9 |
2018** | 178 | 32.2 | 34.5 | 10.0 |
2019** | 389 | 50.5 | 37.6 | 10.2 |
% change | +119 | +57 | +9 | +2 |
NMS: | 5,000 | |||
BETA: | 0.63 | |||
*Pre-merger numbers, includes intangible assets of £83.4m, or 77p a share | ||||
**Broker Panmure Gordon estimates, adjusted PTP and EPS |