Estia Health is beset by uncertainty surrounding the sustainability of earnings and this is not expected to moderate in the near term.
-Raising $136.8m in equity via non-renounceable entitlement offer to re-pay corporate debt
-UBS envisages growth opportunity from acquisitions provides better shareholder value
-Declining trend in RAD may put pressure on capital to fund growth
By Eva Brocklehurst
Estia Health ((EHE)) is beset by uncertainty surrounding the sustainability of earnings. The company has a poor track record in setting guidance, in Morgan Stanley's opinion, and there is a risk of further blow-out in costs associated with integrating acquisitions. There is also no full-time chief financial officer.
The company is raising $136.8m in equity to pay its corporate debt. A fully underwritten 1-for-3 accelerated, non-renounceable entitlement offer will be made at a fixed price of $2.10 a share, a 21.6% discount to the last closing price. Net debt will then reduce to $143m from $274m.
Morgan Stanley welcomes the capital raising, as it believes aged care operators should maintain low corporate debt in order to meet net outflows for refundable accommodation deposits (RAD). The equity raising has reduced balance sheet risk but also diluted earnings per share by 17.4%, in the broker's estimates.
Uncertainty overhangs the stock, given regulatory changes mooted for FY18. Morgan Stanley struggles to offset the revenue impact emanating from the recent changes to the government's aged care funding instrument (ACFI).
The broker also expected more from the strategic review, given a poor performance from assets recently acquired, and wanted a detailed update on why returns will improve and what capital expenditure is also required.
While FY17 guidance is reiterated for earnings of $86-90m, a strong skew to the second half is necessary. The broker wants more evidence of operational improvements in order to become more positive and maintains an Underweight rating and $2.10 target.
The company's presentation outlined more detail on the transition from RAD to daily accommodation payments (DAP) and combinations. Over the three months to October 31, the mix had shifted in favour of DAP. The company stated that the weighted average paying resident mix was 45% RAD and 55% DAP.
Morgan Stanley was surprised at the magnitude of the shift and believes this poses a substantial risk, finding it difficult to envisage how the company can maintain a net RAD inflow. The company has identified an increase in average deposit prices and deposits on new places as countering the cash flow impact.
Dividends have been suspended for the first half and after that the company will target 70% of net profit as the pay-out ratio. The company has replaced its operational matrix structure with a regional structure. A number of significant refurbishment opportunities were identified, as well as an initial nine non-core assets suitable for sale in the short term.
UBS believes the company has taken a conservative stance to ensure its balance sheet adequately provides for its operational objectives. The broker doubts there is any absolute issue to warrant the capital raising, as trading in the year to date remains in line with guidance and there is good net RAD inflow.
The broker's FY18 earnings per share estimates fall 16.6% after the issuance. Average occupancy rates for the year ending November 2016 are at 93.1%, down on FY16's 94.4% because of a slower transition in newly acquired homes. Actual occupancy at the end of November was 92.8% and this is expected to increase because of new initiatives.
UBS retains a Buy rating and believes that residential aged care is unclouded by balance-sheet concerns and the stock price should revert towards peers.
The market should be thinking about the growth opportunity in aged care in terms of acquisitions as in the broker's opinion, based on an internal rate of return measure, these provide better shareholder value. Traditional returns on invested capital (ROIC) measures do not account for the cash flow timing differences between strategies.
Under the government's previous intentions with ACFI and given the top ten operators are disproportionately providing complex care, UBS notes they were over-represented in the proposed reductions, whereas indexation now has the effect of distributing the cuts more broadly across the sector.
CLSA believes second half FY17 occupancy will need to be above 94.6% to achieve underlying earnings guidance, which may be a bit of a stretch as the company has not delivered this percentage in the past.
The broker, not one of the eight stockbrokers monitored daily on the FNArena database, retains a Sell rating and reduces its target to $1.90, while earnings per share estimates are cut by 12% for FY17 and by 17.9% for FY18.
Shaw and Partners believes there are still ongoing funding issues which pose concerns, as well as liquidity issues. The main concern regarding the company's development plans is the trend of incoming residents not choosing to pay a RAD.
If this trend continues, the broker suspects it likely that Estia Health will be unable to to sustain the growth capital expenditure required over the next 24 months. Therefore further debt will have to be drawn down from the current debt facility.
The broker suspects ongoing uncertainty regarding the funding structure of the sector will continue to put pressure on share prices and advises investors to be cautious. Shaw and Partners, also not one of the eight monitored daily on the FNArena database, has a Hold rating and a $3.50 target.
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