Treasure Chest: Aveo Group’s Retreat Presents Opportunity

This story features STOCKLAND. For more info SHARE ANALYSIS: SGP

By Eva Brocklehurst

Aged care services provider Aveo Group ((AOG)) is trading at a discount to its aged care and New Zealand peers, yet does not carry the same regulatory risk. Hence, Morgans considers this discount is undeserved.

The stock has recently slipped around 10% from its highs and the broker considers it is timely to accumulate exposure to its preferred retirement stock, upgrading to Add from Hold. A very strong FY16 result is expected, underscored by strength in both the residential retirement business and the non-core land bank. The broker believes there is risk to the upside if momentum in non-retirement sales and/or margins continues.

Brokers are mindful substantial cash from the sales of non-core business can be recycled into retirement developments and boost earnings. The stock is expected to meet its FY16 retirement returns target of 6.0-6.5%. Moreover, in FY17, further growth will be underpinned by the realised benefits from the Freedom acquisition. Morgans believes this should provide at least 6% earnings growth in FY17 and FY18 and contribute to the company growing its retirement returns to 8% by FY18.

The company has recently been able to increase its interest in unlisted Retirement Villages Group (RVG) via the buy-out of a number of minorities at a 20% discount to the current book value, with the consideration funded through its debt facility. Morgans calculates the acquisition of the remainder – 27% – would cost $100m and gearing would rise above the top of the target range.

The broker assumes the acquisition of the remainder would be earnings neutral, given the probability of an equity requirement. Unless the company decides to take gearing to a higher level.

Macquarie has noted that strong cash generated from the sell-down of the non-retirement developments should mean debt levels decline. The recent acquisition of the RVG minorities is modestly positive, in the broker's view, as the earnings yield acquired is greater than current interest rates. It also allows Aveo to take greater control of the business. Brokers expect the remaining investors will sell out in time.

Morgans envisages upside to RVG's valuation in coming years, with not only a revaluation of the book but also a roll out of the Aveo Way contracts across the portfolio. In the meantime, for Aveo, key catalysts to its valuation include the realisation of benefits from better quality contracts, an increase in new development sales and the expansion of care services.

Morgan Stanley has also stated a preference for Aveo Group, citing the success gleaned in New Zealand with its retirement model. The implementation of the Aveo Way strategy in Australia is expected to drive higher turnover and lower risk. Furthermore, Stockland ((SGP)) is expected to emulate the Aveo Way contract at generic villages, which involves a higher fee for certainty and an automatic buying back of the home. The broker expects higher returns for Aveo over the long term if this contract becomes the norm, although this is not a base case.

What is Aveo Way? The recently launched contract simplifies the financial model that prospective residents have to deal with when joining a retirement village. When the resident leaves the village the home is sold by Aveo and no marketing or refurbishment costs are required to be contributed in the process. There is also no capital gain or loss provided on the sale. Sales of homes are guaranteed within six months.

Aveo claims the contract is fairer and works for both the company and the residents. The company expects its financial model will be embraced over time by the sector and will reduce the negative perceptions surrounding village contracts.

There are three Buy and one Hold (Ord Minnett) ratings on FNArena's database. The consensus target is $3.72, suggesting 18.5% upside to the last share price. Targets range from $3.11 (Ord Minnett) to $4.35 (Macquarie).

See also, Anxiety Grows Over Planned Cuts To Aged Care Funding on June 8 2016.
 

Find out why FNArena subscribers like the service so much: "Your Feedback (Thank You)" – Warning this story contains unashamedly positive feedback on the service provided.

Click to view our Glossary of Financial Terms