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Uncertainty Grips Estia Health

Australia | Oct 07 2016

This story features ESTIA HEALTH LIMITED. For more info SHARE ANALYSIS: EHE

Aged care provider Estia Health has downgraded FY17 guidance and flagged the potential divestment of non-core assets. Brokers remain cautious about the sector.

-Guidance downgrade stems from lower growth rates in occupancy, higher non-labour expense
-Brokers diverge over amount of risk that remains on the balance sheet
-Uncertainty prevails over federal government's planned cuts to funding


By Eva Brocklehurst

Estia Health ((EHE)) has appraised the market of its intention to review options around several non-core assets while re-setting its FY17 guidance lower. Brokers are cautious about the aged care sector as a whole, given the federal government flagged a tightening of regulation in its budget and there is substantial development work entailed.

No operator as yet has provided an assessment of the expected earnings impact from the federal government's proposed cuts to its funding instrument, expected to affect earnings in FY18-19. The government is reviewing the current funding environment, with potential policy changes expected in late 2017.

Estia has downgraded its FY17 EBITDA (earnings before interest, tax, depreciation and amortisation) forecast by 15-20% from guidance released back in August. Now guidance is $86-90m, the downgrade stemming from lower growth rates in occupancy and higher non-labour expenses versus budget. The asset replacement contribution fee has been axed and $15m in shares will be offered to the Kennedy family under the dividend reinvestment plan, providing proceeds for working capital.

Moelis observes management remains reticent about quantifying the earnings impact from government funding changes. The broker reduces earnings per share estimates by 25% for FY17 and 13% for FY18. The company has a substantial debt load and Moelis is wary of the risks in integrating the $700m or more in acquisitions since 2015. The broker, not one of the eight monitored daily on the FNArena database, maintains a Hold rating and $3.01 target.

Projections for growth have been re-set to what appear to UBS to be very conservative levels. The company is reviewing its costs and ways to mitigate the government funding cuts and UBS believes a new base has been set, with high conviction regarding this being achieved. Moreover, the broker believes management has now passed the most difficult period in terms of cash flow and balance sheet risk.

UBS reduces estimates to align with the new guidance but continues to believe around 11.2% as a 3-year forward compound growth rate is plausible. UBS does not believe there is substantial financial risk associated with the refundable accommodation deposits (RAD) as, while government changes to the framework in July 2014 caused some movement in resident preference, subsequently the mix has settled. The broker doubts shifts in resident preferences will cause risks to the balance sheet.

UBS asserts that the market should be thinking about the growth opportunity in aged care in terms of internal rates of return (IRR), which are far more instructive as a measure of value. This, in the broker's view, suggests that acquisitions provide better shareholder value versus developments in terms of non-organic growth.

The strategic review has already identified several non-core assets that may be divested to reduce costs. Macquarie suggests this strategy could include underperforming facilities which do not fit into the network and/or a number of greenfield sites which appear to have been shelved. The broker also warns that this review could result in future write-downs, with around $715m in goodwill likely to be scrutinised.

Along with the additional money from the Kennedy family, the company should have around $70m in working capital to fund requirements and upcoming dividend payments. The broker notes that based on the revised guidance and updated debt levels, net debt to EBITDA (ex bonds) will likely exceed 3.5 times in FY17.

Despite the guidance downgrade, Macquarie believes the company is heading in the right direction as it re-sets expectations and cleans up some of its accounting practices. Still, with uncertainty prevailing over government funding the broker sticks with a Neutral rating.

Morgan Stanley has decided the guidance re-set and lack of certainty is a case to downgrade the stock to Underweight. A lower sustainable margin and less ability in the balance sheet to cope with regulatory changes underpin the downgrade.

The database has one Buy, one Hold and one Sell for Estia Health. The dividend yield on FY17 and FY18 forecasts is 7.5% and 6.7% respectively.

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