Small Caps | Dec 20 2017
Challenging conditions continue for Japara Healthcare, which has flagged a weak first half, and lower FY18 guidance, in the wake of a severe flu season that has affected occupancy.
-May be harder for Japara Healthcare to recover from a tough FY18 vs peers
-Lower level of leverage vs peers an advantage
-Two brownfield completions slip into first half of FY19
By Eva Brocklehurst
Aged care operator Japara Healthcare's ((JHC)) earnings have succumbed to the flu and FY18 operating earnings (EBITDA) guidance is now downgraded by -5-10%. This implies an updated earnings range of $54.2-57.2m. First half operating earnings are expected to be -15-17% below the prior corresponding half.
Management has blamed a severe flu season as a key driver of the downgrade, which UBS finds curious given the company reiterated guidance as recently as a month ago. The broker had always suspected that the swing required in the second half to hit the lower end of guidance was a stretch and this has now materialised.
Morgan Stanley also points out that there was no mention of an impact on expectations from a severe flu season at the AGMs of either of the company's key competitors. The broker believes cost reductions and additional services may be harder for Japara Healthcare to deliver compared with peers, and the recovery from a tough FY18 will be less pronounced than the share price implies. Hence, the broker retains a Underweight rating.
Morgan Stanley also suggests the poor occupancy and continued margin pressure raises questions about the quality of the portfolio. This exacerbates a first half where two wage increases are annualising from last year.
Occupancy
An extended outbreak of influenza across south-eastern Australia affected occupancy in the aged care sector. Japara's occupancy fell to 91.7% as of the end of September versus 94.2% of the end of June.
Following the trading update, Morgans revises profit forecasts down by -11.9% for FY18 and by -2.0% and 2.1% for FY19 and FY20 respectively. The broker assumes a decrease in occupancy to 93.0% from 94.4% in FY18.
Operating uncertainty is likely to continue to weigh on the stock, in the broker's opinion. Uncertainty surrounding funding cuts, however, is now factored into the share price. The downside risk involves an inability to pass additional costs onto residents while the upside risk centres on the attractive acquisition potential that is emerging.
Macquarie had already reduced its assumed occupancy to 93.3% from 94.5% at the time of the AGM, as the company had indicated the influenza outbreak was greater than usual in terms of duration and the number of people affected.
The broker also defends the sudden downgrade, noting AGM commentary had stated that flu incidents abated in October and occupancy levels had started to increase, although with the benefit of hindsight this optimism appears misplaced.
Macquarie finds the company has a significantly lower level of leverage, in terms of bank and refundable accommodation deposits (RADs), than its peers and this is attractive, given the current regulatory uncertainty. The stock is viewed trading at attractive multiples versus peers and the broker retains a Outperform rating.
UBS suggests the market should be factoring in the organic growth in the aged care sector – for the same site and optimised facility – in the low single digits. The sector is not consolidated and demographic-driven demand is healthy, so more substantial growth can be expected from acquisitions or developments, supported by RAD inflows.
Still, the broker notes the execution risk on the company's extensive development pipeline, with two brownfield projects slipping from the second half to completion in the first half of FY19.
FNArena's database shows one Buy (Macquarie), two Hold and one Sell (Morgan Stanley). The consensus target is $1.95, signalling -2.8% downside to the last share price. The dividend yield on FY18 and FY19 forecasts is 5.0% and 5.7% respectively.
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