Under the Radar has managed to profit from Australia’s ageing community by not following the trend and investing blindly in retirement villages. In contrast, our subscribers are making healthy profits. Find out how.
DON’T FOLLOW THE CROWD
Ever since I first entered the investment industry people have been spruiking about the money you can make from retirement villages due to the undeniable demand from the much publicised “ageing population”.
I must say, I have been fortunate not to buy into this argument where it comes to anything related to “bed funding”. The bellwether stocks in this sector have fallen an average of over 25% a year for the past three years, and they’ve been in freefall since the government announced a Royal Commission into the sector the past month. What the government can give, it can easily take away.
One of the features of the retirement industry has been a growing top line, but a cost base that climbs even faster. In the wake of the announcement of a Royal Commission, I noted how both brokers and the ASX listed companies themselves – Regis Healthcare (REG), Estia Health (EHE) and Japara Healthcare (JHC) – have said that that they expect the financial impact to be minimal and they are well positioned for growth. This strains credibility. Certainly, when you look at the steep falls in market valuations of these companies, investors aren’t buying it.
Management comments are based on the assumption that the government will pick up the tab of increased costs. This would be in the ball park of $3.6bn a year, reflecting an increased staff per bed cost of about 24 per cent if mandatory staff to resident ratios are imposed on the industry, as advocated by the nurse’s union, the ANMF. This is in a sector that currently only makes just over $2bn in annual earnings before interest, tax, depreciation and amortisation (EBITDA).
The economics don’t look good, but how can we as a society accept the need for mandatory staff ratios when it comes to our children, but not when it comes to our aged? Having volunteered for the Red Cross in the past at a nursing home, I’ve seen first hand how tough it is for stretched aged care workers to provide quality care.
RECOGNISING SUPERIOR BUSINESS MODELS
As an investor my aim is never to be in the position those people found themselves in, and I instinctively avoid areas whose business model is based on government funding. Being an investor I also recognise that there is big demand from Australia’s growing cohort of retirees. The good news is that long-term readers of this column will know that two stocks that I like are beneficiaries of this demand – the retirement communities providers Ingenia (INA) and Lifestyle (LIC). Both do not rely directly on government funding or on skilled labour as they do not operate nursing homes. They are targeting a less affluent market of downsizes.
For me, the key to Ingenia’s business model is the simplicity of the ownership structure, which gives owners more flexible terms than retirement villages do. The homeowner owns their own home but leases the land under a 90 year leasehold agreement. In a retirement village, the occupant often only has a licence giving them the right to occupy a home. The current weekly lease payment is $173 for a single and $200 for a couple and Ingenia home owners can also receive government rental assistance if they qualify.
LIFESTYLE VERSUS AVEO
Lifestyle is more easily compared to Aveo (AOG), which also owns and operates retirement communities, but both, unlike Ingenia, continue to operate a deferred management fee model, which is a kind of profit share model. However, Lifestyle’s ownership structure is much simpler than Aveo’s and similar to Ingenia’s.
The people who move into an Aveo village might pay $800,000 for a well-positioned apartment and then pay a deferred management fee of 35% of the value of that apartment upon exit.
In Lifestyle’s business model, in addition to paying the weekly fee, homeowners pay a deferred management fee when they sell their home of 4% of the sale price for each year of home ownership and is capped at 20%.
This deferred management fee component is quite complicated from an accounting perspective because the profit being booked relating to it is based on actuarial assumptions and are often very different from the cash flow outcome.
PREGNANT WITH DEFERRED MANAGEMENT FEES
Leaving this aside, Lifestyle is effectively pregnant with deferred management fees. If you only account for its home sites under management and homes awaiting settlement, and exclude those under construction and awaiting commencement, then you multiply this by the average resale price and assume its 20% deferred management fee, you get a figure well over $150m.
Just to remind you, Aveo was the subject of an ABC 4Corners’ investigation in which customers alleged the aggressive charging of extra-fees and overly complex contracts that were hard to get out of.
Both Ingenia and Lifestyle’s models are more straightforward, which suggests they will be less affected by anything thrown at the sector by the upcoming Royal Commission.