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Morningstar | Aveo’s Potential Takeover Overshadows Soft 1H Result. FVE Falls 9% to AUD 2.10

Aveo reported first-half fiscal 2019 underlying profit of AUD 12 million compared with AUD 36 million in the previous corresponding period, or pcp. Development was the major detractor, with earnings falling by AUD 10 million and profits booked from the divestment of noncore assets falling AUD 20 million.

In many respects, the first-half 2019 financial result is a mere side-show, overshadowed by a potential part or even full sale of the business being progressed by Aveo’s investment bankers. Indicative and nonbinding offers were received from multiple parties during January and a more detailed due diligence is expected to take a few months given the complexity of assessing 93 Australian villages, five U.S. villages, a development pipeline of over 5,000 units, plus five aged care facilities. Management wouldn’t comment on specifics other than to advise there is interest from Australian and international investors. At this point, the most logical outcome is for an investor to make an offer to acquire the entire business via a scheme of arrangement. There is no guarantee a transaction will arise given the considerable uncertainty around long-term cash generation prospects of existing assets and pipeline initiatives. This is amply illustrated by Aveo’s share price sitting at less than 50% of the firm's net tangible asset backing of AUD 3.83 per share. The interplay intentions of major shareholder Mulpha International, which has a 24.4% stake--and growing--add further complexity to a potential transaction.

We’ve further cut our medium-term sales earnings and distribution expectations, incorporating the softer housing market. We’ve trimmed expectations for deferred management fees for outgoing residents. Our fair value estimate for no-moat-rated Aveo declines to AUD 2.10 from AUD 2.30. The firm continues to screen as undervalued, currently trading around AUD 1.75.

The target to sell 1,150 new and used units for fiscal 2019 was reiterated. But even with the seasonally stronger second half, this looks unachievable given there were only 332 settlements in the first half. According to management, the retirement living industry is at a cyclical low, with Sydney particularly soft. Customer surveys point to stable demand, but elderly residents are deferring settlement due to a reluctance to sell their dwellings (that in most instances comprise the bulk of their saving) in a weak housing market.

Against the backdrop of weak sales, we take some comfort in commentary from Aveo CEO Geoff Grady that potential acquirers are far more focused on long-term demographic trends and largely overlook the recent downturn in the Australian housing market. A further insightful quip is; “People don’t stop ageing. The underlying demand is there, it’s simply a matter of being persistent”.

Management didn’t provide earnings guidance for fiscal 2019 due to uncertainty around margins and volumes of settlements on legacy units. Aveo also couldn’t commit to a figure for the number of units it will delivery in fiscal 2020 due to uncertainty around sales and levels of unsold stock. Further, it currently seems to be more value accretive to buy-back than add to the current base of unsold inventory. We now forecast an approximate 50% decline in fiscal 2019 underlying profit after tax to AUD 64 million or AUD 11 cents per security, or cps. We forecast distributions of AUD 5.0 cps, implying a 45% payout ratio.

Aveo’s statutory result was a loss of AUD 45 million, mostly due to a AUD 87 million or 4.3% non-cash write-down in the carrying value of its retirement units. Aveo has taken a marginally less aggressive view on the value of its AUD 1.9 billion retirement portfolio, which is now premised on long-term property price growth of 3.95% from 4.25% previously.