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Morningstar | Increased Confidence in Ryman's Development Prospects Prompts FVE Update to NZD 13.60

We have a more upbeat assessment of long-term growth prospects for narrow-moat-rated Ryman Healthcare and have upgraded our fair value estimate to NZD 13.60 from NZD 11.30. Our upgrade follows a revisit of industry drivers for the broader Australian and New Zealand retirement living and aged care sectors. The biggest upgrade relates to the outlook for Ryman's Australian operations, where the firm has just delivered the first phase of its second village, its largest to date, the 580 bed Nellie Melba in Brandon Park. At the recent annual general meeting, management advised Ryman has acquired it eighth Melbourne site in Aberfelde, has received planning approval for its 400 bed Burwood development, and is on track to have five villages open in Victoria by the end of 2020.

Collectively the revisions--a mix of positive and negative--result in a faster medium-term growth outlook, with our five-year earnings compound annual growth rate increased to 13% from 8%. This is below Ryman's average earnings growth of 15.2% for the past five years, but nonetheless exceptionally strong, underpinned by very favourable demographic trends. In five years, the number of units required by the market, will be circa 45% above the current requirement, a five-year CAGR of 7%.

Ryman's standard village template provides a continuum of care to residents, combining retirement living units and aged care on a single site. These combined facilities are common in New Zealand but rare in Australia. Due to the high customer amenity of integrated retirement living and aged care, we foresee robust demand for the villages in Ryman's pipeline in Melbourne and surrounds. Ryman opened its first Melbourne village in 2014, its second in mid-2018 and has a further six in various stages of planning and development.

The first major revision to our outlook is an upgraded delivery assumption of retirement living units and aged care beds. The rationale being an escalation in the number of Ryman development sites in the Melbourne area plus recent planning success at points to a shortening of the expected time it takes for Ryman's Australian development team to progress sites through permitting, as the team becomes more familiar with the local planning environment. Ryman’s Nellie Melba site took nearly three years to achieve planning approval, but approval for Coburg took 1.6 years and Geelong looks set to be approved in a similar timeframe. Combined, these result in a faster rate of deliveries in Melbourne and by extension a steeper growth rate in the income generating asset base. Ryman's portfolio of 17 development sites underpins our forecast for delivery run-rate of 1,460 in 2022 (30% above our prior forecast of 1,100), being the sum of new retirement units and care beds. We forecast the rate of delivery to then grow around 2% annually thereafter.

The second major revision is an increase in the expected number of units resold annually going forward to better account for the three to seven year lag between when new units are delivered and when they become income-generating. Our new forecast resales in fiscal 2021 are 5% higher than prior forecasts. Ryman has stepped up the number of units it has delivered in recent years, but given resident stays for serviced apartments, or SAs, and individual living units, or ILUs, average 3.5 and 7 years, respectively, it has yet to generate deferred management fee income from these additions to the asset base.

The third revision is an increase in the average price for new retirement units being developed and subsequently resold in account for the increased delivery volume in Melbourne, a market where unit prices are markedly above those in New Zealand (excluding Auckland), where Ryman’s business has historically concentrated. Four, the expected EBITDA per care facility has been increased to reflect the gradual reweighting of the portfolio to Melbourne, where the EBITDA per care bed is 20-30% above that in New Zealand.

Finally, we've reduced the expected inflation in prices for individual living units and serviced apartments for the decade to 2028, being our explicit forecast period. ILU and SA prices follow dwelling prices, and our view is that dwelling prices are extremely elevated relative to incomes. We expect negligible growth in dwelling prices and by extension retirement unit stock for an extended period. Our central scenario is retirement unit prices trend sideways for five years then appreciate by 2% annually thereafter.