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Morningstar | Ryman Continues to Ride on Momentum, NZD 13.00 FVE Unchanged

Transition of our coverage to a new analyst and an acceleration in fiscal 2019 build rate prompts a revision in our development and margin forecasts for narrow-moat Ryman Healthcare, but our fair value estimate of NZD 13.00 remains intact.

Ryman finished fiscal 2019 in line with consensus, with underlying earnings of NZD 227 million, or NZD 45 cents per share, up 11.5% on fiscal 2018. This was driven by increased development margins, particularly from Nellie Melba, Ryman’s second village in Melbourne. While resale volumes were flat from the pcp, only 1% of resale stock was available at year-end. Care occupancy in established villages remained above 97% during the year. We have lifted our underlying assumptions on the build rate as the firm acquires additional sites in Melbourne and New Zealand, and slightly lowered our forecast profit on resold independent living units, or ILUs. Our fair value estimate remains NZD 13.00 per share following higher volumes offsetting slower unit price inflation. At current prices, Ryman screens as undervalued. Our fiscal 2020 earnings forecast of NZD 51 cents per share, represents 12% earnings growth, a forward P/E of 26, and a distribution yield of 2%.

Underpinning our valuation is a gradual ratcheting up in the number of new ILUs and aged care beds the firm delivers each year. Ryman continued to impress, delivering a total of 757 new combined ILUs and care beds over fiscal 2019. Momentum should persist in the short- to medium term, with the firm guiding to 850-900 new combined units in fiscal 2020 and about 1,000 in fiscal 2021. A key highlight is the record-high land bank, capable of supporting the delivery of over 7,000 beds (2,900 in Victoria and 4,100 in New Zealand). The land bank should support an annual delivery of 1,550-1,750 units, assuming each project takes about four to five years from site purchase to completion.

Owing to favourable demographic trends, our forecasts project the delivery of about 890 units in fiscal 2020, 1,000 units in fiscal 2021 and thereafter an average of 1,630 per year through fiscal 2029.

The average resale gain for each unit in fiscal 2019 was NZD 124,500, down 4% on the NZD 130,000 a year prior. There are no surprises here, given generally weaker housing market conditions. Retirees typically use the proceeds from the sale of the family home as the primary funding source to enter a retirement village. Subdued house prices may lead to residents choosing to defer or cancel their plans to move into a retirement village, should they be unable to sell their homes at a desired price. Until we see a material improvement in housing conditions, our assumed growth in resales price averages 2.2% over the next five years. This will weigh on future resale gains.

Nevertheless, we remain optimistic about Ryman’s newly developed units, many of which are being sold at a far higher price point than legacy units. The average price for new units in fiscal 2019 was NZD 702,000, up 5% on NZD 670,000 in the prior year. This was mainly attributed to favourable pricing in Nellie Melba, Ryman’s second village in Melbourne. This, combined with benign construction cost pressures, has resulted in development margins edging up to 30%, compared with 19% on the pcp. We think Ryman’s increasing exposure to Melbourne bodes well for the firm because retirement living units there sell at higher margins than those in New Zealand. We forecast newly developed unit sales should grow by about 3% per year over the next five years.

We continue to see earnings growth ahead for Ryman, despite the current drop in house prices. Demographics in Australia and New Zealand remain supportive, with the number of individuals turning 75 (average entry age into a retirement village) set to increase materially by 30%-55% above that from 10 years ago. In addition, Ryman’s integrated model of combining retirement living and aged care on a single site differentiates itself from Australian operators who typically operate only in either aged care or retirement living. For example, residents in units will be automatically placed at the forefront for available aged care beds. It is common for the health of an elderly person to deteriorate, thus access to healthcare will become an increasing important factor in prospective residents’ housing decisions as they get older.

Ryman’s strong intangibles underpin its narrow moat and we do not see this at risk of being eroded. The deferred management fee, or DMF, charged by Ryman compares favourably to major competitors. It also enjoys a reputation for providing quality care for elderly residents after more than three decades of operations. We believe the nearly full occupancy in Ryman’s aged care facilities is a testament to its strong brand name, with these facilities reported to be operating at 97% occupancy. Further, there are only 69 retirement units available for resale from a portfolio of 6,878 units. This amounts to an uncontracted stock percentage of 1.0%, an improvement from 1.2% in September 2018.