Budget Price Jolt Just A Speedbump In Japara's Journey
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With Australia experiencing, in common with many other developed countries, an ageing population, the aged care business is clearly one with good prospects. Aged care and retirement living is now a hot mini-sector on the stock market, as investors hone in on the companies that offer services to the estimated four million-plus Australians born between 1946 and 1961.
These are the notorious “Baby Boomers,” and not only are there big numbers of them, they are living longer, too. The combination of these factors means that Australia will see an historic surge in the proportion of the population aged 65 and over. The Australian Bureau of Statistics (ABS) estimates that the number of people aged 65 to 84 will almost double by 2031, and double again by 2045.
The implications for aged care are clear – the market has growth that is demographically locked-in. But the “grey tsunami” on the way is not anywhere near being matched by increasing supply. An extra 70,000 aged-care beds need to be created by 2020, says the industry, just to meet near-term growth.
The government has reacted by effectively deregulating prices to free up investment by operators in new beds, and changing the mix of payment between daily payments and refundable bonds. Providers are more free now to charge what they want, allowing for price differentiation based on levels of quality – and also geography – in exchange for them advertising their maximum bond on a government website, My Aged Care. The result of the changes, introduced in 2014, is that providers are investing in new beds.
This stimulus of funding has benefited the providers. Also, because aged care is a fragmented market – virtually a cottage industry, with a large number of small operators – the aged care companies have plenty of room to expand, through the combination of development and expansion of their portfolios, and acquisitions.
Japara Healthcare Limited (JHC) is a good case study. Japara listed in April 2014 after raising $450 million at $2 a share, which capitalised the company at $525 million. At that stage it had 3,131 places across 35 residential aged-care facilities, mainly in Victoria but also in New South Wales, South Australia and Tasmania.
Since its IPO, Japara has added 845 places and expanded its national presence, having bought the Whelan Care (November 2014) and Profke Aged Care Group (October 2015) businesses. Whelan Care came with 258 beds and 41 serviced apartments in South Australia, while Profke Aged Care brought to the portfolio four facilities, with 587 beds, in New South Wales and Queensland, expanding Japara into the Sunshine State for the first time. Japara now operates 43 residential aged care facilities and four retirement complexes throughout Victoria, Queensland, South Australia, New South Wales and Tasmania: its total number of places is now 4,750, with an average occupancy rate of 94 per cent.
Until recently, the stock market has been a big fan of Japara, as well as its peers Regis Aged Care and Estia Health. Japara shares rose to $3.40 by November 2015, but concerns started to develop that the government was considering changes to the core funding mechanism of aged care, the Aged Care Funding Instrument (AFCI). Given that the federal government pays up to 85 per cent of the cost of aged care in Australia, this was a worrying rumour, and it hit the trio’s share prices. Then, in May, these concerns were realised when the government proposed in the Budget to cut funding by about $20 a day per resident, and moreover, crack down on making sure that the appropriate AFCI payments were being made based on individual residents’ actual care needs – not the categorisation of the residents’ needs forwarded to it by the aged-care providers.
The result has been a fair bit of confusion among analysts as to what effect the decline in AFCI will have on each company – and to what extent the post-Budget pessimism was priced into the stocks. Japara, Estia and Regis were hit by a slew of earnings expectation downgrades in June – but not from all brokers. And overlaying the confusion was the fact that no-one argues against what are seen as the key drivers of the sector, namely an ageing population, that is living longer, and which will require increased health spending. For example, the number of Australians suffering from dementia is expected to rise from 316,000 in 2015 to 553,000 by 2020, and then to 943,000 by 2050. Aged-care service providers will bear the brunt of this.
Residential aged care is a significant and growing sector: it is an $18 billion market (revenue) at present. Japara says 82,000 additional places are required over the next decade, which will require investment of more than $33 billion. In both its greenfield (new facilities) and brownfield (refurbished and expanded existing facilities) it has 900 new beds in the pipeline.
Having taken a hit from the expectation – and then the reality – of regulatory and funding changes, Japara is now priced at $2.64, which gives it a market capitalisation of $696 million. It has an extensive pipeline of both greenfield and brownfield projects that will boost profit over the medium term future.
For the December 2016 half-year, revenue grew by 13.4 per cent to $155.9 million, net profit was up 2.5 per cent to $16.2 million and the interim dividend was lifted by 0.25 cents (4.5 per cent) to 5.75 cents, fully franked (the interim dividend for the December 2015 half was unfranked.)
On Thomson Reuters’ analysts’ consensus numbers, Japara is expected to lift earnings per share (EPS) by 11.7 per cent in FY16, to 12.1 cents, and boost this by a similar proportion in FY17, to 13.5 cents.
Analysts’ consensus has Japara trading at 21.8 times expected FY16 earnings, and 19.5 times expected FY17 earnings. On a dividend yield basis, the price implies a fully franked FY16 dividend yield of 4.55 per cent, and 5.01 per cent for FY17, which equate to grossed-up yields of 6.51 per cent and 7.16 per cent respectively. As the dust settles on the Budget changes, the analysts’ consensus price target of $2.89 implies upside of 9.5 per cent. On these numbers, and the prospects that appear to be in place for the growth of its business, a case for buying Japara is easily made.
James was founding editor of Shares magazine, and oversaw one of the most successful magazine launches in Australia. He has also written for BRW, Personal Investor, The Age and Management Today, and was subsequently personal investment editor at The Australian and editor of financial website, investorweb.com.au