FY22 results. The result saw depressed earnings (largely expected) due to the ongoing impacts of COVID-19. EBITDA fell -39% to A$38m due to -A$50m in COVID-19 costs. Most of these costs however are yet to be recovered through government grants (A$29m).
Occupancy improved over the year suggesting pandemic influences are easing. Government revenue per occupied bed day increased ahead of employee costs per bed (on an ex-COVID basis). This is expected to offset wage pressures into FY23E.
The group is moving ever closer to regulatory and financial clarity with Australian National Aged Care Classification (AN-ACC) funding, Star ratings, Care minute legislation and Fair Work Commission (FWC) wage considerations finalising over the next 6 months. These regulatory issues have been overshadowing Estia’s earnings outlook. Therefore, by gaining regulatory clarification we have a better indication of the business’s outlook. Expectations are that the initial AN-ACC subsidy will be in-line with the sector average ($225 per day) which we expect will provide ~$12 per day uplift in government funding for FY23E.
Upcoming pricing discussions. The Independent Health and Aged Care Pricing Authority (IHACPA) will commence providing the government with pricing recommendations from 1H24 which will have implications for EHE and the sector. EHE expects this new framework to provide ongoing funding levels that better reflect sector cost inflation.
Care time regulation changes. The Australian Government has mandated that care providers are required to meet a mandatory care time standard of 200 minutes for each resident. This will come into effect from October 2023 and is expected to lift to 215 minutes from late 2024. The staffing implications of this decision and the FWC’s award wage finalisation will clarify the underlying impacts. Nevertheless, we are still some time away so for now we must await greater clarity.
Valuation Metrics. Fwd P/E of 15x, EV/EBITDA of 5.6x, FCF of 5.5%. The Dividend Yield is 5.1% representing an FY23 DPS of 10.4cps (70-100% target pay-out ratio). EHE is currently trading at a 5% discount to book value, although this has been a common theme with listed aged care assets even prior to COVID, with the market discounting the profitability of aged care businesses.
Covid headwinds continue to cloud stronger fundamental business operations. EHE’s average and spot occupancy both improved with respite care being a key driver. Net RAD inflows were A$23m which included A$17m from new homes. Removing COVID impacts, EHE saw an EBITDA per bed uplift of ~25%. Due to longer-run COVID impacts, Victoria has been subject to a drawn-out recovery although it’s trending in the right direction.
Management has maintained a sound balance sheet over the pandemic. A$80m in net debt consists of A$38m related to developments that are set to come online in FY23-24E and doesn’t incorporate A$29m of grants that are yet recovered from FY22. Despite the pandemic moving further into the rear-view mirror, the impacts continue to weigh on EHE. The group plan to use cash earnings to pay down debt and is expected to be net cash by FY26e.
Risks To Investment View
Risks for EHE include 1). longer-than-expect costs impacts from COVID-19. 2) Falling house prices market could weigh on EHE income stream. 3) Regulatory changes create harder conditions for operations. EHE is a COVID recovery story that is relying on the normalisation of conditions to promote the growth outlook. If conditions are unable to meet pre-COVID levels once COVID costs unwind, the market will become sceptical about the recovery potential.
Investment view
EHE has felt the brunt of COVID-19 impacts and is reliant on the idea of a swift COVID-19 recovery. The operational outlook should improve on falling COVID-19 costs and an easing of labour issues.
The market appears confident that the business can achieve a return to pre-COVID levels by FY23. The stock trades at a discount to book value in part because asset values have risen, and the business’s low single-digit ROA isn’t going to change any time soon.
We need more clarity on the regulatory situation before we can have a more directional view so for now, we retain our Hold rating for EHE.
Figure 1: Market expecting eBITDA recovery from FY23 onwards.
