Oceania's retirement village at Meadowbank, Auckland. Photo / Supplied
COMMENT:
The impact of Covid-19 on those aged over 70 has been well-documented. Senior citizens infected with the coronavirus have a much higher chance of dying, compared with younger people.
In New Zealand, the over-75s comprise about 7 per cent of our population (330,000 people), with 14 per cent of those calling a retirement village home.
Nationally, there are around 400 retirement villages, with about 32,000 units and more than 40,000 residents. And there are an estimated 20,000 additional aged care beds within retirement villages (about half of of the NZ total). These cater mostly for over-85s.
There are six major operators in New Zealand, five of which are listed on the NZX (the exception is Bupa), accounting for around 55-60 per cent of total units. The NZX-listed entities have seen their shares decline much more than the wider NZX market since Covid-19 became a reality for New Zealand in late February.
It's easy to see why: the reputational and financial risk associated with a Covid-19 outbreak in a retirement community would have a very real impact on their future operations. That's in addition to the direct financial impact that is hitting nearly every NZ business.
All listed operators had implemented stringent requirements to minimise the spread of Covid-19 well before the Government-decreed lockdown.
Interestingly, Metlifecare was until recently under a takeover offer (more correctly, a "scheme of arrangement"), a process started in late 2019 at a value of $7.00 per share.
This maintained Metlifecare's share price at close to that level right up until mid-March.
The company's fall from grace has been marked, however, as the market first factored in the probability of the scheme of arrangement not proceeding, then received formal advice on April 8 that the bidder no longer wished to proceed.
More fundamentally, each company operates a slightly different business model, which may result in investors differentiating between them as Covid-19, and the subsequent impacts, evolve.
All the operators derive their value from their ability to develop new units, sell "occupation rights" and provide specialised care services. As shown in the tables, each company has a very different balance of these three core activities.
Development activity will face a heavy toll, with work halted during the level 4 restrictions. Each of the five listed operators has clearly set out its development targets for 2020, with some being more reliant than others on profits from their development arm.
While the lockdown is currently planned at only four weeks, the impact will be much longer, given the time it takes to halt and then restart development projects. Not to mention the risk of a longer lockdown.
It's safe to assume that each of the operators will take some pain on the "development" arm of their profit and loss statements. A less certain statement might be that this is likely to be more significant for Ryman and Summerset, thanks to their heavy focus on development of units and associated sales of occupation rights.
Both organisations had set a target of 8 per cent growth in units in 2020. For Ryman, much of this growth was targeted in their expanding Melbourne business.
For context, Summerset's development margin in its 2019 accounts is shown at $61 million (compared with underlying profitability of $106m for the same period). At the other end of the scale, Metlifecare's development margin represented only $5.6m (out of $39.3m underlying profitability) for the first half of its 2020 financial year.
In the medium term, Summerset in particular would be impacted by any slowdown in the market for new units, with a land bank that comprises 120 per cent of its current units. At around 65 per cent of its current units, Ryman also has a large land bank. Both are targeting increased development into the medium term.
Nonetheless, economic slowdown or not, the growth in population of over-75s in both New Zealand and Victoria (Australia) will continue, underpinning longer-term growth in unit development and sales.
In 30 years, the number of New Zealand over-75s will have increased from 330,000 today to around 850,000, with even greater growth in that age group forecast for Victoria.
Resales of occupation rights for existing units represent another source of value for the operators. When a resident (or their estate) sells their occupation right, the capital gain is banked by the operator rather than the resident.
Resale percentages range from a low of 5.4 per cent (Oceania) to 8.5 per cent (Ryman).
In the current environment, a higher resales rate has a positive impact, as it allows the operator to realise a capital gain in a year when income from new developments will reduce significantly.
This assumes, of course, that resales are more likely to continue immediately after lockdown, with a shorter-term impact for the operators than the slowdown in development.
This is the other major source of value for the retirement operators — the extent to which they can provide additional healthcare services to their residents, as their care needs increase.
Ironically, in the recent past, the provision of care services has been seen by many as the least financially rewarding source of profitability for operators — care requires intensive effort, translating to higher wage costs. While subsidised by the Government, the general school of thought is that the subsidy does not cover the full cost.
Provision of care, however, is taking on a whole new meaning in a post-Covid-19 environment and may provide a level of stability for the sector as development revenue decreases. Oceania has a relatively large number of aged care beds compared to the industry average of 34 per cent — although current development plans will reduce their exposure to closer to this level. Both Metlifecare and Summerset are under-represented, and seemingly intend to stay that way.
Those operators that have a more "balanced" revenue stream between development, resales and provision of care are likely to find favour with nervous investors, who are looking to maintain their exposure to the sector while limiting downside risk.
Given the current decline versus the NZX50, however, why maintain exposure at all? The reality is that long term, this is still an attractive sector. Projections for the population of over-75s will continue to grow in future, Covid-19 or not. They will continue to seek a range of lifestyle options in their retirement, from "independent living" through to fully-assisted hospital care.
KiwiSaver has ensured that future generations of pensioners are likely to be better off in retirement than previous generations (assuming future governments maintain the scheme and minimise withdrawals from the investment).
There's no doubt that Covid-19 has hurt financial markets right now, and particularly the retirement sector. The industry has taken a painful, short term lesson in the risk of maintaining facilities for more vulnerable individuals in the context of a global pandemic, but this should not change fundamental attractiveness in the longer term.
In the short term, investors' choices will be guided by the "balanced portfolio" of income streams inherent within each operator.
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