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Long term trends can be powerful drivers of stock price performance and few trends can match the certainty of the upcoming flood of ageing baby boomers.  Investors appear to well aware of the enormous growth potential here as the ASX Healthcare Sector (XHJ) has risen 45% over the last two years, the best performance of any sector by a wide margin.
The Healthcare Sector is comprised of a wide variety of companies offering an equally wide variety of healthcare services from drugs to diagnostic imaging to hospital care.  The subsectors likely to see the strongest baby boomer tailwinds are senior retirement living and aged care accommodations.
The state of the senior citizen marks the differences between the two.  Some seniors are capable of taking care of themselves with minimal assistance while others require sophisticated care.  The latter end up in aged care centers that here in Australia have typically been non-profit operators.
In 2014 three aged care operators listed on the ASX, each touting the benefits to be gained from injecting free-market capitalism into the system.  Investors liked what they heard and the fact the federal government heavily subsidies aged care through the Aged Care Funding Instrument (ACFI) made investing in these companies even more attractive.  The prospectus of the largest of these companies, Regis Healthcare (REG) stated 71% of its operating revenue as a privately held company came from the government. 
Regis and Estia Health (EHE) debuted in December of 2014 and both got off to blistering starts.  The third new public player, Japara Healthcare (JHC) came on in April of 2014 and within a month fell victim to concerns over upcoming cuts to federal spending on healthcare.  The following table summarizes the price action to date for these three companies. 

Regis showed the highest price appreciation but still lagged far behind the 45% sector gains over a two period.  All three companies are down year over year:
REG – down 16%EHE – down 50%JHC – down 30%
Short term investors looking for quick profits on Regis and Estia should have paid heed to what happened to Japara.  The Healthcare Sector may be the hottest spot in the market, but all healthcare stocks, to varying degrees, come with the risk of government regulation. 
In the modern world government’s everywhere are subsidising healthcare to varying degrees at increasingly astronomical costs.   Cuts to what a federal government is willing to spend on forms of healthcare can have devastating effects on the stock price of companies affected.  Take a look at a price chart for the top two stocks in the table.

Regular followers of market news know what happened that sent the stock price of Estia plunging 62% at one point while Regis dropped closed to 37%.  Speculation about changes to the ACFI began earlier in the year and on 2 September the government announced aged care providers would no longer be allowed to charge fees characterized as “capital reimbursement” going towards maintenance and repairs.  Some analysts estimate the fees in question amount to $15 per day per resident; others estimate $20.  The government is also casting a skeptical eye on the process employed for ACFI funding approval. Payments are based on responses to 12 questions grouped into categories intended to determine the level of care an applying resident actually requires.  Providers already willingly admit some residents may be receiving payments exceeding their needs.
While the government will undoubtedly continue to look for ways to control costs ranging from fee cuts to changing eligibility requirements, there is one thing investors can count on with relative certainty.  The Australian government is not going to put the senior citizens of this country out on the street.
Revenues may be impacted in the near term but over the long haul cuts to federal reimbursements are to be expected given the rising cost of care and the growing demand for it, but they hardly amount to the “end of civilization as we know it.”
Why?  The “size of the pie” is about to expand dramatically. Take a look.

Source: Australian Bureau of Statistics, Population Projections (Series B), 2013.
In ten years an additional ten million Australians will be 70 and over, and not all of them healthy enough to live on their own.  The population most relevant to aged care operators – those 85 and over – is expected to double by 2032 and then double again by 2046, according to financing authorities at Japara healthcare.

While Regis and Estia are strictly aged care operators, Japara is diversified, adding retirement living villages to its operations, arguably making the company somewhat less risky.  Japara owns 43 residential aged care facilities housing 4,000 residents across Victoria, Queensland, South Australia, NSW and Tasmania along with five retirement villages.  The company pays a fully franked dividend, with the current yield of 7.4%.
Full Year 2016 financial results were acceptable but guidance disappointed investors and the share price fell. Revenues increased from $278.3 million to $327.3 million, an increase of 6.4%. Profit rose from $28.8 million to $30.4 million, an increase of 5.6%. EBITDA (earnings before interest, tax, depreciation and amortisation rose 10.9%.  Unfortunately management issued EBITDA guidance for FY 2017 at 10%. Occupancy rates are important for aged care operators and Japara’s was solid at 94.4%.  Investors ignored that along with the company’s expansion plans. The stock price plunged from $2.50 to $2.18 and continued to decline.

Japara now has 15 additional projects under development throughout Australia, both Greenfield (new construction) and Brownfield (conversion of existing structures).
Regis Healthcare (REG) is the largest of the three in terms of market cap although Estia has more facilities. Currently Regis has 47 aged care centres in six Australian states housing 5,000 residents.  The company has been in the aged care business for 22 years with its founders still actively involved.  Regis announced Full Year 2016 results on 26 August with solid results.  Profit was up 54%; occupancy was 95.2%; and the 12% increase in revenue came from both acquisitions and organic development. The company pays a fully franked dividend with a current yield of 3.55%.Every year the Department of Social Services goes through an Aged Care Approval Round (ACAR), allowing existing aged care providers and newcomers to apply for a range of new aged care places, funded by the federal government. It is a competitive process.  In the 2015 round, Regis was awarded 844 places, while Japara was awarded 313. Estia received only 12.
Estia Healthcare (EHE) has been in business for 50 years and now operates 69 aged care facilities in Victoria, South Australia, New South Wales and Queensland, with about 5,900 residents.  The company’s Full Year 2016 financials were solid, with a 50% increase in revenues along with a 16% increase in profit.  The company pays a fully franked dividend with a current yield of 7.6%.  The high yield reflects the company’s plunging share price, down 50% year over year.  
However, the company missed guidance in both the Half Year Results and the Full Year Results.  Estia CEO Paul Gregersen said:
despite coming in below guidance the business performance was strong, driven by improvements to the Company’s existing and acquired assets, a full year contribution from homes acquired in FY2015 and a positive contribution from Kennedy Health Care(Kennedy) and the other FY2016 acquisitions. 
Some analysts would disagree with that view, in the belief the company spent too much on its acquisitions and too much on integrating the new facilities. Following the release the company’s CFO (chief financial officer) resigned.  Shortly thereafter the founder of the company and still a member of the board resigned and sold all of his Estia shares in a single transaction. On 16 September CEO Paul Gregersen resigned.  The share price has recovered some but investors who include solid management as a criterion for buying in may want to wait and see what the new management does.
Searching the financial news would lead one to conclude many, if not most, analysts and market experts recommend avoiding the aged care stocks, seeking instead other less risky healthcare stocks.
However, one could make a strong case for long term investments here based on two factors.  The demand growth is the first and most obvious.  Less obvious is the fragmented nature of the market with acquisition possibilities too numerous to mention.  By some estimates, the three publicly traded operators account for a miniscule 7% of aged care beds in Australia.  Economies of scale suggest publicly traded aged care operators could lower costs, protecting against reduced government fees, by acquiring private operators.
The problem is the loss of the refundable accommodation deposits formerly used for acquisitions leaves a funding gap.  Given the negative view of the sector, capital raises are unlikely.  However, investments from big institutional investors are a possibly, given the ever-expanding size of that pie.  Despite the recent problems, a few days ago international investment management firm AMP Limited (AMP) increased its stake in Regis Healthcare from 6.4% to 7.9%. 

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