What could be better than investing in a sector with typhoon proportion tailwinds at its back, with something approaching 70% of revenue stemming from the federal government?
In 2014 three ASX stocks listed, all operating in that sector – care of Australia’s aging population. Japara Healthcare (JHC) was first out of the gate in March, followed by Regis Healthcare (REG) in October, and Estia Health (EHE) on 31 December.
Some financial websites equated these residential aged care operators with the likes of booming private hospital operators, openly speculating which would be the next Ramsay Healthcare (RHC).
By November of 2015, all three had reached all-time highs and then began an agonizingly slow descent, as seen in the following price movement chart from au.finance.yahoo.com.
Investors who bought the “next Ramsay” hype may have been shocked, given the demographics of Australia’s aging population. Using the term “aged care” reduced the broader category of the needs of an aging population from health and living accommodation needs to housing needs alone. Healthcare stocks that cater to medical issues had already received the stamp of approval as beneficiaries of aging population demographics. From the Australian Institute of Health and Wealth, the following graph displays the enormity of the tailwinds.
An article appearing in the AFR (Australian Financial Review) in September of 2015 supported the idea of a pending “grey tsunami” with statistics from the ABS (Australian Bureau of Statistics) forecasted a doubling of Aussies over the age of 85 by 2037 and then doubling again by 2045, without enough beds to meet demand. Shortly after the article appeared, the three market darlings of the day reached their peak.
So, what happened? The adage about those who live by the sword die by the sword applies here. The wielder of the sword is the primary revenue source for the sector – the ACFI (Aged Care Funding Instrument). Aged Care providers are not paid a flat fee for each resident in one of their facilities. The AFCI determines how much the government pays based on the needs of the resident. Providers file “claims” and the rate they receive can range from lows around $36 per day to $110 per day. Given the massive dollar drain on the federal treasury it shouldn’t have come as a surprise as speculation began of changes in the AFCI.
The sword fell in May with the announcement of $1.2 billion dollars in cuts to the AFCI with more bad news later in the year with changes in the add-on fees the providers were charging direct to the residents.
In July of 2017 the ACCC (Australian Competition and Consumer Commission) stepped in to investigate contract and fees prevalent in the retirement living sector focusing on Aveo Group (AOG), a crushing blow to the stock price which has yet to recover.
Government regulation is not limited to revenues but to residential beds allowed per provider as well via the Aged Care Approvals Round (ACAR), a competitive bidding process for additional aged care spaces.
Now the government is about to step in yet again, this time focusing on quality of care. On Sunday 16 September our new Prime Minister Scott Morrison announced a Royal Commission to look into multiple complaints leveled against aged care operators. Additional fuel was poured on the fire with the first airing of an Aged Care investigative reporting series featured on Four Corners entitled “Who Cares.” Market reaction was swift and severe on all four stocks.
Macquarie Group was the first major investment firm to react, downgrading the entire sector, citing two caveats. The first, declining occupancy, is seen to be a likely result from the negative publicity heaped on the entire sector, without regard to the operations of individual providers. The second is declining profit margins resulting from higher operating expenses required to meet new compliance standards.
The preliminary scope of the investigation adds a cause for concern extending beyond care issues. Here is the relevant statement from the government’s announcement of the commission:
The Terms of Reference will be determined in consultation with the community, including residents and their families and aged care providers. We expect that it will cover:
1. The quality of care provided to older Australians, and the extent of substandard care;
2. The challenge of providing care to Australians with disabilities living in residential aged care, particularly younger people with disabilities;
3. The challenge of supporting the increasing number of Australians suffering dementia and addressing their care needs as they age;
4. The future challenges and opportunities for delivering aged care services in the context of changing demographics, including in remote, rural and regional Australia;
5. Any other matters that the Royal Commission considers necessary.
The fifth item could open a pandora’s box of issues with how Aged Care providers operated.
Given the less than rosy outlook, should retail investors sell Aged Care holdings they have; buy into the beaten down sector for long-term gain; or simply stay away and look elsewhere for opportunities likely to benefit from the aging population explosion.?
Although there is no denying the expected demand for a wide range of services required by senior citizens, another megatrend is clashing with the prevailing tailwinds. The cost of health care around the developed world has exploded to the point consumers and for-profit insurance companies simply cannot keep up. Enter federal governments everywhere. With government footing a substantial portion of healthcare bills, investors can expect regulatory changes aimed at cost saving, regardless of services offered.
Lost in the avalanche of negative sentiment on the outlook for the sector is any discussion of its fragmented nature, nor of where the predominance of negative findings exists. In 2015 the AFR estimated that close to 63% of aged care homes were operated by single facility operators. A July of 2016 report from the Aged Care Financing Authority – an agency of the federal government established in 2012 to monitor the sector – found that 54% of Aged Care places were operated by not-for-profits, with no differentiation reported of the percentage market share of the publicly traded providers.
The sector is consolidating, a trend likely to increase as lack of funding is one of the preliminary conclusions from reported complaints about the sector, with inadequate and ill-trained staffing chief among them.
The ASX providers could actually benefit in the long term from consolidation fueled by higher operating costs difficult for non-profits to manage. Investors are already being treated to speculative articles about the possible long-term rewards of investing in the sector, with insufficient attention paid to the business models of the three ASX providers always included in any piece about aged care operators – Estia, Regis, and Japara.
Where is Aveo? Aveo was scalded along with the dominant three, despite the fact it is a relatively minor player in aged care with fourteen centres across Australia. Aveo’s core business is retirement living, the first stage through which many seniors pass in the aging process. Daily living requirements become burdensome, making a move to a Retirement Community where meals are prepared for you, your laundry and cleaning is done for you, and basic monitoring is provided an attractive proposition. Aged care is the term describing higher levels of services required, often involving medical monitoring and treatment.
The Retirement Living sector has already gone through a round of regulatory review regarding fees and contracts and may be in for more down the road but is not expected to be part of the current Royal Commission Review. Aveo operates 32 retirement communities with 12 more soon to open. Japara operates primarily in Aged Care, with 41 facilities and only 5 Retirement Living communities. Estia operates strictly in Aged Care with around 68 facilities across Australia.
High risk investors might be willing to gamble on any of the three, but there are two stocks worthy of consideration for those with lower risk tolerance.
There is one type of Aged Care where the federal government is actually increasing its support – In-Home Aged Care. Regis operates in this space as well as in Aged Care.
A newcomer to the ASX also operates in the In-Home Aged Care space but has the added benefit of operations in community-based health services, a cost-effective alternative to large-scale institutional care. The company is Zenitas Healthcare (ZNT), listing in January of 2017 following a reverse merger.
At the time of its entrance to the ASX the company had already made multiple acquisitions, an ongoing strategy with more community health clinics acquired in 2018. Zenitas is aggressively pursuing growth in community-based health care services as a cost-effective alternative to acute and post-acute institutional care. It operates in both Primary Health – general practice medical services and skin care – and Allied Health – podiatry, occupational and physical therapy, and sports medicine.
The company is not considered an aged care operator since it has no residential facilities and escaped the carnage following the Royal Commission announcement.
Following the company’s reporting of its first Full Year Financial Results since coming to the ASX Zenitas received a takeover offer from a consortium of private equity firms for $1.46 per share, a 40.3 per cent premium to the company’s three-month volume weighted average price according to the AFR which broke the story.
The results were outstanding, with a maiden underlying profit of $5.7 million, a 78% increase with an equal percentage rise in revenues to $76.6 million. Zenitas has a current dividend yield of 2.5% with a two-year dividend growth forecast of +41.6% along with earnings forecast of +37.2%.
Regis Healthcare (RHC) is the most diversified stock in the sector, offering Retirement Living, Aged Care, and In-Home Care. The company operates 63 Aged Care facilities, most in densely populated areas, along with six Retirement Living communities. The company offers basic home help and home care in six locations around Australia. In addition, Regis operates a Day Respite Centre in Darwin for caregivers and Day Therapy Centres offering allied health services at its retirement living communities.