Attractive buying point
During uncertain times, it becomes a priority for investors to focus on high quality, low-risk businesses with proven track records. Primary Health Properties PLC (LSE:PHP, OTC:PHPRF) (Primary Health Properties PLC (LSE:PHP, OTC:PHPRF)), the real estate investment trust (REIT), fits this bill given that its shares yield a chunky 4.7% (on our current year forecast), with the dividend having increased every year over 26 years, and the business having a 90% government-backed rent roll. In addition, a quarter of the rent roll is inflation-linked. The group's expansion into Ireland adds some spice as that market offers higher property yields combined with cheaper financing costs. The shares have slipped by c 18% since last September, as investors rotated into higher risk segments in the property sector. We believe this creates an attractive entry point for long-term investors. PHP holds a portfolio of 521 primary health facilities in the UK (92% of the portfolio by value) and Ireland (8%). The business model involves managing the properties for rental income and growing the portfolio over time. The asset base has several attractive characteristics for yield-focused investors:
- 90% government-backed rent
- 99.7% occupancy rate
- 25% of rent roll is linked to inflation
- Weighted average unexpired lease time (WAULT) of 11.6 years
- EPRA cost ratio is the lowest in the sector at 9.3%
Strong performance in 2021
Net rental income increased by 4.1% to £136.7mln in the fiscal year 2021 (FY21), reflecting like-for-like growth of 1.8%, up from 1.6% in the prior year, along with net property acquisitions. When combined with the revaluation surplus and profit on sales, PHP generated a total property return of 9.5% in FY21, up from 7.4% in FY20. Adjusted earnings increased by 13.8% to £83.2mln. This reflected the impact of the decline in the EPRA cost ratio to 9.3% from 11.9% in the prior year — the fall includes the impact of the £4mln savings achieved from the management internalisation via the acquisition of Nexus in January 2021. Adjusted earnings per share rose by 6.9% to 6.2p and the annual dividend was increased by 5.1% to 6.2p, reflecting a 100% payout ratio. The investment property valuation improved by 4.1% to £2.796bn, partly reflecting a 17 basis points (100 basis points or bp = one percentage point) decline in the net initial yield to 4.64%. Adjusted net tangible assets (NTA) per share improved by 3.4% to 116.7p. The gearing (loan-to-value or LTV) ratio rose by 190bp to 42.9% but remains towards the lower end of the group's targeted range of between 40% to 50%.
We forecast the portfolio value to increase by 5.1% to £2,939.5mln over this year and by 4.9% to £3,084.7mln in FY23. On our forecasts net rental income increases by 3.3% to £141.2mln in FY22 and by 3.5% to £146.2mln in FY23. We forecast adjusted NAV to rise by 1.6% to 118.6p in FY22 and by 2.2% to 121.3p in FY23. Adjusted earnings per share (EPS) rise by 4.4% to 6.5p in FY22 and by 5.3% to 6.8p in FY23 and we assume a 100% payout ratio going forward.
Forecasts
Year end Dec 31 · 2020 · 2021 · 2022 · 2023
Portfolio value (£mln) · 2,576.1 · 2,795.9 · 2,939.5 · 3,084.7
Net rental income (£mln) · 131.2 · 136.7 · 141.2 · 146.2
Adj. Earnings (£mln) · 73.1 · 83.2 · 86.3 · 90.9
Adj. EPS (GBp) · 5.8 · 6.2 · 6.5 · 6.8
DPS (GBp) · 5.9 · 6.2 · 6.5 · 6.8
Adj. NAV/Share (GBp) · 112.8 · 116.7 · 118.6 · 121.3
Gearing (LTV%) · 41.0 · 42.9 · 44.6 · 46.1
Over the past ten years, PHP has delivered an annualised total shareholder return (TSR) of 10.7% (to March 9, 2022). Total shareholder return is defined as dividends plus capital gains. The total shareholder return closely reflects the underlying performance of the asset portfolio.
The chart below shows the ten-year record of PHP in terms of shareholder capital returns. This shows an annualised capital return for PHP of 5.9%, compared with 2.6% for the UK REIT sector and 4.8% for the UK 350. PHP has sustained a stronger trajectory, but the pull-back in recent months leaves it only slightly ahead of the UK 350 level. The REIT sector has a lower volatility than the UK 350, as does PHP.
Investment summary
The average dividend return (dividend paid / starting share price) for PHP over this period was 4.8% with the rest of the 10.7% total return coming from share price growth. The dividend is an important part of the overall investment thesis. PHP has increased its dividend every year since listing in 1997. Very few stocks in the UK market can match this track record.
Dividend record
Source:: company accounts and Proactive Research
Real Estate Investment Trust focused on primary healthcare facilities
Primary Health Properties is a UK Real Estate Investment Trust (REIT) specialising in investing in modern primary healthcare premises. Primary health care is the first point of contact for health care and is mainly provided by general practitioners (GPs), along with pharmacists, opticians and dentists. PHP's focus is on area ‘hub’ facilities rather than very small neighbourhood GP practices, as these ‘hubs’ are a core feature of local health infrastructure that do not tend to shut down or relocate. These are local health centres usually encompassing GP surgeries, sometimes alongside other NHS services, pharmacies and dentists. In the UK, GP contractors are eligible for rental reimbursements and in the case where the GPs are tenants in a building they receive leasehold cost reimbursements. Consequently, 90% of PHP's rental income is government-backed rent, with the balance being mainly pharmacies.
In both the UK and Ireland the national health authorities have a committed policy of strengthening primary health care. This reflects the need to reduce pressure on hospital-based services, and to meet the needs of an ageing population. In the UK PHP owns 501 properties, representing 7% of the addressable market, leaving plenty of headroom for further growth.
PHP acquired MedicX, a rival healthcare real estate investment trust, in an all-share deal in 2019. The deal was a major elevation in the scale of the business, as MedicX held property worth around half the size of PHP. In January 2021, the group completed the acquisition of Nexus, enabling the internalisation of PHP's management structure and this resulted in annual cost savings of approximately £4.0mln.
Case study: Victoria Medical Centre, Eastbourne
Source: Primary Health Properties
PHP acquired the Eastbourne property in December 2019 and the building was constructed on an area of 1976 square metres. The property was fully let for 25 years from completion to an enlarged GP practice, which combined three GP practices into one super-practice with new management and operating as a single primary care network. The building has some 27 consulting rooms, along with paramedics and a pharmacy. The building also enables remote consultations and has been designed to the latest ESG (environmental, social and governance) standards to conserve energy and mitigate its impact on the environment.
Primary healthcare facilities have some attractive qualities as a tenant base:
- Occupancy rates are high, and tenant turnover is low
- Properties are typically let under long lease terms. PHP has a weighted average unexpired lease term (WAULT) of 11.6 years
- Government is the direct payer for 90% of rents. This leads to a dependable and timely payment of rents
- 25% of rent roll is linked to inflation. Management argues that the balance are effectively linked to inflation through replacement cost
Strategy
PHP invests in modern primary health infrastructure in Britain and Ireland. The group looks to selectively grow its property portfolio by funding and acquiring high-quality developments, newly developed facilities and investing in already completed, let healthcare real estate.
Given that the tenant base is low risk, the group is able to leverage the business at a higher level than typical across the REIT sector and the group targets a LTV ratio of 40-50%. This enables the REIT to generate a superior total return while also benefiting from the REIT tax status. At the end of December, the LTV ratio stood at 42.9%, and we forecast this to gradually move up as the group makes additional property purchases.
Ireland offers favourable investment opportunities
Republic of Ireland growth opportunity
PHP is the largest investor in this space in Ireland, with a portfolio comprising 20 assets, valued at £213mln (€253mln) with a large average lot size of £11mln. 75% are let directly to Health Service Executive or government agencies with long leases (WAULT: 21 years). The rent roll on these properties is €14.6mln and all rents are linked to Irish CPI (inflation), which is forecast to grow by c 2% in 2022.
The aim is to grow the portfolio to around £500mln, or 15% of the group total and management believes it can achieve this goal within two to three years. While the UK market has seen yield compression, the Irish market has lagged, hence management believed that there remains potential for yield compression in Ireland.
As with the UK, Ireland has a growing and ageing population. There is a government support programme to modernise healthcare in Ireland and establish a national network of 200 purpose-built primary care centres. The chart below highlights the attractiveness of the Irish investment opportunity compared with the UK, reflecting the higher yields and low financing costs in euros.
Source: Primary Health Properties
£444mln pipeline for delivery over the next 2-3 years
Investment pipeline
PHP says that the market in 2021 was characterised by a lack of suitable acquisitions, strong pricing and a very competitive market. PHP acquired nine assets in 2021 for £86.6mln (2020: 27 assets, £93.0mln) and sold one asset for £2.3mln.
Going forward, the group has a total investment pipeline of £444mln, including £337mln in the UK and £107mln in the Republic of Ireland. The plan is to fund the pipeline internally, supported by £320mln of undrawn debt facilities. The current pipeline would take the LTV of the group up to around 47%.
In Ireland, the group has an advanced pipeline valued at £107mln (€127mln) including nine forward funded developments with a gross development value (GDV) of £89mln and three standing investments totalling £18mln.
Investment pipeline
Source: Primary Health Properties
The primary healthcare investment environment
The NHS model has been evolving following its 2019 five year plan, which has put an increased emphasis on primary care networks. In the wake of the pandemic, the requirement for modern, integrated, local primary healthcare facilities is becoming ever more pressing in order to relieve the pressures being placed on hospitals and Accident & Emergency departments, where a backlog of missed procedures is building up. While the pandemic inspired the shift to online consultations, it does not remove the need for physical consultations. Further, there is also the emphasis on carbon reduction in buildings.
PHP works with the NHS, HSE (Ireland's equivalent to the NHS) and the group's GP tenants to help them use the group's properties for deployment in the front line of the COVID-19 pandemic, delivering vaccines and boosters across the UK and Ireland. PHP argues that medical centres are much more efficient than small GP practices, with a lower carbon footprint, and patients using them can avoid going to hospital. There are around ten thousand properties in the UK, though numbers are shrinking. PHP and its competitor Assura each have market shares of around 6-7%.
Net zero carbon across the portfolio by 2020
ESG strategy
In the presentation of the results, management outlined their approach to ESG. As a property company, the main area of focus is on the climate and the group is committed to transitioning to net-zero carbon (NZC) by 2030 for all operational, development and asset management activities. On the social side, it argues its activities result in better patient experiences and have a positive impact on health and wellbeing in its communities. On governance, it emphasises a strong commitment to acting responsibly with integrity and transparency.
PHP's NZC targets:
All operational, development and asset management activities to be NZC by 2030 and to help its occupiers achieve NZC by 2040
- 2023 — Operations to be NZC with offsetting
- 2025 — All new developments to be NZC
- 2030 — All asset management activities to be NZC and properties to have an EPC of B or better
- 2035 — All buildings to achieve an 80% reduction in carbon footprint
- 2040 — all buildings are NZC across the portfolio
The reductions will be achieved through a number of initiatives, including switching to LED lightings, air-source heat pumps when appropriate and solar panels on the roofs. It also involves electric vehicle (EV) charging facilities and insulation.
The estimated cost to bring the portfolio to an EPC rating of B is £15mln to £20mln, where economically viable, increasing to £35mln to £40mln for the whole portfolio and this will be incurred as part of a planned asset management programme.
Great track record of stable growth
Financials
PHP has established a strong track record of delivering a resilient and growing stream of earnings and cash flow to support a dependable and growing quarterly dividend to shareholders.
From the perspective of supporting dividend growth, the profit metric we focus on is the ‘EPRA EPS’. This is the earnings per share (EPS) as defined by European Public Real-Estate Association (EPRA). It is the industry-standard measure of profit per share based on rental income (not capital gains). This is important because the EPRA EPS represents the profit per share available for paying dividends.
Growth in EPRA EPS, for PHP, is primarily attributable to two drivers:
• Rent reviews on existing properties
• Additional capital investment, in new properties or upgrades to existing properties
Additional capital investments are typically earnings-enhancing for PHP from the first full year of inclusion. New investments are financed using a combination of retained cash flow and new debt issuance. PHP last completed an equity raise in July 2020, for £140mln, but internal cash generation and debt financing is sufficient to fund the current investment pipeline. The following chart shows PHP’s balance sheet leverage as measured by the loan-to-value (LTV) ratio.
Loan to value (LTV) ratio
Source: Company accounts
FY21 final results
Net rental income increased by 4.1% to £136.7mln in FY21, reflecting like-for-like growth of 1.8%, up from 1.6% in the prior year, along with acquisitions. When combined with a revaluation surplus and profit on sales, PHP generated a total property return of 9.5% in FY21, up from 7.4% in FY20. Adjusted earnings increased by 13.8% to £83.2mln. This reflected the impact of the decline in the EPRA cost ratio to 9.3% from 11.9% in the prior year — the fall includes the impact of the £4mln savings achieved from the management internalisation via the acquisition of Nexus in January 2021.
Adjusted earnings per share rose by 6.9% to 6.2p and the annual dividend was increased by 5.1% to 6.2p, reflecting a 100% payout ratio. The investment property valuation improved by 4.1% to £2.796bn, partly reflecting a 17bp decline in the net initial yield to 4.64%. Adjusted NTA per share improved by 3.4% to 116.7p. The gearing (LTV) ratio rose by 190bp to 42.9% but remains towards the lower end of the group's targeted range of between 40% to 50%.
Forecasts
We forecast the portfolio value to increase by 5.1% to £2,939.5mln over FY22 and by 4.9% to £3,084.7mln in FY23. On our forecasts net rental income increases by 5.5% to £144.2mln in FY22 and by 3.5% to £149.3mln in FY23.
We are cautious on revaluation gains in the near future, as we see further potential for yield compression as already seen in the UK. Nevertheless, there continues to be scope for yield compression in Ireland.
We forecast adjusted NAV to rise by 1.6% to 118.6p in FY22 and by 2.2% to 121.3p in FY23. On our forecasts, adjusted EPS rise by 4.4% to 6.5p in FY22 and by 5.3% to 6.8p in FY23 and we assume a 100% payout ratio going forward.
Conclusion
PHP’s growing dividend stream is underpinned by one of the safest asset bases in the UK real estate sector — primary healthcare facilities.
We argue that Primary Health Properties offers a number of compelling investment characteristics for the shareholder — an acyclical business model, delivering strong returns and consistent cash generation. This is underpinned by the nature of the underlying property portfolio:
- 90% government-backed rent
- 99.7% occupancy rate
- Weighted average unexpired lease time 11.6 years
- 25% of rent roll is linked to inflation. Further, management argues that the balance is effectively linked to inflation through replacement cost. This is comforting in a time of elevated inflationary concerns.
The current outlook for primary healthcare infrastructure spending in the UK and Ireland is supportive for PHP in terms of development and asset management opportunities, in our view. In addition, Ireland offers some extra spice to the portfolio, as the rental yields are higher while financing costs are lower than in the UK. The company has a strong existing pipeline of opportunities and has the balance sheet strength to execute on these. We believe that this leaves PHP well positioned to deliver further value creation within the portfolio while continuing to deliver a growing dividend stream.
Peer analysis
PHP and Assura are the clear leaders in the sector and command premium ratings reflecting their stronger market positions and scale. They trade broadly in line in terms of forward earnings and dividend metrics. We note that both Assura and Target have recently carried out a fundraisings to finance their inorganic growth plans.
Peer analysis
Source: regulatory news and market sources. *Proactive forecasts. Priced at the close of March 9, 2022.
Income statement
Source: Company accounts and Proactive Research
Balance sheet
Source: Company accounts and Proactive Research
Cash flow statement
Source: Company accounts and Proactive Research