Primary Health Properties Plc (PHP) Earnings Call Transcript & Summary

Good afternoon, and welcome to the Primary Health Properties PLC Interim Results Investor Presentation. [Operator Instructions] The company may not be in a position to answer every question received during the meeting itself, have the company review all questions submitted today and publish responses where appropriate to do so. Before we begin, I'd like to submit the following poll. I'd now like to hand it over to Harry Hyman, CEO. Good afternoon.

Hello, everybody. Let me introduce my colleagues and myself. My name is Harry Hyman. I'm the Founder and Chief Executive of Primary Health Properties. Richard Howell, Finance Director is on my right. David Bateman, who's the Chief Investment Officer, is on my left. Just before we start with the slides, I just wanted to give you a very brief overview of what the company actually does. We have a very simple business model. We buy properties, assets, which are let on a long-term basis to health care users in the U.K., predominantly GPs and the NHS and pharmacy operators and in Ireland, our other area of operation, to the HSE, which is the Irish equivalent of the NHS, GPs and pharmacy operators. And we derive the income from that and nettable costs and our interest charges, we pay that out to investors in the shape of a dividend, which I'm proud to say, has grown in each of the last 26 years. And if you were to buy the shares today, the dividend yield is something like 4.5%. So we have a very simple, very robust, low-risk business model. With said that, now, let's give you some highlights of our results before we drill down into the detail of the presentation. So clearly, just to say a few words in the beginning, we're fortunate to operate in a very good and growing sector. The good news is that populations in both Britain and Ireland are growing. They are getting older and there is more incidents of chronic disease like type 2 diabetes, like drug and alcohol abuse, heart disease and things like that, all of which puts an enormous strain as we know on health care systems. And one of the best ways of dealing with that is to move a lot of the demand into the primary care arena. So gone are the days when the GP sensor was just the doctor's house, where a single doctor or maybe 2 doctors practiced, and the future is very much more the hub core primary center where a wide range of services and therapies that delivered alongside a large practice of doctors, 6, 10 or even 20 in some cases. So this is a very good way for the government to reduce the pressure on their health care budgets. And therefore, we have a vibrant future ahead of us as a business. We all know the incredible stresses and strains that COVID-19 put on the health care systems, and that strain has not gone away. If there are no other reason, then we still have to carry on with the vaccination program for people over 50. And I can see that carrying on for quite some time. From our standpoint too, there is an enormously large opportunity to invest more in the primary care estate. So some 40% of that, according to BMA statistics is not fit for purpose. And we've estimated that that is a total capital requirement of between GBP 4 billion and GBP 5 billion here in the U.K. and in Ireland, around GBP 1 billion is needed to modernize the estate. We had a lot of talk about digital and the impact that that would have on medical sensors but so far, our experience is that while the internal configuration and some of the buildings is changing to take into account online consultations, the actual amount of space that's needed within the primary care state is not reducing but still increasing. Anyway, let's give you some highlights from our results that we came out with for the 6 months to 30th of June. We carried on with our track record of paying a progressive dividend. We've already paid 3.25 P. We've announced the third quarterly payment, which is paid on the 28th of August, and we're on track for the 6.5 P that brokers are predicting our dividend to be for the year as a whole. And our dividend cover is very good at 103% of the amount that we paid out. Our accounting returns, we'll get shortly, is very strong at 6.3%, driven by a good accounting re-evaluation surplus. And our total property return also reflected that. We, of course, are conscious of the fact that there's a lot of uncertainty in the various marketplaces around the world, and we've taken a cautious stance towards acquisitions, acquiring 3 assets for GBP 49 million during the period. We've also done some capital recycling, selling a portfolio of 13 assets for just under GBP 28 million, which closed after the period end. We do have a good pipeline, which you'll hear more about during the presentation. And we're focusing very much on our own on balance sheet development and our Irish opportunities. Many people think that we're exposed to higher interest rates and will be worse off from higher inflation but in fact, we are 95% hedged out on the debt side, so the impact there will be very muted. And in fact, both through the combination of our index-linked income, where 25% of the portfolio is formally linked to inflation, but also through the way the rental mechanism works, we believe that higher inflation will lead to a firming tone in the amount of rental growth that we are getting. The first half saw an increase in the rent roll of some GBP 1.8 million, in part from asset management opportunities and also inflation linked increase but also a firmer tone on the open market value reviews. We're seeing the benefits of some of the excellent refinancings that we did in '21 and the early part of '22. So our portfolio today stands at GBP 2.9 billion. Our rent roll is GBP 144 million. 89% of the total top line of the business comes from either the British or Irish government, balanced mainly from pharmacy operators. We have a portfolio that is almost 100% net with a very long wall outstanding of over 11 years. And as I mentioned earlier, most of our debt is hedged out for the next 8 years. And just to reinforce that point, here is a chart showing our track record of paying an increased dividend. It's when we prepared the slide, our share price is just under 144 P, showing a 4.5% yield. And we have every intention of maintaining this track record from the financing of social infrastructure as we move forward. Looking at the relative performance of the business, on the next slide, you can see that we have done very well on a 20-year basis, we've done very well on a 10-year basis and a 5-year basis and so on and so forth. And we believe that our returns are superior to that of our competitor but we're not here to talk about them, we're here to talk about us. And what we have is a very dependable source of high-quality growing revenue, which comes out to our shareholders quarterly in February, in May, in August and in November. And we can be safe in the knowledge that we're helping play our part, not only in the levelling up agenda, but also in the modernization of social infrastructure across the U.K. So that is our overview. And with that, I'm going to hand over to Richard, our CFO, who's going to talk about the finances in a bit more detail. Over to you, Richard.

Thanks, Harry. Here's some of the key financial highlights for the first 6 months of 2022. Net rental income was up just GBP 3.4 million. Very encouragingly, and we'll come back and touch on it a bit later, half of that increase came from revenues in asset management, where we saw an increase of GBP 1.7 million in the 6-month period. The balance came from acquisitions and developments that we acquired last year and this year, and they add to the balance of the number. So often enough of interest and administered costs, we come down to adjusted earnings, and this is a number we like to pay out to shareholders in the form of increasing dividends. So that was up by GBP 4 million, GBP 24.7 million. And that was driven by those 2 factors I just touched upon but also interest cost savings, we delivered around GBP 5 million of interest cost savings last year. So some of that sales to flow through to this year, which resulted in GBP 1.1 of interest savings in the first 6 months of the year, notwithstanding additional debt that we've drawn down over the course of the year to finance new acquisitions and developments. There's a slight increase in admin costs of around GBP 0.5 million, which represented additional staffing that we've taken on board to manage for the increasing size of our portfolio. So on adjusted earnings per share basis [indiscernible] 3.4p per share, as far as dividend that was paid out to shareholders as a dividend grew to 3.25p. We had dividend cover of hopefully, 103%. Like-for-like rental growth, GBP 1.8 million or 1.3%. That was a record in the first 6 months of the year. We're very pleased with that, and we'll come back at actual later a bit later this year. As I already mentioned, we saw very strong revaluation surplus, just over GBP 50 million. That was driven by 2 key factors: half of it was the rental growth we've just touched upon. We continue to see a very strong investment market. We saw yields compressed by further 7 basis points in the period. Most of our portfolio now relied at GBP 2.9 billion, we'll touch on that bit in a more detailed a bit later in the presentation. Adjusted net tangible assets per share, just under 121 P, that was up 4.1 P in the first 6 months, half of that, 3.8 of that came from the valuation surplus with the balance from retained earnings. Loan-to-value ratio, we like to leverage this portfolio relatively high compared to most other REITs because we have a very strong government back to income stream. There's a lower end of our target range between 40% and 50%. And at 30th of June, we were at just about 43%. We also have GBP 290 million of onshore firepower of various loan facilities, which was there to finance our pipeline, which we will talk about again in a bit more detail a bit later. These other metrics, Harry has already mentioned, pretty much fully occupied, long lease lengths and average cost of debt down at just 3%. We also have the lowest EPRA cost ratio at just over 10% in the whole of the U.K. REIT sector. This next slide we'll touch on most of these key numbers but this falls out the differential between our adjusted earnings because you now have to pay out to shareholders and accounting numbers are called IFRS. So when you add on the adjusted earnings, 24.7%, add on the revaluation, there's some gains on our derivatives and reversible bonds. We saw a total profit of just under GBP 108 million in the first 6 months of the equivalent 8 P per share. Looking at the balance sheet, we have adjusted net changeable assets, just over GBP 1.6 billion. We're up 3.6% in the period. Most of that was driven by the revaluation surplus. So all this chart is trying to show you that the starting net asset value just under 117 P rose from the adjusted earnings 3.4 P that was paid out to shareholders in the form of a dividend. So the revaluation surplus increased by 3.8 P and the other is just the premium in the shares, which we issued through the scrip dividend mechanism. Turning to the debt pool for Primary, we have just under GBP 1.6 billion of various debt facilities with a wide range of lending partners. There are a number of institutions that are being very keen lenders to the sector, all the high street banks in forms of revolver credit facilities which provides a lot of flexibility in terms of when we have spare cash, we can pay the earnings down and we need cash to buy acquisitions, we can draw it down. We also have a number of bonds and private placements, including euro-denominated borrowings which hedge out our euro exposure in Ireland. That debt is fixed down for just under 8 years. As Harry mentioned, 95% is fixed, so we have very good exposure to rising interest rates in the future. GBP 290 million of 1.5, which is said to finance our future capital commitments and our pipeline into the future. When you look at the chart at the bottom of that graph, this is just showing the maturity profile of our debt. We don't have any particularly large waterfall. And all of these facilities maturing in '23 and '24 are revolving credit facilities with typical U.K. high street banks. Those banks remain very supportive of the sector, they're keen to lend more to us. We're in a process of renewing those facilities at the moment. These pie charts or bar charts, I should say, show the improving debt metrics across the whole of pool. Average cost of debt is pretty much at an all-time low, 3%. As we always said, that ticks down for just under 8 years. Interest cover ratio continues to improve. As we said, money on the interest cost, our rental income continues to grow from acquisitions and rental growth, loan-to-value ratio at the lower end of our target range, we will take that up towards 50% but we prefer to be towards the lower end of our target range at the moment. And debt maturity, just under 8 years. So at this stage, I'm going to just touch upon our net zero carbon ambitions. So we're very keen to green the portfolio and we want to work our operational development and asset management activities to be net-zero by 2030. Through our asset measurement program, which we'll come back and talk about a bit later, we are improving the environmental credentials of all of our assets. And by 2030, we want to get these assets to be at least an EPC rating of B. This is really to avoid a brown discount across the portfolio in future years as, obviously, listing requirements become more and more stringent in the future. We also have a very key role to play in the social side of ESG, and World properties are delivering well-being and health care for the U.K. in Irish populations and around 9% of the U.K. population is registered at one of our properties. So with that said, I'm going to hand over to David, who's going to talk you through the investment and development pipeline.

Thank you, Richard. Well, notwithstanding the outlook for nominated interest rates, I'm pleased to report that, so this half year for this period, we're able to deliver a GBP 51 million revaluation surplus and this has further been underlined by a recent sale of 13 assets at 13% ahead of the December 2021 book value, which obviously bodes well for our valuation. During the course of the period and indeed, just after the period end, we've acquired 3 assets for a total value of GBP 49 million. They are listed up on the presentation page I think you can now see. And we like all of these assets, obviously, but particularly, they've all got long leases. 2 of the 3 have index led RPI, index led revenues. They all have strong underlying site values. And in 2 of the cases, they are effectively government-backed income. And indeed, in the third case, which is the Chiswick Medical center, the covenant of that tenant is extremely strong in HCA International. Looking to the rest of the year and the second half of the year, we anticipate continuing to make cautious and indeed selecting further investments. Moving on, we are progressing our development activity. On-balance sheet on for us is relatively new. And we are proud to say that we have our first on-balance sheet development now on site, taking place at the Kraft Lebanon with Sussex, additionally, as well as delivering a higher yield on cost than we can generate from acquiring investments. On the market, these assets allow us to bring forward cutting-edge medical centers with very attractive sustainability credentials, such as net-zero carbon accreditations, BREEAM ratings and EPC grades of A. We have a growing pipeline of developments, one of which is listed on this slide, it spills in Lincolnshire, and we expect to have more developments on site during the second half of the year. The slide also briefly touches on 2 of our forward funded schemes that we have completed on in Ireland during the period, both of which recognize strong sustainable credentials, provide government-backed tenancies via the HSE, which is Ireland's equivalent of the NHS, and provide for index-linked rent reviews further driving our net profit line. Moving on and just picking up on the theme of those 2 Irish forward funded developments that we've completed, we've also planned to further our strategic expansion into Ireland. We already have 20 assets there with an approximate value of GBP 200 million. And we have a pipeline there of approximately GBP 43 million via 3 assets. The Irish assets provides with an opportunity to acquire products at a higher yield, or should I say, softer price than we can generate in the U.K. and indeed, similar to the U.K., the vast majority of the income is government led. I won't dwell too long on my final slide, which touches on our pipeline looking forward but really, I highlight here that we have a strong pipeline across all our core investment spaces. Effectively in the U.K. to include development, we have a pipeline of GBP 123 million spread across 12 assets, which includes our development pipeline. And in Ireland, GBP 43 million spent across 3 assets, which are predominantly forward-funded schemes. I should also touch on our pipeline for asset management projects. This side of our investment in our infrastructure shouldn't go unnoticed and during the course of the next 3 years, we've planned to draw approximately GBP 52 million across 50 projects, whereby we'll be improving the buildings, lengthen the leases and using their capital to generate higher rents. So fundamentally, a positive picture for the portfolio, ensuring it's future proofed. On that note, I'll hand over to Harry to provide some summary comments.

Thanks very much. But before doing that, I'm going to talk a little bit about the property portfolio. As you can see, it's a very granular portfolio at the 30th of June before making those disposals of 524 properties with 20 of which were in Ireland. Interestingly, the net initial yield was some 4.57% and the average drop size, which has increased over the years, is now some GBP 5.5 million. When you look at the income expiry profile, of the GBP 10.2 million which is circled as being arriving in the next 3 years, the good news is that 80% of that has already had terms agreed or is in advanced discussion with the NHS tenants about renewal. It's extremely unusual for properties to come back. What normally happens is that we carry out an asset management project to improve the properties both from an environmental standpoint but also with a view to extending the lease. The distribution within our assets is shown in the bottom half of the slide. And as you can see, we have a large percentage, 1/3 of the portfolio is invested in assets valued at over GBP 10 million and only 5, just 5 of the 524 are valued at under GBP 1 million. And this is one of the reasons that we rotate capital around is in order to keep that size growing and remove the smaller assets, which, in general, have a higher degree of risk associated with them. I mentioned at the outset that the prospects for rental growth after a very fallow period of some years is beginning to look up and that's driven by growth inflation, actually on the index-linked pieces but also because the rent review process within this sector, it follows inflation because although 69% of the portfolio has got open market value reviews, what is an open market value review where the district valuer and executive agency of HMRC is responsible for agreeing the rent and who are the alternative tenants? Well, the honest answer is there aren't any alternative tenants and therefore, the open market value is kind of determined in practice by a proxy to index replacement cost. So you'll understand that as the replacement cost goes up, so do prospects for rental growth goes up too. Plus, we're spending more on our buildings now because of the need to have environmental concerns taken account of. We've heard about our first net-zero carbon development and all of the projects that we're looking at in asset management have as an important component of the work that we're doing and improvement in the BREEAM rating and the EPC rating for the properties. Just to pick on one at Lyng, which is in West Bromwich, it's a fairly substantial building. We're spending GBP 1.3 million and receiving a further GBP 78,000 in rent, so a yield on cost of 75%. There are 10 doctors in that building but a vast array of other medical services and it services some 15,000 patients. Following the project, the lease length will go out to 20 years. And the BREEAM rating, as you can see, or the EPC rating rather, will move to AB, and that is illustrated across the other 3 projects that are listed. So in order to leave plenty of time for questions, let me just summarize what we've told you. There are very strong demographic trends behind this business. We are playing our part in the levering up agenda by bringing capital into the less well-off parts of the country, trying to reduce the health care disparities. We have very strong prospects for rent roll growth driven by our 25% of the rent roll that is index linked. The government in Ireland and Britain pays 89% of the total rent roll and we are gradually going towards our GBP 3 billion gross asset value. There's a lot of uncertainty in the marketplace, so we're taking a disciplined approach to further capital commitments in the second half of the year. We're likely to wait and see before doing anything radical and different for the rest of the year into '23. So our strategy is very clear. And I think what we've got is a very defensive, predictable business, which pays good dividends to our shareholders. So with that, I'm going to return to the moderator, who is going to deal with questions.

Thank you to the team for the presentation. [Operator Instructions] I'd like to remind you, a recording of the presentation, along with a copy of the slides and the published Q&A can be accessed via Investor Dashboard on the Investment Company platform. We did receive a couple of presubmitted questions. If I may, we'll start the Q&A session with those. The first one reads as follows. Having recently listened to a presentation from a PHP competitor, with average development size of GBP 7 million to GBP 8 million, I'm interested in knowing more about the average size of investment for PHP's new property developments and some views to the extent to which the future development model is for fewer but larger scale developments in the polyclinic star facilities?

Well, thank you for that. Is that a question from Nick Beem or was that a separate question?

That was a presubmitted question.

Okay. I think the answer is that, firstly, I'd highlight that our average lot size now is GBP 5 million. And as the portfolio is growing, it is logical to either seek to maintain or grow that lot size. As Harry had touched on earlier during the presentation, this is the case for all smaller assets. But indeed, certainly for some, the threat of obsolescence of smaller assets is perhaps greater and it's in line with our strategy to invest in larger hub facilities, which will attract larger patient lists and the fit for the future in terms of housing more services as they come out of secondary care into primary care. So I think the answer is, in short, yes, we are looking to manage up our minimum lot size. Presently, that's about GBP 5 million. And in terms of bringing our development forward, as a generalism, really, they are at that size and indeed larger. So I don't think that's going to change the spots of our average lot size in the portfolio.

We've actually rejected a couple of smaller ones recently because the size of the opportunity was too small for us.

Yes, yes, absolutely, both in terms of development and investments. So we're selective with what we buy. We'd like to ensure that it's fit for the future. And we like to believe that the assets that we are focusing on are those that are likely to see the best, the greatest patronage and furthermore, the best rental growth opportunities.

The second presubmitted question or, I guess, really sort of a market question, but who are your peers? How are they faring? Who are the competitors, who are the comparable companies in your space?

Okay. Well, let me have a go at that. I mean, our nearest closest competitor is Schroder, which is very similar in size. It's been later into the marketplace in Ireland. It has a different funding strategy from our own and it's got a greater number of smaller buildings due to the history and what they've acquired. And it's further along the piece in terms of development with a bigger development pipeline that we've currently got. But actually, they are quite similar businesses. BlackRock have a GBP 300 million, GBP 400 million property portfolio, very similar stock, but they're not interested in disposing of it. And there's a couple of private owners that have smaller portfolios. And that's about it. In Ireland, there's one other competitor, has a similar sized portfolio to ourselves but one of the difficulties of private care is actually assembling a portfolio of significant scale. And over the last 26 years, the team has put together that portfolio and that's one of the reasons why it's worth the premium as indeed is the high-quality income that is driven from that, its consistency, its predictability and its durability.

That concludes the pre-submitted questions. And as you can see, we've had a number of questions that have come through throughout today's presentation. If I may just hand it back to you, just where appropriate to do so to read out the question and give your response, please?

Okay. So the first question is from Nick. Thanks very much for this. What is the rationale for disposals from the estate? When you have such great, I guess it should be properties, is it to take development returns to further expansion? Well, I think whenever we have a portfolio or if anyone's got a portfolio of stocks and shares, it's always a good ideal to keep it under review and where you see better growth potential elsewhere, to rotate that capital around. And that's what we did with the disposal portfolios. Is that David?

that those assets, we felt first, if we could sell them for a strong price, which indeed was demonstrated by the premium to the December 2021 valuation. And indeed, we feel we could at least rotate that capital into new assets, perhaps at higher yields, i.e., to generate more income with perhaps stronger potential to deliver better returns going forward.

Thanks. Should we go on to the next question. This is from Ryan. With new developments, do the government put this up to tender for the build-out of replacement sites that are fit for purpose or are these new sites? And how has the development pipeline manage from that basis? Well, that's a very good question. As with everything with the NHS, it tends to be quite complex and could be driven by many different sources because GPs technically are not part of the NHS themselves, they're independent contractors. It's managed by the GPs but obviously, they need to get budget approval, which comes through a business case. Now this business case is written by the GPs or their advisors, sometimes in conjunction within the old days, CCGs, but now, independent primary care networks. And they will have a shortlisting process with 4 or 5 developers in [indiscernible] and they will pick the person who is best suited to their needs. So that's the first part of that question. In many cases, the requirement for new surgeries is not just consolidation like our Eastbourne Project, which you can see on Slide 26, maybe you can just click to that quickly. So at least for, as you can see here, 3 older properties which are converted residential, not purpose built, have been scrapped effectively, dealt with by the developer, which was not us, in this case, we forward funded this deal and being replaced by a set GBP 10 million surgery or primary care center really with 20 GPs and a wide range of services. So that's one illustration of how new projects come about. But a much more common way is actually around new housing development. So with the Spilsby development that we saw back on that particular side is brought about because there's a large number of houses being built in Lincolnshire and particular Spilsby. And the planning requirement is for a new medical center to be provided and we want the competition to become the preferred provider of that working in conjunction with the developer. So it is a competent process, which, of course, adds to the complexity and the time taken but it's not as bad as being in a full-on competitive tender for the government, where the only real way of competing is on price. Clear specification is important, as is control of the sites and track record and the standard of fit-out that goes into the building also are very important.

That concludes the questions you had so far. And if, of course, if there are further questions, the company will be able to review those and we'll be able to publish responses on the Investor Me company platform. Harry, before redirecting investors to provide you with their feedback, which I know is particularly important to, if I could just ask you for a few closing comments, please?

Sure. Well, thank you very much. I think when times are volatile, somebody once said to me that PHP stands out as a beacon of stability. We operate in a sector which is an essential part of life, as we've discovered through the pandemic, having a vibrant and good health sector is very important. That means there's no shortage of demand for our buildings as you see. And because of prudent financial management, we're not able exposed to higher interest rates. The inflationary tailwinds that people are so worried about are actually quite positive for our business. And we're determined and committed to carrying on with our 26-year track record of paying an increasing dividend. Stability, defensiveness, predictability, these are all great phrases to describe primary health properties. And we look forward to playing our part in the modernization of the health care infrastructure in the U.K. and in Island in essentially responsible and environmentally friendly way. And we're looking forward to being back with you and delivering a further update with our full year results in the early parts of '23. Thank you for attending. We appreciate it and look forward to speaking to you all again.

That's great. Thank you very much, indeed, for updating investors today. [Operator Instructions] On behalf of the management team of Primary Health Properties PLC, we'd like to thank you for attending today's presentation. That concludes today's session, and good afternoon to you all.