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

Well, good morning, everyone, and welcome to PHP's interim results presentation. My name is Harry Hyman. I'm the CEO and founder of the business. On my right is Richard Howell, who is the CFO; and on my left is David Bateman, who is the CIO. In this morning's presentation, I'm going to give you the highlights from what was a very strong and resilient performance. Richard will drill down into the details of the financial performance during the period, and David will talk about the property portfolio and in particular, the rental growth that we have experienced. Just to remind you all that we have a very simple business model. We own properties that are let on a long-term basis to the NHS and GPs in Britain and the Irish equivalent, the HSE and GPs in Ireland. We have 513 properties property portfolio of GBP 2.8 billion, which is pretty close to 100% let, with 89% of the total rent roll, 89% coming from the British and Irish governments, which is why we can operate at a slightly higher level of leverage than some of our other competitors in the REIT space. The key highlight for us this year -- this half year has been the much stronger performance on rental growth. This has been driven by inflation, which accounts for 25% of our actual lease rent roll, but also a market firming in tone on the open market value increases that we drive out from the 69% of the portfolio that is let on open market value reviews. This is very important because it leads to greater cash flow and income. And this will be -- has been and will be sufficient to enable us to carry on with our progressive dividend policy. Just to say a few words about the background of the sector we work in. As we all know, the demographic drivers are very strong for primary care. We live -- both countries have growing populations. Both countries have aging populations and both countries have an ever higher incidence of chronic disease, like type 2 diabetes, like obesity and like dementia, all of which needs to be treated. And health care policy in most Western countries is about taking care out of overcrowded, expensive and sometimes disease written hospitals and putting it into the primary care setting. But you can't do that from dilapidated buildings. It needs to be done for modern purpose-built premises, and that's where PHP steps in. So the financial highlights for us are that we've already paid half of the 6.7p dividend that analysts have been projecting. And indeed, we've declared the third quarterly installment, which will be paid on the 18th of August. Moreover, this has been well covered from a coverage standpoint at 102% of dividend cover. Our property return, notwithstanding the fact that we saw a slight weakening of values in the first half remained positive with a huge impact on that from the higher level of rent that we've already experienced and that we predict in the years to come. And the benefits of this will become apparent to you as we move through the presentation. Our exposure to development is very limited. We have one project on site on the South Coast of Britain, and we confidently expect that to be delivered in the early part of -- we've maintained a disciplined approach to both acquisitions and also our development pipeline. We've put a lot of our acquisition activity on hold because of the higher level of interest rates and because of the lack of adequate rental levels in order to fund those developments. We put a lot of effort though into lobbying government at all sorts of levels to get policy shift in order to improve those rents and to enable our pipeline to get back on track. Moreover, we spent a lot of time, as you'll hear later on in the presentation on asset management, keeping our existing portfolio fit for purpose, negotiating rental growth associated with those fit-outs and maintaining the portfolio and improving our environmental scores and reducing our carbon footprint. So we confidently expect our rent review level to be over GBP 4 million for the current year, which is a marked improvement on last year, which was a 50% increase on the year before. And this endowment effect of the growth in rental income needs to be understood properly to understand the defensive nature of our business. Our cost of debt, very importantly, has been hedged out, 97% hedged out, up from 94% at the end of last year. And Richard will tell you a little bit more about that later in the presentation. We have a lot of undrawn headroom. We have no current intention of raising any capital anytime soon. We don't need to. And we have a full agenda of work on asset management, and we hope very much to get our Irish acquisitions back on track in the second half of the year. So if we move now to remind you of the dividend track record, you can see it set out there in all its glory. As I've mentioned already, 102% covered for the first half. And a statistic that I'd like to draw your attention to on a comparative basis is that PHP has performed better than its leading competitor on a property basis and better than the overall commercial index, which is not surprising given the high quality of our income, the disciplined approach to acquisitions and our emphasis on driving rental growth out from the portfolio. It really has been a focus of all of our activity in the first half of the year. And just let me show you the paradigm shift that I'm talking about in primary care. Many of you will have seen this slide before, but here it is. This really represents a fantastic story, moving the care out of the 3 rather dilapidated old residential properties that you see at the top of the slide, top right, moving into this -- or transmogrifying into this wonderful modern medical center at the bottom, 22 GPs, 100 health care professionals, a whole suite of activities, keeping people from the unnecessary journey to a hospital, doing procedures that could only have been done in the hospital before and acting very much as a walk-in center, again, to relieve pressure on secondary care. These are the sort of buildings that we see our focus of activity in both here and in Ireland. So having given you that brief overview with the emphasis on rental growth, I hand over to Richard, who will take you through the financials.

Good morning, everybody. I'm on Slide 7, if you're following the presentation. Just looking at the key financial highlights for the first 6 months of 23%. Net rental income was up GBP 4.4 million or just over 6%. And that increase was driven predominantly by rental growth coming from rent reviews, GBP 3.4 million, with a very strong number. The impact of a full 6 months from acquisitions and disposals last year added a further GBP 0.8 million, and we also saw a small reduction in property costs of GBP 200,000. So after admin and interest costs, which I'll come back and touch on those a bit later, we saw an overall increase of GBP 1.2 million in adjusted earnings to just under GBP 46 million or a 2.7% increase. Earnings per share were unchanged at 3.4p, but it led to a fully covered dividend which we saw those payments going up by 3.5%. So dividend per share, 3.35p for the first 6 months of the year. Dave will come back and touch on this in a bit more detail for later on, but we saw rental growth of 1.5% in the first 6 months or GBP 2.2 million. Rent reviews driving pretty much all of that performance with asset management having around GBP 200,000, but we saw some a few vacancies come through this period, which reduced that by 200,000. Small revaluation deficit, just under GBP 12 million, where we had 8 basis points of yield expansion, equivalent of GBP 35 million, and it really was so partially mitigated by rental growth, which added GBP 33 million to valuation. So overall, down at GBP 12 million or 0.4% deficit. That revaluation deficit along with the cost of acquiring Axis, which we'll come back and touch on a bit later in the presentation, resulted in the adjusted net assets falling to 111 or a reduction of 1.3%. That reduction in valuations also led to a small 50 basis points increase in leverage to 45.6%, but that still remains in the middle of our target range of 40% to 50%. WAULT declined slightly by 0.4 years despite this mitigate passing of time, asset management projects have helped mitigate that. So 10.6 years and pretty much a full occupancy at 99.6%. And we still have one of the low separate cost ratios in the whole of the U.K. REIT sector at just over 10%. And the average cost of debt remains at 3.2%. No change from year-end. Just turning down into the detailed income statement in a bit more detail. I won't go through the net rental income increase again. But just to highlight, we had GBP 500,000 of income from our new acquisition access in Ireland, and we expect the results for the second half of the year to be slightly stronger in the second half. Admin expenses up GBP 600,000. That reflected to GBP 200,000 of costs for the team in Ireland, which has now come on board additional pay rises for the team and a bigger provision for performance-related pay. Net financing costs up just over GBP 3 million in the period to GBP 24 million. That was really driven by additional debt, GBP 15 million increase from this time last year. That added about GBP 1 million. So of interest cost and the impact of rising interest rates across our variable rate debt, which is about GBP 50 million unhedged at the moment. We also lost our interest line GBP 500,000 of interest receivable from our developments that is now accounted for as a rent and was really in that increase in net rental income of GBP 800,000 coming through our acquisitions and disposals. Revaluation deficit has already touched upon just below GBP 12 million. We had adjusted profit -- adjusted earnings of just below GBP 46 million. There are a few other sort of exceptional adjustments relating to our IFRS acquisitions and acquisition cost ratio the Axis acquisition at the start of the year, which related in IFRS profit before tax of just below GBP 39 million, a reduction of 64%, but that really reflects the strong surplus we saw in the first half of last year that obviously reversed out in the second half. Just looking at the movements in the net tangible asset or net asset value. So opening net asset value, 11.6p. Adjusted earnings were fully paid out as a dividend, and the portfolio revenue adjustment of just under GBP 12 million of equipment to 0.9p [indiscernible] acquisition crossed EUR 8 million, and that was equivalent to 0.5p per share. The other sort of key highlight here to note is the portfolio is now valued or 4.9% stent yield, an increase of 8 basis points. And we continue to see stronger value ERV growth of 1.4%, and that compares to 2.2% in the whole of last year. Just looking at the debt summary transaction. As Harry already mentioned, 97% of our debt is now fixed or capped out for just under 7 years, and our LTV ratio remains in the middle of our target range of 40% to 50%. Just to highlight sort of a level of hedging we have for every 50 basis point increase in interest rates only adds 2 basis points to the blended average cost of debt. And for us to get close to hitting our loan-to-value covenants across the portfolio, the valuation needs to fall by GBP 1.2 billion or 42% decline. Now we don't have any refinancing now until July 2025, when the convertible bond is up for maturity is very much on our radar, and we're looking at various options to refinance that over the second course of this year or maybe the first quarter of next year. So what we did do in terms of financing in the first half of the year was convert GBP 52 million of sterling debt into GBP 60 million of euro generated debt, taking advantage of the cheaper euro interest rates that save us around 100 basis points on that debt. But we also did some caps. We purchased 2% cap for 2.5 years, obviously much cheaper to buy those in euros and sterling. So across all of our key debt metrics, they all remain very robust. Average cost of debt unchanged at 3.2%, a strong interest cover ratio over 3x, loan-to-value at 45.6% and just under 7 years weighted average debt maturity. So at that point, I'll hand over to David to take through the property portfolio.

Thank you, Richard. It's probably worth just recapping on how our rents are reviewed. 25% of our rent reviews are reviewed to indexation, typically with collars of 2% and caps of 4%, 6% of our reviews are fixed. The remaining 69% of our views are effectively upwards only market-led reviews, which obviously gives you a feel for the nature of the predictability of our rental growth. Year-to-date, we settled 172 rent reviews, generating an additional GBP 2.2 million worth of income, which on an annualized rental growth basis would reflect 4.4% allowing for build cost inflation and the increasing costs of development, we're perfectly comfortable to see an increasingly positive rental growth trend. Moving on to Slide 14. I think this slide really fundamentally underlines why we're so positive about rental growth. And just to draw your attention to a key line, if one looks at the table to the right of the page, you can see that we've highlighted the number of reviews that have been completed during different years. Obviously, the period of greatest inflation is more recently. And if you look at the year for 2022, you can see that to date, we've only settled 6 reviews of an outstanding 210 to go at. So therefore, I think you should be positively -- you should see that positively in terms of generating future positive rental growth from the open market side of our portfolio, which, as I said earlier, reflects 69% of our rent roll. Moving on. Obviously, we remain cognizant that maintaining the existing portfolio is very important, defending against WAULT decline and seeking to increase rents during the course of the year. We've completed 5 asset management projects. We have a further 8 on sites. We've done 4 lease regears and we have a strong pipeline of 32 projects with a capital value of about GBP 24 million. It's important to point out that these projects -- we ensure they carry an attractive yield on cost. And on average, for our pipeline, we can see that at about 5%. While carrying out these asset management projects, we seek to improve the environmental ratings of our buildings, typically targeting an improvement of 2 grades on the EPC ratings or AB. Positively, most of our asset management projects do allow for extensions, which I hope underlines the strong demand for our primary care space, both from services coming out of secondary environments and indeed to tackle NHS backlogs or as ever to allow for us to manage the growing and aging population. Moving on to Slide 16. If people are following the numbers. It's probably just worth standing back and highlighting the defensive nature of our portfolio. It's very granular. We have over 1,200 tenancies. It's effectively 100% let of the rent roll, 89% or 90% of the income is generated from the U.K. government. And it's worth pointing out that in terms of delinquency, which we tightly control, only about 9% of our income is due to expire in terms of rent roll during the course of the next 3 years. And with the large majority of those tenants, we're already in conversations about regearing and extending those leases, quite possibly around asset management projects, while at the same time, as I pointed out in the prior slide, improving the environmental credentials of the buildings. Moving on. I think as both Harry and Richard touched on, Ireland remains a key opportunity for us in looking at the cash-on-cash opportunity or the accretion to earnings bar chart to the right of the page, you can see that perhaps the level of profitability from these acquisitions has reduced, but it still remains positive and attractive. The schemes we can acquire in Ireland are larger than in the U.K. and benefit similarly from high proportions of government income. We are working on a near-term pipeline, and although development in Ireland remains challenged for the same reasons, frankly, it does here in the U.K. while rents need to catch up with inflationary pressures with a lower cost of capital and higher yields, we do see near-term opportunities to acquire standing let investments. With this theme in mind, moving on to the next slide, and as Harry touched on, our acquisition of Access Technical Services, the property management company in Ireland, is proving to be a very good move. It's giving us increased bandwidth to carry out asset management projects in Ireland, which is already proven to be good news. It comes with a very strong relationship with our key tenants in Ireland, the HSE and is allowing us greater -- allowing us to have greater communication with them. And as a result, we think that we'll be able to drive the portfolio better with, if you like, boots on the ground. We did have via a sister company of Axis Technical Services, a development pipeline. That pipeline a bit like our U.K. development program is essentially on hold while rents catch up with costs. but we do expect to come back to that in the near or medium term. Moving on. And as we always say, we have a disciplined approach to our pipeline. And as you'd expect and sort of as I've already articulated, our focus really at the moment is on potential expansion in Ireland, where it makes most sense and on profitable asset management deals. We think that development will feature more significantly in this chart, perhaps later in the year once our positive conversations with the District Valuer or ICBs progress, and we can positively agree to move rents on in order to ensure viability for our development. In coming on to development, I've now raised ahead to Slide 21. And as I've said before, development at PHP is really very low risk. We don't commit to acquiring sites until those sites have got planning permission and to the lease has agreed -- been agreed with the core tenants, particularly in the U.K., the GPs or in Ireland, the HSE. And indeed, the rents have been agreed such that we can see that development will be profitable and viable. We are having very positive conversations with the relevant ICBs regarding the 3 U.K. schemes you can see here being South Kilbane, Spilsby and Colliers Wood. And we're starting to see potential rent increases coming through between 20% and 30%, which would be very positive, not only for freeing up, liberating these schemes, but equally as a read across to rental growth for the rest of the portfolio. I'm not necessarily saying that would be a direct read across, but I'm saying it would be remarkably positive. The schemes we've listed here or behind me are historic schemes, but it's also worth pointing out that we're having conversations regarding new schemes where there is a slightly different approach to setting the rents at the outset. On that note, I'm going to pass back to Harry, who's going to round up the presentation.

Thanks, David, and thanks, Richard. So there we are. PHP has demonstrated another resilient and robust period and its trading history. We remain keen to assist in the modernization of the NHS and the HSE in Ireland. Our social infrastructure assets are really key to the delivery of the national health in both countries. Cross-party support. If people -- I think we don't need to be worried about political change because both parties, both major parties remain committed to the NHS in Britain and both parties in Ireland, Fianna Fail and Fine Gael are the same. People expressed a fear about digital during the pandemic. In fact, whilst digital accounts for a large number of initial consultations. Interestingly, the number of face-to-face consultations in Britain is already higher than it was pre the pandemic. So whilst your initial triage may be done on Zoom or Teams, a follow-up, particularly for people with complex medical needs, comorbidities to use the jargon, has to be done really by the doctor who can make an informed assessment about the holistic nature of the patient's woes. So we don't need to -- we keep a weather eye on it, obviously. But digital is not a life-threatening threat to PHP. The key message that we wanted to get over to you today as well as saying that our portfolio is 100% let, with 89% of the income coming from the British and Irish governments is that the improved rental outlook puts us in a very good position to withstand the volatility that we've seen in the economy and in the interest rate environment. As inflation abates, which we all hope it does gradually and as interest rates return to a more normal level once they've had a chance to operate. The prospects are that PHP will get back on track for its expansion policy. In meantime, we see attractive possibilities in Ireland. We've maintained a very disciplined approach to the market, and that's shown up through our property returns. We're pleased with our acquisition of Axis, although it was small, it gives us a very important strategic benefit in Ireland. I see no reason for us to change our focus on dividend growth continuing the track record of the last 27 years. estimates in the market are that we'll pay 6.7p for the current year. And as I said at the outside, we've already paid half of that, and we declared the third quarterly installment, which is due on the 8th of August. We're focusing on our low carbon approach to making sure that our impact on the environment is reduced. And overall, we're helping to deliver a robust health care system and service fit for the 21st century. So that completes the formal part of the presentation, but I'd now like to open to questions from the floor. Maybe if you have got a question, you can just say for the benefit of others who you are representing. And we can take it from there. Any questions, please?

It's James Carswell from Peel Hunt. Just on the pipe. I appreciate you scale back and put things on hold. But just in terms of the -- on the rents you're now talking to, both in Ireland and the U.K., the increased rents, what kind of returns that will translate into and kind of the return hurdles you're looking to achieve before you kind of press the [indiscernible]

I think in simple terms, you can reverse engineer the answer to that because if you had to fund the developments of today's interest rates, you'd be looking at a much stronger rental level that would be needed to make it stack up. And as David said, they could be anywhere between 20% and 35%. But before everyone gets excited, you couldn't make a direct read across from that into rental growth, but some of it will be reflected -- so if you -- if a current project was at GBP 230 a meter, we would need 265 or 270 million to get it going in Britain. When you're reviewing a surgery nearby, which might be of GBP 190 or GBP 200 a meter, it becomes much more -- a much easier argument to say that there needs to be some growth on that. So index replacement costs in my experience over the last 27 years has been quite a good proxy for the rental levels of open market value projects in Britain.

Okay. And then maybe just on yields on costs and again on those appraisers, how have they changed from, say, 12 or 18 months ago? Are you now looking at trying to actually significantly higher yield on cost on those developments?

Yes. I mean it's -- the portfolio yield for our projects for our properties overall, we've stated at around 4.9%. Obviously, new deals are tighter than that, but those levels have gone up from frankly unsustainable levels that they were when interest rates were extremely low or close to 0, where people were paying 3%, 3.5% initial yields and they'd be probably closer to 4%, 4.25% initial yields across the space, higher in Ireland.

Rob Murphy, Edison. Just coming back to the developments and just general planning. You talked about interest rates returning to normal levels. I mean, some might argue that interest rates are normal now. And my question would be how are you -- when you're looking at those talking about the rental increases, are you planning on current rates lasting for a long time? Or are you assuming they're going to fall?

Okay. So I'm not in the business of predicting interest rates. That's a foolish past time. But the Bank of England's target at any way, remains 2% for inflation, and there would need to be a margin above that. So I guess my comments were not that interest rate is going to go back to 0, but they might level out at 3.5% or 4%. That's my own personal view, not the company's view. But it will take time. However, our debt is on average hedged out for 7 years. And if we see rental growth of 3%, 4% per annum across the piece during that period, there won't be any need you could work this out in a little spreadsheet, I'm sure, for there to be a reduction in dividends by the time we get to refinance the debt. So it's a question of those rental growth numbers feeding through into the income account, which is -- it's all well and good to talk about property valuations, but you can't spend a property revaluation but what you can do is spend rental growth income and that is coming into our P&L account, and we'll have a huge impact on the P&L account moving forward. Because, of course, what people tend to forget is it is cumulative. Your 4% rental growth this year, you will still get next year, plus another 4% hopefully or higher as inflation comes through. And when David said, the impact on rental growth is lagged because it takes a long time in this sector to get your rental reviews settled. We're working hard and diligently at it, but it does take time.

It's Max Nimmo, Numis. Just a quick one on the access development pipeline. At the current pace of the rent growth that we're seeing at the moment, and I appreciate you've kind of got a bit of a forward look on that. When would you be able to expect to kind of commit to those developments?

Well, I mean it's hard to say because the -- when those vets become viable, we'll be keen to press on with them. I suppose it's probably fair to say that the situation in Ireland with the realization around rents arresting development potential has probably hit them a bit later than it has us, partly in line with what's happened with the European economy versus the U.K. economy. But what I would say going forward is that once those schemes become viable, we'll be very keen to press on them now whether that's early next year or later next year, I really couldn't say. But I think that's the message that we're anticipating to become viable once the government there have reviewed the rents and come to a determination as to what they're prepared to pay.

I think it's also, you have to bear in mind that because we're dealing with public sector projects and public sector money, some of the projects will probably have to be retendered, which is quite a long bureaucratic process, whether they do an accelerated retender or not, I don't know. But we have raised these issues with senior people within health ministries and politicians to make them aware that unless we get a return to more sensible levels of rent, there just won't be any new medical centers built. And so that's a policy question for the NHS, and it's a policy question for the Irish Ministry of Health because you do know one can magic these numbers out of thinner. And we've moved from a position, you don't need me to tell you where 0 interest rates were very much the norm, indeed, negative interest rates were the norm in Ireland and the European area where inflation didn't really exist. And now inflation has come back to bite and that means that rental levels will have to go up. It's a simple economic mathematical calculation.

Hi, I am [ Shan ] from Travis Capital. Just a quick clarification. Obviously, you mentioned the direct development you sort of paused on, but then you've got EUR 14.8 million of forward funded project in Ireland. I sort of want to understand why you're happy to sort of progress with that rather than -- and keep the direct developments on hold?

Well, it is quite simple. For the project in Ireland, it's viable based on the cost to develop and the rent that exists. It's a different territory, whereas in the U.K., as it stands, the development costs required to build those projects out would make the scheme unviable until, as we said before, the rent increases. So it's kind of a consistent theme, but there are some differences in some cases, perhaps nuance between projects, by geographical location and jurisdiction. And the scheme you're pointing out in Ireland is just one scheme that should things work out in line with what we hope it would be viable.

Well, we seem to have exhausted questions in the room, we're now going to go to questions from our listeners online.

[Operator Instructions] We'll take the first question from Kanad Mitra from Barclays.

So one question from me is, how would you see your business model evolves if interest rates and your marginal cost of debt settles at current levels or maybe at higher levels compared to very recent past averages? And do you also see the conversations with NHS evolving if such a situation kind of stabilizes? And what would be your pecking order in the capital sector, that would be all...

I didn't quite catch the second part of your question, Kanad. Could you just repeat that a bit?

Yes. And it's such a higher interest cost environment purpose, how would you see conversations with the NHS evolving? Would they be flexible regarding their conversations?

Yes. Well, I think they live in the real world as do we. And I think we were trying to indicate that on new projects, there is some flexibility creeping into the conversations. They're not documented as yet, but as and when they are, then that will be more good news to bring forward. I think it's a moving dynamic with the interplay of rental levels with underlying long-term interest rates and rental growth will come through to make the model work because the capital cannot be found by either government, there is quite a shortage of capital. The governments in Britain -- in Britain anyway is a very large borrower and it doesn't have a lot of headroom on the capital account. So this method of funding the needed improvements in primary care will have to come from the private sector in part, and it will have to come from the private sector in part in Ireland. So this investment in social infrastructure will continue, but it will take a period of adjustment, which is what we're seeing now for the system to change and to adjust. So we're very confident about our ability to carry on, but it will need the higher rental levels that I indicated, which will need to pay for the higher cost of construction and the higher overall cost of finance. But the key point is that, that doesn't threaten our income model because over time, the, let's say, 3% to be conservative or 4% rental growth over the next 7 years will enable us to fund that higher cost of interest moving forward.

There are no further questions on the phone at this time.

Okay. Well, let's close the presentation there. Thank you all for attending both online and in the room. And we'll be around to answer more questions or have a chat for those who want to stay. Thanks a lot.