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

Thank you. We're here for the Primary Health Properties investor presentation following last month's half year results. This presentation is being hosted by Research Tree -- on Research Tree by Capital Access Group. [Operator Instructions] So now without further ado, I'd like to pass the baton to Harry Hyman, CEO; and Richard Howell, CFO of Primary Health Properties. A very good morning to you guys.

Thanks very much for that kind introduction, and good morning to you all. Thank you very much for joining us. We're here to give you an overview of our results for the first half of the current year and to talk a bit about the prospects for us, which are, in fact, remarkably good, although it would be hard for us to believe that from the reaction our share prices have to rising interest rates. Now for those who don't know us terribly well, PHP has a very straightforward business model. We own properties on a long-term basis, principally to the governments of Britain and Ireland, who are responsible for paying 89% of our total rent roll. Of that rent roll, 25% is actually linked to inflation measures and therefore, is a direct beneficiary of the current higher rates of inflation. Our debt, which is around 45%, 46% of the loan to value is 97% fixed out for the next 7 years on average. So we have remarkably little exposure to current higher levels of variable interest rate. So 97% of our debt is fixed out. Buildings, unlike other sectors in property, are almost 100% let with a very strong renewal rate. So we don't face the headwinds to retail and other parts of the property sector face. Our rent roll has grown and is now GBP 147 million. And our total portfolio is about GBP 2.8 billion. There was a very small decrease in monetary terms of an 8 basis point shift out in yields that we experienced in the first half, but a lot of that was counteracted by the growth in rents. And the real key headline -- the headline message from us for the first half of the year is that rental growth is here and is accelerating. If we could just jump forward for a moment to Slide 14, I think -- sorry, 13, you can see this in graphical form illustrated quite well here. Thank you. So back in 2022, we received GBP 3 million worth of additional income. That's the second from the right column in the bar charts on the top right-hand corner of the slide. That was 50% up on the year before, which was at GBP 2 million. And you can see how that growth was accelerating through '21 and '22, but has really come on quite a lot, and we are now forecasting GBP 4 million plus for the year '23 as a whole. And this is a combination of the higher inflationary linked increases, but also a marked firming in tone of the open market value component of our portfolio, which is some 69% of the total rent roll. We've been hammering home the message to the District Valuer, who is responsible for agreeing the rents on behalf of the NHS and the governments in England, Wales and Scotland that we are subject to inflationary pressures, that the cost of new buildings are increasing and this needs to be reflected in higher rents for both new developments but also the existing portfolio. So that's one of the key messages that we wish to emphasize during this presentation. If I go back to Slide 3, please, Richard. The other key points that I wanted to make are that obviously, we are an income stock. We are delighted to be paying our 27th year of consecutive dividend growth. Brokers are forecasting 6.7p for the year as a whole, which is up 3% compared to '22, and we have already declared 3 installments of that, and we paid 2 installments of it. And indeed, the third installment of 1.675p is being paid to shareholders this Friday. The fourth dividend payment is normally made in November of the year. So this high dependency, high transparency, high clarity of income is one of the key messages, coupled with our debt being substantially all hedged out, means that there is no threat to the likelihood of us paying what the projected dividend is for the year as a whole. We have put our activities in terms of adding new properties in the U.K. on hold because we want to make acquisitions that are accretive and in a strange but true way because property values have not slipped out terribly much or as much as people might have been expecting and as much as the share price is implying, that's meant that we can't make attractive acquisitions in the U.K. But we still have our activities in Ireland, and we'll come and describe a bit more of those in a few moments. Our dividend track record is set up in the next slide. And as you can see, that 27-year track record, which we're very proud of, the dividend is fully covered in cash terms. And we believe that we have a very good portfolio and you can see how it has outperformed the MSCI index over every period, and it's also outperformed our nearest quoted competitor.

Just jumping in very quickly there, Harry, sorry, if I may. Your dividend history there suggests that PHP has a long track record of delivering consistent performance. Is there any difference between PHP's positioning at this point in the cycle compared to downturns of the past?

Well, when we look back at the global financial crisis, that was much more of a question as to whether we could get through that and carry on paying our dividend, but we did. We have robust banking partners. And I don't think there's any question of us not being in a position to carry on with that dividend track record. And indeed, as we'll sort of get into maybe during questions, even if we were to refinance our debt when it expires, and there isn't any debt expiry for at least 1.5 years with the convert being first up to be refi-ed, then we're confident that the rental growth will mean there would not need to be any reductions in dividend moving forward and indeed, we should be able to carry on with a modicum of growth. Okay. So having dealt with that, let me just say a few words about primary care in the U.K., which is where we operate, obviously. We do not own any buildings, which are similar to the ones in the top 3 at Eastbourne, which is an example of how we've spent about GBP 10 million on this building a few years ago, where you've seen smaller GP practices merging into one super practice. And this really emphasizes that the demographic drivers are very firmly in our favor. We all know, and this is true for Ireland as well as the U.K. that we have a growing population. We have an aging population, and we have one that has got an ever higher incidence of chronic disease. And one of the good ways for both patients and health care systems are dealing with the increased demand on it is to treat more people in the primary care arena. Very difficult to do in the old-fashioned, not fit for purpose and not purpose-built buildings in the top 3 illustrations inside but much easier to do from the modern purpose-built building at the bottom, which has 22 doctors, 100 health care professionals and delivers a lot of services that otherwise would have to be delivered in a hospital. So the key message is that demand is very strong for our buildings. The digital threat that people were worried about during the pandemic has not translated itself into reduced demand for space. A lot of initial consultations are clearly done by Zoom or over the Internet rather like this. But most follow-up consultations have to be done in person and services being [ de-counted ] out of hospitals into primary care, make up any slack that there is. And an interesting statistic is that there are already more monthly face-to-face consultations than they were prior to moving into the pandemic.

And Harry, just if I may, just while we're on this slide. Another risk I suppose would be political risk. Given the high level of U.K. government borrowing, is there any risk of a change in government or NHS policy as far as moving care out of hospitals and into the community, guys?

No. This is a western health care dynamic. And if you were in Holland, France, Germany, America, Ireland is a good example of it. It's all about taking care, making -- taking advantage of technological advances and moving things like diagnostics into the primary care arena. 25 years ago, it would have been impossible to have an x-ray or a scan in a building like the 3 old ones at the top of that slide, but perfectly feasible to do that in a building like the modern purpose-built one at the bottom. And that's what our mission is to help modernize health care systems. And indeed, you could argue that a moderate socialist government would be very good for our business. It was certainly the last time in '97 when Tony Blair was elected. So I'm itching to hand over to Richard, who's going to take you through the numbers in more detail. Richard, over to you.

Thanks, Harry, and good morning to everybody. I can see there's a couple of questions on interest cover and debt. So I'll try and cover these points off as we go along. So just looking at the key financial highlights for the first 6 months of the year. Net rental income was up GBP 4.4 million, just over 6%. And the key component of that was the rental growth that Harry has alluded to at the start of the presentation, which added GBP 3.4 million of additional income. The impact of acquisitions and developments that came online in the first half of last year added further GBP 800,000. I mean you had a small reduction in property costs of GBP 200,000. So after we deduct admin costs and interest, we had adjusted earnings just under GBP 46 million, up just under 3%. Again, that was driven predominantly by the rental growth coming through from rent reviews and acquisitions. But also for -- have extra GBP 500,000 from our acquisition of Axis, and we'll come back and talk about that a bit later in the presentation, a property management business we acquired at the start of the year. That was offset with higher interest costs coming through from the increase in interest rates that we've seen over the last year. So that led to adjusted earnings per share, 3.4p. No change over the previous year. Obviously, we touched on, fully covered dividend at 102%. Like-for-like rental growth, we dealt with is GBP 2.2 million, up 1.5% in the first 6 months of the year. And we had a relatively small revaluation deficit of just under GBP 12 million. Now we saw yields on the portfolio widened by 8 basis points, which led to a GBP 45 million revaluation deficit rental growth, and this is a key message from us. Really helped to mitigate that deficit, and that's resulted in a surplus of GBP 33 million. So overall, GBP 12 million down. So we really see rental growth is really the -- underpinning the bedrock of the portfolio revaluation. Portfolio was valued at just under GBP 2.8 billion and a very small deficit, just under minus 0.4%, which is quite strong performance compared to most other property companies in the U.K. That deficit was equivalent to 0.9p per share and a key reason why the net asset value fell to 111p. Loan-to-value ratio is flat bang in the middle of our target range of 40% to 50%, and that really reflects the security of our income stream at 45.6%. I'm just looking at key metrics for the portfolio. Long WAULT 10.6 years, pretty much full occupancy at 99.6%. EPRA cost ratio is 10.1% and it's one of the lowest in the whole of the U.K. REIT sector. And the average cost of debt, and we'll come back and touch on it a bit later, is unchanged since the -- this time last year, despite the increase in interest rates, which really reflects the hedging and fixed nature of our debt book. Just touching on the movements in the portfolio net asset value. Start of the year at 112.6p, adjusted earnings 3.4p were fully paid out as a dividend to shareholders. But as we touched on the revaluation deficit equipment to 0.9p was a key reason for the small decrease in the net asset value. And then we have the cost of the Axis acquisition, EUR 8 million, which is coming to another further 0.5p. What other sort of key things here? Net initial yield on the portfolio, 4.9%, and we've seen value starting to increase ERVs between 1.4% in the first 6 months of the year. So if you double that, we're on target to perhaps delivering 3% rental growth over the course of the full year. Looking at the debt stack. Obviously, we don't have much development exposure. So we like to use leverage to try and drive returns. So you have a number of various facilities with a number of lending partners, most of which is fixed or hedged out for just under 7 years and average cost of debt is 3.2%. So for every 50 basis point increase in interest rate, it only adds 2 basis points to the average cost of debt. So there's a lot of protection there. So when you look at the inter -- forward interest rate curve, you can see it's increasing quite significantly over the next couple of years. But that really shouldn't have any impact on our earnings over the next couple of years. And the only -- the key refinancing coming up is in 2025. We have 2 facilities maturing. One is a convertible bond in July '25, GBP 150 million. We also have a further bond for GBP 70 million. So at the current period, we are not really looking to refinance those because the market is so uncertain. I mean we do have time on our side if we have to really come back and renegotiate those facilities. All the other facilities maturing in '25, we expect to be extended out to 2027 in due course. As I already touched upon, 97% of our debt is fixed or hedged out, which just under 7 years there's a lot of security there. And we don't really expect the impact of increasing interest rates to really impact the earnings. And really, any increases that do come through will be offset by the additional rental growth that is coming through. We do have GBP 340 million of undrawn headroom across our various facilities, sort of firepower there to keep expanding the portfolio, but also deal with any sort of unforeseen circumstances that may come through. There's just a few sort of key metrics here. Perhaps I want to focus on is interest cover over 3x. Long weighted average debt maturity, 6.9 years, and we're still continuing to do some hedging, especially in Euro generated interest rates much cheaper than sterling. Again, trying to help protect the earnings for the future. Harry, back to you. I think we already touched on rental growth.

Yes. So I think maybe we can just go back to talk about...

Just maybe before we move on to rental growth. You said that you're having, as I say, firm negotiations around price. How receptive is the district valuer at NHS you've seen?

I mean a few points to make, and I'll try and tackle some of the questions that have been asked as well at the same time. In Ireland, everything is linked to Irish CPI, but on a 5-year capped 25% basis. So what that means is that it's not that rent can only go at 5% per annum, it's that rent can only go up by 25% measured over a 5-year period. So in fact, we're managing to capture most of our CPI now because we've had a couple of years of very small inflation and then Irish CPI, I think, is running at 7% or 8% of what's last month. So we're capturing much of that as we go through the rent review process. So Ireland is very formulaic and is linked to Irish CPI. So that's kind of good, ticking the box. In Britain, some of our index-linked leases are capped. But at the moment, that's not having much impact on the level of inflation that we're capturing. And a lot of those will be capped at 2% to 4%, but a vast majority of our inflation-linked increases in the U.K. are not specifically capped. Now the district valuer himself probably sees himself as guardian of the public purse, but actually has to set a fair market rent. And there is an independent appeals process for us to go through should we not agree with the district valuer. And it's true to say that although we've -- we've commissioned a report from CBRE, which is on our website under Presentations, which sets out all the reasons, the economic reasons why rents should grow which is higher inflation, higher interest rates, lack of yield contraction, higher specification of buildings, the District Valuer is dragging his and her feet, but it's true to say that we're still dealing with a lot of prior years. So when you look at this chart, slightly complicated. Slide 14 on the screen now, you can see that we're still dealing with '20 and '21 and '22 increases rather than '23 increases. So as we move into like a more modern vintage as we go through '23 and '24, we should get a higher level of open market value. I mean, it's true to say we're not able to pass on inflationary increases as quickly as someone like Unite or Workspace or Big Yellow. But equally, we have a much longer lease in place with the NHS. And as a proxy, our rent reviews happen every 3 years. And although they take a long time to settle, we get interest backdated to the date of the review. And obviously, the higher base rate is good for that calculation where there have been delays caused by the district valuer. So I think that probably deals with those questions on rent review. And maybe now we should turn to asset management, where we're keen to keep our buildings fit for purpose to improve their environmental impact, i.e., reduce the carbon footprint of the buildings and what is true to say is that we operate in a sector where there isn't normal supply and demand equation, everything is built to order. There is no surplus supply and provided we invest in modern buildings and not scrubby old, single-handed and double handed practices like the ones we saw at Eastbourne, there's a very, very, very strong likelihood -- 99% likelihood that the assets will renew. And here are 4 examples of projects that we have entered into in the current year. A refurbishment at The Lyng in West Bromwich; a refurbishment and lease renewal of Falcon Road in Battersea, which was actually one of the first assets PHP ever bought way back in '96 or '97; a major extension at Long Stratton in Norfolk showing the real demand for facilities in primary care; and a reconfiguration of space at Sprowston in Norwich. We're aiming to spend about 24 million over the next couple of years. And our target for yield on cost here in terms of the extra money spend is some 5% -- 5% to 6%, which should give us a return over our cost of funds even if higher base rates were to continue for the next 2 years and beyond. So this is another key message that our properties don't have to have massive amounts of money spent on them in order to comply with our ESG target, but there is good continuing demand for our assets. And we have a team of perhaps 10 people engaged in asset management. So if you just turn the page, Richard, if you would. Here, you can see that the portfolio has got an average lot size of 5.4 million. You could take that as a rough proxy for quality within the primary care space. Average WAULT of over 10 years, the occupancy figure that Richard mentioned at the beginning and with a very high percentage of government backed rent at 89%. Of the 13.3 million of our lease income that has less than 3 years left to run, over 70% of that has already been agreed in terms of renewal. And this is a constant program, which we monitor day by day and week by week with our asset management team. So that is good. Richard, would you like to talk about Ireland perhaps?

Yes, certainly. Here I am. As Harry has already mentioned, we've pretty much paused activity in the U.K., but we continue to look for new acquisitions in Ireland, which is our preferred area of expansion. The portfolio in Ireland is currently around 8% of the total, but we do want to grow that to around 15% of the total around EUR 500 million in size. You can see from these pictures, the [indiscernible] generally tend to be much larger. 75% of the income is coming directly from the Irish government. It's a very strong covenant there. And also very long leasing. So average lease length and expiry at the moment in Ireland is 20 years. At the start of the year, we acquired Axis, which is a property management business in Ireland. That gives us a permanent presence in Ireland. It really helps us to seek out new opportunities there and also deal with some asset management initiatives. So I'm sure to have people on the ground dealing with local [indiscernible]. The yields in Ireland is also much more attractive, 5.4%. Obviously, the cost of finance is also much cheaper, around 3%. So it's much more accretive to buy these assets in Ireland, and we have -- also all of our debt so far in Ireland is all fixed out for around 10 years at a blended rate of 2.3%. So very accretive to earnings in terms of drop down over 3%.

Yes. And although we haven't had much through it at the moment, we do have a pipeline agreement with a sister company of Axis Technical Services, not the company we bought, in order to have first right of refusal to buy their stock in the future. Let's move on to the pipeline, please. Pipeline slide, please, Richard. And here, you see nothing in the stocks for U.K. investment, although we hope to make 1 or 2 smaller acquisitions during the second half of the year. Another 3 developments coming on board possibly in the second half, early doors in next year and a stronger pipeline but still a very moderate pipeline in Ireland. So what I think this means is we're not absolutely having to buy assets in order to generate dividend growth, but we're quite capable of generating dividend growth that people are looking at by growing the rent roll and the asset management opportunities that are the meat and drink for us. However, if we look at the development pipeline such as it is, we're on site, at one particular -- perhaps if you can just move the slide on, please, Richard, to 21. Thanks a lot. We're on-site at one project in Croft in West Sussex, which is proceeding and should be finished next year. We're looking at a fit out. So not a particularly high risk of the bottom floor of a high-rise block in an estate that's been rebuilt at South Kilburn. We're looking at and maybe close to a medical center development at Spilsby in Lincolnshire. And we have others in Colliers Wood and another one in Ireland, which we hope to announce further progress on in the second half of the year. So in sort of summarizing before we get on to further questions, we have a very dependable, low risk ultra conservatively finance business. The yield for anyone thinking about topping up is a very attractive 7% plus at the current share price. We are very infused by the stronger rental tone that is coming through. And in fact, we might be described as a company that ultimately will do much better from inflation. Ultimately, we'll do much better from higher spending on health care that might follow from a different colored government. We have a disciplined approach to what we're doing. We're not looking to raise our leverage anytime soon. We have minimal debt repayments due. The next one is the convertible, which is not due till the middle of '25. And this higher rent growth will enable us to get through the current shorter-term higher interest rate scenario. We're very pleased with our acquisition of Axis, which is actually moderately earnings enhancing. And we're going to carry on improving and modernizing health care for the benefit of populations in Britain and Ireland. So we have a lot of social impact. We're going to focus on continuing to grow that dividend. So that is the message that we wish to pass over and the rental growth is very, very strong.

Harry, Richard, thank you very much for taking the time to run through the presentation today. [Operator Instructions] I just have a couple of questions before we get to those on the line just that were raised through the presentation. Coming back briefly to asset management, is there any difference in the scale and scope of the asset management activities that you're undertaking today compared to some time in the past?

Yes. I think we continue -- as the portfolio ages, there's more to do. We have 513 properties. Time waits for no man. And we -- I think you can see particularly, like Long Stratton is a very good example, where we're spending almost GBP 2 million and generating an acceptable yield on cost. And almost doubling the size of the facility in order to cater for consolidation in primary care, but also to deliver with these -- sorry, to enable us to the NHS to house these additional services. So that -- there are some pretty substantial investments going in and the creation of integrated care systems, which replace clinical commissioning groups, do enable a more whole system approach to be taken by the NHS, under which better decisions can be made and move care out of expensive, inflexible hospitals. In the middle of the pandemic, a senior figure in NHS England said to me that they had made a terrible strategic error by co-locating all the diagnostic facilities basically in the country in hospitals where people were told not to go. And that's one of the reasons there's such a big backlog is that people simply couldn't get their diagnostic tests done. But now that can be handled much more in primary care or in community diagnostic centers, and that's one particular adjacent that we're looking at, where we'd be very happy to own a community diagnostic center let to the NHS where cans and x-rays were done routinely. And of course, the work flow through those sort of centers can be much easier. It's much easier to schedule because it's not constantly interrupted by trauma cases and ER type cases that walk in through the door, which caused delays to regular screening activity in major hospitals. So the ICBs and ICSs are very much the way of the future for the NHS, and we're looking forward to perhaps a new administration having a slightly longer time horizon in order to sanction investments in primary care.

And then just briefly covering off the last probably a bit of asset management and maybe jumping in slightly into the shape of the portfolio. You set out your net zero carbon framework with a target of net zero across your operations by 2030 and the whole portfolio by 2040, including tenant activities. Can you run us through how this is progressing and how that changes the shape of the portfolio?

Can I take that, Harry?

Yes.

Yes. So 3 key steps for us to achieve being net zero. We set out ambition of being -- for all of our operations to be net zero by 2023. We achieved that last year by buying some offsets, and that is really the carbon emissions from our business travel and running our 2 offices. We want all our new developments to be net zero by 2025. Now all of the ones we showed you pictures of earlier have been designed to net zero standards, and we have one development on-site at the moment, Croft and that has also been built to net zero at present. And then lastly, we want to talk about asset management activities to be net zero by 2030, and we're running the first 2 pilot projects this year, which will be completed next year to really learn from that process with a view to trying to get those projects to net zero much more quickly than the 2030 target we've given ourselves. Though there are perhaps bigger challenges in engaging with the tenant base to try to get them to net zero and their activities is going on in the medical centers by 2040, which is a longer-term objective. But that's what dovetails in with the NHS' objective of being net zero by 2045. So you want to try and get there 5 years ahead. But this is also all about protecting long-term value of the estate, so we don't ever see any brown discount appearing in the future.

And then just a final couple for me before we pass across to those on the line. So Harry and Richard, you may have to scroll down to see [indiscernible] on your screen there. Can you talk about the difference between the U.K. and Ireland as far as developments go? Why is it still bothering Ireland but less so in the U.K.? And then maybe dovetailing into that, does the current environment present an opportunity for M&A for some of the smaller private companies that you might be competing with?

Richard, over to you for that.

Well, I think Ireland, on development side, we do have a number of sort of relationships with some of the key developers there. But it comes back to a point that Ireland is much more accretive to earnings and our preferred area of expansion, much better yields, cheaper cost of finance. So very accretive. We would like to do more in Ireland, but obviously Ireland is quite a small country. As and when we can find these opportunities, we will progress them.

And it's driven by the higher yield compared to the U.K. and the lower debt cost is as simple as that and the block chart on the right-hand side of the screen that Richard put up shows for people to study at their leisure. This is obviously on our website as well. Just picking up some of the other questions that have been asked. Certainly, we -- one of the most carbon effective ways of delivering new buildings, actually to use old buildings, and repurpose them. So we are certainly -- and we already have some examples in our portfolio. An iron foundry, believe it or not in [ Star Head ], a railway shed in Oslo Street, a fire station in Southampton, all of which have been repurposed, and that results in less embedded reutilization of the embedded carbon rather than launching off with new cement, brass and steel. And we do see a couple of opportunities for repurposing offices. Indeed, we're looking at something in Ireland, which is a repurposed office block. So yes, I mean that's very high up our agenda. Someone's asked if we have looked at other European countries, which we have. We haven't found anywhere to compare with the length of lease that we're getting in Ireland, which is like 20 years plus. The most we've seen is sort of 15 years, in places like Holland. Holland has already been quite well permeated by its own health insurance companies in terms of those buildings. But we keep a weather eye open for opportunities. And I suppose the most pertinent question perhaps today is are you surprised by the fall in the share price? Yes, but I think a lot of this is driven by index-linked funds, algorithmic trading, private investors, dare I say it, panicking or putting money into gilts for a short-term return. So -- but what people think of is that we are a simple bond proxy, but we're not. Because the key difference is that the real value of our assets and our income will continue to broadly track inflation. So inflation -- actually this is why I said inflation is actually our friend. And so there are good opportunities to buy our shares. And from my standpoint, personally, it might have been overbought when it was 150p, 160p. And perhaps it's oversold down in the low 90s where it is today. But I suspect that we'll have to wait for interest rates to have definitely peaked for people to change their outlook. But the U.K. is quite a challenged investment market, I think, at the moment for all sorts of reasons, which are beyond our control. But we -- what we can do is stick to the netting, stick to delivering the rental growth and stick to delivering the dividend growth for the future, and that's what we are all intent on doing.

Perfect. I think that covers off all of the questions that we have had through. So Harry, Richard, would you like to leave us with any final comments?

Keep the faith. We're going to keep the faith in delivering the rental growth and the dividend increases, and we will -- we will get through. I mean this is actually not nearly as difficult as the global financial crisis in 2008, where there was a real question on the survivability of the banking sector. Primary care is a growing part of the health care system. We all know -- we can read every day the stresses and strains that the NHS is under and primary care is an effective way of helping relieve that stress and strain by dealing with many simple issues within the enlarged modernized primary care estate. That's the message from us.

Perfect. Harry, Richard, thank you very much for taking your time to run through the presentation this morning. [Operator Instructions] We sincerely appreciate all your participation in today's presentation, and we'll now bring this session to a close. Good morning to you all.