Target Healthcare REIT PLC (THRL) Earnings Call Transcript & Summary

Good morning, ladies and gentlemen, and welcome to the Target Healthcare REIT PLC investor presentation. [Operator Instructions] Before we begin, I would like to submit the following poll. And if you could give that your kind attention, I'm sure the company would be most grateful. And I would now like to hand you over to the management team from Target Healthcare REIT, Kenneth, Gordon. Good morning.

Good morning, and welcome to our discussion this morning about the merits of Target Healthcare REIT as a long-income company. And welcome also to Sterling in Scotland on a beautiful sunny morning. Gordon and I are presenting. I'm the founder of the business and the Chief Executive. Gordon joined me 11 years ago when we launched Target Healthcare REIT and is my long-term Finance Director, and we're delighted to do this together. We want to show you the portfolio that we have created over these 11 years. It's a portfolio of modern purpose-built homes with en suite wet-rooms as standard. You're going to hear me speak a little bit about that through this whole presentation. As I say, we were founded in 2013. Today, we have just under 100 homes, 6,500 beds, about GBP 58 million of contracted rent. And our rent rises annually in line with inflation with collars and caps of typically 2% and 4%. We're a FTSE 250 business. So we have got to some reasonable scale. And we love the fact that we are highly diversified. The largest tenant is only 17% of our total income. We have 3 or 4 at 5% to 7% and then a bunch, 25% plus, less than 5%. And we have GBP 911 million of portfolio value at 6.25% and very long income. That was part of what we originally set out to be long income of 26 years. So with that, what is our business model? Well, it was, as I say, to create long income. Typically, we signed 35-year leases. The income is inflation-linked. It's investing in exclusively modern purpose-built homes with wet-rooms. We think that is a worthy cause. And with this diversified income and multiple tenants based on sustainable rent with private pay being paid by the residents in the home, we are able to create for you long income for pensions and other needs that we all have as we age. There are a number of tailwinds that I want to speak about in investing in this sector. We don't have the challenges of that you'll have heard about in the retail sector, for example. The first tailwind is the number of baby boomers. I'm one of them myself. And there are a lot of us, and there are a lot more who will be over 85 in the next 25 years. And typically, 1 in 7.5 of us at that age require some form of residential care. So this is a big long-term tailwind for us over the next 20, 30 years. The next tailwind is that the sector has moved from geriatric wards and tour houses and old bed and breakfast and conversions to modern purpose built, in particular, purpose-built with wet-rooms for holistic care of the elderly. And you'll see that the percentage of wet-rooms when we started was about 14%. It's across the sector in the U.K. up at 32%, but Target Healthcare REIT is miles ahead of that. That's 99% of our bedrooms with wet-rooms. So we're in a great place in terms of the physical real estate. And we're also in a great place in terms of who pays our tenants when they stay in their homes. You'll see more than 70% of the residents in the care homes are private pay. And that is some 2.5x what the percentage is for our listed peers who are similar to us. And that's particularly interesting in times of government austerity. There is significant net worth in the seniors, and that's part of what our tenants dip into. I'm also going to tell you a little bit about the financial highlights. We've just had our 6 months accounts. Our NAV is at 106.7p. That's our net asset value, net tangible assets. These are the same terms. And it's been our fourth consecutive quarter of growth in that metric. In addition to that, our income has grown a little and is stable with a good certainty of income growth. And in addition to that, our dividend at the current share price is around about 7.1%, and our dividend is fully covered by cash earned by the business. So we're in a good place in terms of being able to give you long-term performance. So in summary for the portfolio, 99% of the rent has been collected quarter-by-quarter. We are very well rent covered at 1.9x. We originally thought that -- and rent cover means the profitability of the home divided by the rent that is paid. So lots of additional money being there. And like-for-like rental growth is 1.9% in the 6 months. We've had a good consecutive growth of our valuation. And for the 10 years of the fund, we have been reporting on the total returns to an index linker called MSCI. And we are the top performing fund in calendar year 2023 in total return terms. So that's been quite pleasing. We're now going to give you a little bit more information about how this fund is managed. It's what's called externally managed. I'm speaking to you from the premises of Target Fund Managers. This is our key client. And we are the leading specialist U.K. healthcare property fund manager without doubt. We are definitely also the longest serving in that role. The founders have been together for -- have history of working in investment for more than 100 years. And we have a long track record of successfully investing in the healthcare sector. And we're very experienced in developing healthcare businesses. We have operational experience of that. We're also well experienced in the modern stuff of ESG principles, and we have the full regulatory authorities. And we are about 35 people, as you see there, more than GBP 1 billion of assets under management. And an unusual thing about us from the very beginning of investing in the sector is that we wanted to be what we describe as an engaged landlord. So we're not just a rent collector. Before we buy the homes, we're very particular about setting the rents safely, so that our income will be stable. And after we buy the homes, we physically visit them at least every 6 months, sometimes every 3 months. We have 4 people with 140 years of experience physically visiting homes year by year. So we have very much a deep understanding. We see profit and loss accounts for every one of our homes. We know occupancy in our homes on a weekly basis. We understand what's going on in our homes, which helps us a lot. We want to speak also about the -- give you some pictures and some data about the portfolio. I've spoken about wet-rooms already, and you'll see later a video explaining why we think that is important. And proportionally compared to others, 99% of our beds have wet-rooms with the listed peers average being a mere 28%. That's a sad position in our view. In relation to EPC ratings, you know the standards that have to be met by 2030. We're already effectively there with all our homes A and B rated in EPC terms. And the age of our buildings compared to our listed peers is also dramatically different. We're trying to stress to you that this is a really modern portfolio compared to what is available elsewhere. You can see there the light green marker for us, so much of us built in the last 10, 15 years compared to a much smaller proportion for the listed peers. And just to accentuate some of that, 2 weeks ago, a home in Dartford was opened. We were down at it. It's one of ours. It's just at the south of the Thames there where the Dartford Bridge crosses. And let us show you a little bit into that home. Wide spacious bedrooms, excellent wet-rooms, wide corridors. Somebody was saying to me last week, this is more like boutique hotels than institutional care homes. And that is truly what we're trying to do, great places for people to live and end their days and excellent balconies. And here's a home that is opening actually next week, and we'll play you a little video of this home as well. It's a little flyover. As you can see, a very impressive home. So how is the portfolio performing? I said I would speak a little about this MSCI U.K. Healthcare Property Index. There is GBP 8.5 billion of assets in this index. It's made up of GP surgeries, of care homes, of hospitals, of medical facilities. You'll see that for the 10 years that we have been reporting, we have always beat the index year by year by year. And this year, we are the #1 performing fund in that index. We're thankful that, that is who we are. How is that created? Well, with great occupancy. Occupancy dipped, as you might expect, during the pandemic. And in fact, it's not yet back up to pre-pandemic levels, up at 86%, 87%. But you'll see on the next slide that we're actually at all-time high rent cover levels. Pre-pandemic, typically rent was at 1.6x. And today, rent cover is right up at 1.9x, which is exceptionally good performance and reflects the quality of our portfolio. And also, our rent collection is at a very good number, right up at 99%. And all of that is helped, of course, by the maturity of these modern homes. When we entered the pandemic, we were down around about the 70% level because we had opened a number of homes. And here we are in 2024 with more than 90% of the homes being mature. And that, therefore, helps as they mature. Typically, a good care home will take up to about 3 years to fill well and stably. And we also spoke about inflation linking for all the rents that we receive. You'll see that these rents rise quarter-by-quarter, approximately 1/4 of the portfolio at each time. So that's a quick summary. I'm going to hand over to Gordon, who's been very patient while I've been going through all of this, and he's going to take you through some of the financial results.

Thank you. So Kenneth has given you some headline earnings and balance sheet numbers earlier on, a bit more detail from me. On this slide, this is a summary of our earnings. I'll cover that first. Our key management metric is the adjusted EPRA earnings number. So the adjusted EPRA earnings number of GBP 18.9 million, and the adjusted EPRA EPS, I should say, of 3.05p per share are in the middle rows in this slide here. The earnings is important to us. Clearly, it's the cash coming into the business. It's a very important metric we use internally and justified. As some of you may not be familiar with EPRA, it's a European industry body and the methodology we follow in producing these numbers. They are the standard setters and disclosure for compatibility and reliable numbers. Effectively, they are taking IFRS and adjusting it for property companies. And so we're following that to be consistent with the vast majority of European property companies. And I will also flag for those of you who may dislike or it may trigger you to hear an adjusted EPRA earnings number, I would just flag that we are adjusting our earnings number down to that to strip out some noncash items. So our adjusted EPRA earnings number is lower than our EPRA earnings number. So what's driving those numbers, the EPRA earnings and the EPS? It's been a stable 6 months that we've been through recently. The notable drivers are our rental income is up, just under 2%. That is largely driven by the rent reviews which we get. So typically, in a higher inflation environment, we will get 4% caps on our leases. It is also reflecting some CapEx or capital expenditure in the portfolio we've had, which has produced a little bit more rent. And these numbers also take into effect the impact of some disposals that we made. So last year, we had some assets which we don't currently hold, we exited the Northern Ireland market and made some disposals. So that brings that earning, income number down a bit. But overall, the earnings growth from our annual rent reviews linked to inflation are driving rental growth period-on-period. Also during this period, we've seen a growth in our interest in our development funding. So we have been busy on 5 development sites in the 6 months. When we invest capital in those buildings, we obtain a coupon return on that capital. And when those 5 assets are complete, that will add GBP 4 million of contractual rent per annum to our rent roll. And indeed, 2 of those have practically completed in February. Kenneth showed you some photos of some of them earlier. So we're making good progress. We have 3 left to add some further brand-new properties to the portfolio. And as you may expect, our debt costs, our financing costs are a bit higher. It's largely as a function of that investment in the portfolio we've been making in building out the sites. We've been drawing down debt to fund those, but also we're in a higher interest rate environment now. So the net financing costs are a bit higher than last year, or the previous 6-month period, I should say. And the results in the EPS numbers or the earnings numbers noted, and I would flag that they are well covering our dividend. We're paying out around about 93% of the profits that we're making, the recurring earnings of the business, to really provide a sustainable dividend. And I'd also flag that dividend has been covered for the full calendar year 2023. So it's a quarterly dividend we pay out covered each time during the year. And you can see the impact this has on the balance sheet. So focusing on the NAV per share or the EPRA NTA per share, this shows how that's moved and what the drivers of that movement have been for the period. So we started the period at 104.5p per share. We've moved to 106.7p, so growth of 2.2p. The 2 kind of chunkier black and blue bars towards the right-hand side there are the effect of the earnings in and the dividend out. So because of our payout ratio and that covered dividend, we are adding accretive to NAV by 0.3p per share. And the other larger bar there in the middle is the effect of the quarter-on-quarter valuation growth that we're seeing, adding 0.9p per share -- sorry, 1.9p per share to the EPRA NTA and your net asset value. The balance sheet itself is -- there's a summary here on this sheet. It's a fairly straightforward balance sheet. The key aspects to drive our LTV level. So we're at 25.8% at the end of the period. That's gone up a little bit from the comparative as we've drawn debt. However, we have plenty of headroom left available. There is still GBP 67.5 million of undrawn debt that is available to draw. And when we account for the remaining spend on the development sites, we have about GBP 42 million of headroom to allocate capital towards. So a good stable balance sheet with flexibility thereon. And this slide will talk to how we manage our debt or how we have managed our debt. So clearly, interest rates moved significantly in the second half of 2022. We were -- already 71% of our drawn debt was hedged or fixed or otherwise hedged going into that period, with good long-term debt, and we've got some valuable hedging already. And then during that period, as interest rates were moving, we were decisive in capping a further GBP 50 million of our drawn debt. So what we've ended up with at the balance sheet date at the end of December, 91% of our debt is drawn. The remaining 9%, which is exposed to floating rate debt. We have low sensitivity to the rate movements because that's a relatively low percentage. So clearly, that could be up or down, but a 1% movement in interest rates, SONIA, the interbank rate effectively equates to less than 1% of earnings and dividend cover. So more sensitivity to rates movements there. And one final point on the debt summary. We have GBP 320 million of total facilities, and it's a good split between GBP 150 million long-term institutional money with Phoenix as a lender, and that is locked in at just over 3% for 10 years. So that's been great. And then we have shorter-term bank facilities with high street names with RBS, HSBC. GBP 170 million total facilities with 2 of them, and that matures by November '25. And as I described earlier, some of that is hedged to interest rate movements. So good debt position, good debt portfolio, lender supportive, good names on there, and we have a good long-term position on our interest cost. I'll pass back to Kenneth to talk you through the market.

So there's another picture of an excellent home, but let me take you into our view on the outlook for the care home sector. Well, I've spoken early on in this presentation about the tailwinds of demographics, of private pay fees, and haven't spoken perhaps quite so much about, typically, this is needs-based care. So this is essential that these old folks are looked after in a safe and secure and community-based setting. And the NHS and delayed discharges give further potential for growth if the NHS would ever get itself well organized. Inflation is clearly under control from the point of view of the operating costs of the home. I've made reference to the excellent rent covers even with the inflation that's been around. There is wage inflation, and we welcome, in fact, that the carers are being paid more. We think that's really important. They do a wonderful task for the residents, and energy costs are managed, and with private fees, that all works well. And staffing is still quite available. A couple of years ago, staffing was a bit tighter. But with the visa schemes and even with the small changes in the visa schemes that are going on just now, there is good availability of staff, and a modern purpose-built home is a better place to work in than some of the old conversions. And I've already spoken at length about the real estate, how modern it is, how ESG friendly, how we don't have significant CapEx to spend. So with great demand for places, with dementia being a reality, with the challenge of loneliness, and with dual income families needing a safe place for their loved ones, the demand is robust. So we believe that the care home sector is in a really good place. Now I said that I was interested and would explain to you a bit more about why we think wet-rooms are important. Have a little look at this video, and I'll go quiet for a couple of minutes. [Presentation]

So I hope you found that informative. It's a delicate subject and we recognize that. But we think it's also really important to explain and the industry recognizes that it's really important that modern purpose-built homes and places for our residents to be living in would have wet-rooms. I was actually in America 2 or 3 weeks ago and I was intrigued to know that 98% of the beds in America have wet-rooms, whereas in the U.K. it's only 68% -- 32% have wet rooms, 68% don't have, but that's not what we do as a fund. So in summary, with Target, excellent real estate quality, portfolio performing well with a conservative balance sheet, 25% geared, and with excellent tailwinds with demographics and the whole trend to quality provision of care for our seniors. And now we go on to -- that concludes the formal part of the presentation, so we can go on now to Q&A.

[Operator Instructions] I would like to remind you that a recording of this presentation with a copy of the slides and the published Q&A can be accessed via your investor dashboard. Kenneth and Gordon, as you can see there in the Q&A tab, we have received a number of questions from investors. And thank you to all of those on the call for taking the time to submit their questions. But guys, if I may now just hand back to you to read out those questions and give your responses where it's appropriate to do so, and I'll pick up from you at the end.

Sure. Thank you. I'm just trying to figure out we've to take them chronologically or -- so we've got some that relate to the portfolio and its performance and understanding that a bit better and then some, as you might imagine, relating to the company. But yes, chronologically probably makes sense. So the first question is, can we talk a little bit about why occupancy rates within the homes are not at 99%, please? The question submitted, as I understand, that there might be a delay between resident changeovers, although the expectation that there may be a waitlist and that would be quite efficient. I'll probably let Kenneth answer that one.

Sure. Occupancy across the U.K. currently is about 86%, 87%, and homes rarely work at 99%. Typically, occupancy level when we do the work about buying a home is that we would expect it to get to around the 90% level. The average length of stay in a home is 18 months. So 2/3 approximately of all of the residents die year-by-year. And it's always thought appropriate that there would be a little bit of delay between the death of one person and the next person coming in and for staff purposes as well. So the whole model is based on around about the 90% level. Occasionally, it goes higher, but actually rent cover is the all-important one more than full out. You can imagine that there's repairs to be done continually. There can be refurbishing of rooms. So that's why we allow the more conservative level of 90%.

I would also flag just for completeness, just in case there's anybody who -- again, just for the avoidance of doubt, our portfolio has a 0% vacancy rate. All of our homes are let out to tenants who are paying us rent. This is the next level down. It's the residents in the homes who are being looked after for the tenants relative to the number of beds that each home has is the occupancy figure we're talking about there. I'm going to throw the next one to Kenneth as well, but we can probably both answer this one to some extent is someone asking about the current discount to the net assets -- sorry, our current share price to our net assets and asking the question that why would we not buy back shares to help boost the value per share. Kenneth is probably well placed to answer that, but I'll help him out if need be.

Yes. Gordon probably does have to help me out. It is something we continue to consider. And there is merit in the underlying thoughts of the question.

At this point in time, so what we've been focused on in the last 12, 18 months is, coming out of COVID and then coming out of the spike in the cost of living and all the pressures and headwinds that the care home sector has experienced through our portfolio, which is a prime portfolio of quality and is significantly differentiated from the rest of the market, will perform and will deliver results. And we've proved that we have done that. At the same time, we have been looking at alternative uses of capital. And to be honest, to fund the buyback right now, we would have to draw debt, which is expensive. And so while the math may work, it's quite marginal at this point in time. Clearly, we will consider other opportunities such as can we dispose of assets from the portfolio to fund buybacks and is that a better use of capital, better allocation of capital? However, we're naturally trying to stick to the long-term plan of growing a really high-quality portfolio and providing sustainable returns for many years to come. But definitely, it's something we've been discussing and analyzing and continue to look at, particularly in light of proving the portfolio is performing, what's the next step for the company and what should we do to add.

Yes. And the other aspect, in the earlier time when there was turbulence in the markets, was we purposely set out to have good headroom in our debt facilities, not knowing what the future might bring. We've tried to create this as a fund, which is long term and conservative. The next question is what's the average weekly charge? That's a really easy one. 1,207p is the average across the portfolio. And then the next question is you mentioned rent cover on average 1.9x. Can you give some clarity on the range of cover? There are 2 homes in the portfolio we have a particular concern for. One is a home where the operator has a new home, which is performing really well, but he recognizes that the other homes in his company are the old secondhand stock conversions and he is wanting to move to modern purpose-built and he set out to sell the older homes. And in fact, the older homes have nothing like the value that they had even 3 years ago or 2 years ago. So that is one of the situations that we have. And then there's another home where the operator hasn't done well. We have put somebody in to operate the home, and he is turning it around very nicely. But you'll note that all of our numbers include all of our homes. We don't exclude any as we report to our shareholders.

Next question is how sustainable is the current dividend cover ratio and what measures are in place to maintain or improve this going forward? It's very sustainable. It's set to be sustainable. Our dividend level is set to be sustainable based on our earnings, based on our rental collection and rental growth, and based on the cost of running the company. Certainly, we are constantly discussing this with the nonexecutive Board to make sure we're happy and content with those levels. And I would add that the forecasting forward that we work out is generally fairly conservative and prudent. For example, I'm already looking out to future interest rate costs, and I'm generally assuming that they stay higher for longer. I'm not baking in interest rate falls, for example. So yes, we believe it's sustainable. It's set at that level to be sustainable. It's set at that level to hopefully grow year-on-year and be progressive. The dividend level we're at now, the quarterly dividend is 2% higher than for the first 6 months of calendar 2023, and we expect to be able to pass that on with future rental growth, again, in a prudent and conservative fashion.

The great situation we're in, to answer that question, is our rents go up quarter-by-quarter. And our costs are fixed. Our debt costs are largely fixed. So we're in a good place for that.

The next one is about government reforms and funding changes in health and social care. Well, we have always taken the view that our government is restrained in its cash availability. And therefore, we would choose to be in private pay much more than in public pay. And as you saw from the slides, the public pay element is only at 29% of what our tenants receive. So we are pessimistic about government policy changing anytime soon. We've answered that question for 15 years in target fund managers, and we've always taken the same position that there will be a lot said and very little done sadly.

What prompted the decision to change valuers to CBRE and what changes may we expect from this? Fundamentally, Colliers have been the company's valuers since IPO in 2013. And from our best practice corporate governance point of view, the decision was made to rotate and change the new valuer to make sure we get a fresh perspective on all and obviously to move away from that and just having someone as incumbent for too long. We're getting fresh insight. We don't expect the valuations to change significantly. However, it's someone else looking at it and its best practice from a governance point of view, so we're delighted to do so.

The next one is about an overview of our operators. They're significant family-sized businesses. How do we assess their operational strength, financial stability? Well, one of the things I could have perhaps spoken about a bit more when I was speaking about target fund managers, the adviser for the fund is that about half of us here are bankers or chartered accountants with 4 people who have run their own care homes. So it's all about assessing the profitability of a home within 10-minute drive times. We have our own software to look at population groupings within the 10-minute drive time. And we have, of course, especially 15 years in, 15 years of data of how our existing homes are working and 15 years of data at the 1,500 homes we've looked at, of which we've only bought just over 100. So we have a lot of experience of assessing the profitability of a home, and that is a core skill, I believe, that we do have here.

Yes. And the key fundamental to that is that if a tenant doesn't perform well for whatever reason, be it circumstance or their own commercial or operation ability, is that we've assessed that 10-minute drive time of the home. We've underwritten -- sorry, investment appraisal is underwriting based on how that home should and could perform and whether another tenant operator will want to come in and operate that home and run that home and be able to do so successfully. I'm pleased to report that we have retenanted a few homes over the years, as you might imagine. And a new tenant has always been able to come in and do that successfully at the prevailing rent on the lease, which really, I think, speaks to our USP and assessing how a home will work in its local drive time, to some degree, regardless of who the tenant is, but someone who want to run it and run it well and be able to run it well because of the great real estate and the great fundamentals of that local market.

What's the average amount of rent per room for the homes? It's just under GBP 9,000 per bed. You mentioned that an average occupancy around 18 months per person. How does that compare with nursing homes? I would have thought... So we have a mix of nursing homes and residential homes in the portfolio and the 18-month figure is an average between these.

What's the next one, Gordon?

Next one. So there is another one, just came in at the bottom there, which I think I probably answered a little bit of what happens if a provider becomes insolvent? Do you have a backup provider? Absolutely. We just talked about the 10-minute drive time and why that's important for someone coming in as an alternative operator. Kenneth has described how we have a long track record. We have a stable team. We know the market. Operators know us, operators know the types of homes that we manage, and we're generally able to have a number of alternative operators lined up to come in and run a home. Sometimes it takes a bit of time, but we feel as though we always have options, and we're able to execute on doing that. And then there's one there. In the current interest rate environment, what's our policy for growing the portfolio? Well, that's a really good question. What's happened with the interest rate environment with interest rates rising is that the yields for buying these properties has also expanded. And it's a time to be cautious and to see how much further they will expand. But we continue to be very actively looking in the market, and we think there will be good opportunities in time to come. And with that, I think, being the final question, where we will hand back to the gentleman who is handling all of this for us, Jake.

Perfect. Kenneth, Gordon, that's great. And thank you very much indeed for being so generous of your time then addressing all of those questions that came in from investors. And of course, if there are any further questions that do come through, we'll make these available to you immediately after the presentation has ended, just for you to review to then add any additional responses, of course, where it's appropriate to do so, and we'll publish all those responses out on the platform. But Kenneth, perhaps before really just looking to redirect those on the call to provide you with their feedback, which I know is particularly important to yourself and the company, if I could please just ask you for a few closing comments to wrap up with, that would be great.

Target is on a mission to improve the quality of the real estate and therefore, the quality of care for our seniors. Our seniors are people who have done a lot for our nation, and we believe they should be well looked after. We believe life is precious, and we believe that providing safe, warm, comfortable places for our seniors to end their days is a wonderful holistic mission. It's our privilege in Target to deliver on that. And with your support, we will continue on that mission. Thank you very much.

Kenneth, that's great. And thank you once again for updating investors this morning. Could I please ask investors not to close this session as you'll now be automatically redirected for the opportunity to provide your feedback in order that the management team can really better understand your views and expectations. This will only take a few moments to complete, but I'm sure it will be greatly valued by the company. On behalf of the management team of Target Healthcare REIT PLC, we would like to thank you for attending today's presentation. That now concludes today's session. So good morning to you all.