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

Good morning. From Stirling in Scotland, we're delighted to be able to present the annual results for our company, Target Healthcare REIT. To all our investors, thank you for your interest in us. Gordon and I are going to be presenting. We've been doing this together for over 11 years. Let's go on to the next slide as we tell you a little bit about who we are, a little reminder for you. We invest exclusively in care homes. We are today a portfolio of some scale with a robust rental income stream, which we are able to turn into a dividend. There are 94 care homes in the portfolio, just under 6,500 beds, just under GBP 60 million of contracted rent, GBP 59 million exactly. The portfolio value over GBP 900 million and the rental income comes from 34 different tenants. And as I say, we've been doing this for 11 years, founded in 2013 and got a FTSE 250 business. And it's a different portfolio in terms of its quality, modernity and ESG compliance. Look at this real estate. There isn't we don't think any other portfolio in commercial real estate which has such excellent A and B EPC ratings. 99% of it is A and B with only one home at C. Also, the portfolio has 99% rent -- inflation-linked rental uplifts. And there is very long income in front of us, 26.5 years. And you've heard me often speak in the past about the need for en-suite wet rooms, and this portfolio has 99% of the beds with en-suite wet rooms to provide human dignity for the seniors that we all love so much. And resulting from that, we have been able to deliver excellent returns in the year under review. We have an accounting total return of 11.8%. And the dividend growth has resumed. We increased the dividend in July 2023, and we announced last week that we've been increasing it for this current quarter. And then there's an index of all health care real estate in the U.K. And it turns out that in 2023, calendar 2023, we were the top performer in that index. We were #1 out of the 37 different funds that are within that index totaling about GBP 8.5 billion of real estate. And so we're in a good and encouraging place. The other thing that we did during the year was we want to continually improve the portfolio and even although it is the best, let's not stand on our laurels, but think about how we can recycle capital and also evidence valuation. So just towards the very end of the year, we concluded the sale of 4 homes for GBP 44.5 million. These were amongst the oldest homes in the portfolio. They were definitely amongst the least spacious. They had the shortest lease lengths. So not the best homes in the portfolio as you're finding in some places in real estate as people are trying to realize cash. This is us selling the poorer end, and we were able to sell them above net asset value. So that was a good demonstration of value of our NAV. And that comes now to a total of about 8% of the portfolio, which we have sold over the last 18 months. However, even with that, we have to reflect that where are we placed in rating terms in our shares. So we wanted to address that head on here and speak about what we see as important in all of this. Well, we have an attractive growing dividend at the current price. We have evidenced great ability to dispose of our assets above NAV. And we've also stated that our dividend will continue to grow even with the new debt costs that are around post Trust lows. And with all of that, we have excellent asset liquidity and good availability of capital of GBP 85 million to provide significant flexibility as we consider our capital options. Gordon is now going to take you through some of the financial results in some more detail.

Yes. Thank you, Kenneth, and good morning, everybody. Yes, focus on the results themselves, the next few slides. This list of highlights from the year under review on this slide are something we're very pleased to have delivered. You can see the NAV or the EPRA NTA growth of just under 6% in the year. You can see the earnings growth of adjusted EPRA EPS is up just over 2%. The total return that Kenneth has mentioned already at 12% is a great result for the year. And you can see that the dividend started growing again and is also very well covered with over 7% headroom there at 107% covered. On the earnings, I would just flag it's a relatively modest 2.2% growth. However, that's in the context of the cost inflation we've seen over the last couple of years in the context of interest rates rising and with the effect of the disposals we've made over the last 18 months, clearly reducing income, we've replaced that income and to see growth in earnings is very pleasing indeed. I'd like a bit more detail, how has that come about in a little bit more detail. We've grown our rent. So net rental income is up by 4%. As I say, we've replaced the assets we've disposed of with our developments, so brand-new real estate, which we've built coming online, completing and starting to generate rental income. And on the development side as well, with continued investment in that, we've also increased the interest we receive on that capital as those buildings are being built and we are investing the capital to grow them. The running costs are stable. You can see the three subheadings there, management fee and operating expenses and then credit loss allowance. The top 2, management fee and the recurring operating expenses is very stable and growing less than inflation at just about 1%. We have an efficient property model. That rental income is being converted into earnings and into the dividend. There is no gross net adjustment of additional property management or service charges. There are no Voids in our portfolio. It's fully let, and we're getting our rent, and 99% rent collection. And the Investment Manager is providing full service. So there are no additional fees such as regulatory fees or transactional fees or accounting fees there. That is all covered. It's a very efficient property company model with, as I say, no gross to net adjustment. There's one quirk in the numbers just worth explaining, the credit loss allowance and bad debts or provisioning as people may know it. That's higher than last year, albeit still low, and that is just as a result of in the prior year, we selected that -- sorry, we received a significant arrears receipt from some COVID era debt from one of our tenants, which was over GBP 1 million. So last year, it was artificially low. So good earnings growth there. And the main driver of that is obviously our rental income. I'd like to spend the next two slides just looking at the point-to-point growth in that. So this slide here is what we've achieved in the year to June '24. You can see that the black and the navy blue bar towards the right there are effectively the acquisitions and developments or new properties coming online, replacing the assets we've disposed of. So as Kenneth alluded to, that is losing some of the older properties, replacing it with brand-new, better quality properties and effectively replacing the income that we're losing at the same time. The main driver of the rental growth is coming from the rent reviews. So the bar towards the left and the middle there, the black bar, really showing the like-for-like rent reviews from our leases coming through and driving rental growth in the year. And this next slide is a look forward. It's a prudent projection just showing that with the organic rental reviews that we have in our lease structures across the portfolio and with the developments we are committed to and building out at the moment and with a little bit of CapEx across the portfolio, on a prudent point of view, we would expect to grow that point-in-point rent roll just over 4% this year, and this is looking out to June '25. This is all organic and committed and coming from the rent reviews primarily, as I say there, and this is showing the collars of those rent reviews. So we have collars and caps roughly at about 1.6% as a collar and 4% as a cap. It will be somewhere in between that. We show the prudent view there. Moving on to our balance sheet. It's not a complex balance sheet. We're conservatively structured from a debt point of view, and there's two large numbers on there, one being the portfolio value and one being the debt. The next slide shows -- or sorry, that slide there shows that we had NAV growth of 6%. The balance sheet grew 6% in the year, and that's the same on a per share basis. How do we come to that? It's a similar story to the rent reviews. The main driver there is really the rent reviews being passed on into valuation growth in the portfolio, and that's coming because the valuers are confident in the portfolio and the rent that is being provided by our portfolio. The other big number on that balance sheet is the debt. We have a good mix of debt providers, three lenders there, a good mix. We've got 2 debt -- sorry, two banks providing shorter-term bank facilities, which are flexible. And we've got the longer-term institutional money with Phoenix, and that's locked away until 2032 and 2037 at attractive 3% -- roughly 3% coupon. The two bank facilities are due for refinancing in the latter half of next year, and we're well advanced in looking at that. Ahead of that point in time, we've received terms, attractive terms, and we should -- we will be refinancing those facilities in short order. I would draw your attention as well. The bar chart on the top right there shows instead of LTV, we've chosen to show you a net debt-to-EBITDA ratio. That has been coming down over the last 2 or 3 years. And what that really shows is the ability to repay the debt out of our annual cash flows. Should we need to do that for any reason, it's nice to have that in the back pocket. That ratio at less than 5x is a pretty low ratio and shows we can pay that off with cash flows and compares well to many other listed real estate companies, which have higher gearing. The bar chart on the bottom right is showing the mix between our fixed interest rates, which are the longer-term facilities and our hedged or capped interest rates on the shorter-term bank facilities. And you can see that we're well in advance -- sorry, well in excess of 90% of our debt facilities are fixed or hedged in terms of interest costs. And then one more slide, there's a lot of detail on here. What we're plotting here are LTV levels relative to earnings yield and the dividend yield chart would look the same. Effectively, one would prefer to be in the top left quadrant in this one. So delivering higher earnings at a lower LTV. So high earnings, obviously good. Low LTV is clearly good from a risk point of view. And we are very much towards the top left of that chart in that quadrant there relative to many other listed real estate companies. So we can see that our conservative structure with low gearing is still delivering attractive earnings returns, and we're passing that on to attractive dividend rates. And I'll pass back to Kenneth to take you through the portfolio.

So we're thankful that the numbers are what we would like to see. And all of that, of course, is predicated on how is the portfolio itself performing. And that's what we're going to take you into here. There's a home on your screen there in Oxford that you may have seen before. And let's now go into the occupancy level. So we all remember the pandemic. Pre-pandemic, we expected occupancy to be around about the 90% level. It's where it was. We dropped to the low 70s percent occupancy actually because of lack of people coming in, in the pandemic. And today, we're back up to just under 88% occupancy. Therefore, with a couple of hundred basis points to go back up to around about the 90% level we would expect in the -- perhaps over this coming winter. But what's really interesting in relation to that occupancy, with it still to grow a little bit, and we are still seeing demand, we have all-time high rent cover, 1.9x in the year under review and actually spot occupancy at the end of the year up at 2x. So the portfolio is performing well in terms of are our tenants profitable, are they able to operate well in the circumstances we live in, in the United Kingdom and especially with modern purpose-built homes, they are absolutely able to do that. Some further insights into how they're profitable. Here on this slide, on the top line, you'll see the average weekly fee increase. And over that 5 years, it's a fee increase of about 40% when inflation rate over that period is 30%. And an important part of all of that is the proportion of private pay that our portfolio earns. In other words, the tenants who have their residents, the residents either are paid by government or from private fee sources. And you'll see here that 5 years ago, for our care homes, their private pay percentage was 66%, and it's risen to 74%, a great place to be. And then we compare on the next line staff costs as a percentage of total fees. And you'll see that 5 years ago, staff costs were 57% and in the year under review, that had fallen to 53%. And an important part of that was that there has been less agency cost, though there was quite a lot of that in '22 and '23 before the benefits of some of the visa schemes came in. Non-staff costs are pretty stable. And you'll see on the bottom line how rent cover has risen from 1.6x to 1.9x over these 5 years. So the importance of private pay, we believe, is really relevant, especially with a lack of clarity from the government about all of this. And in fact, we expect that demand for private pay to continue as we're even seeing within the NHS, but I'll cover some of that later. Some more insights into the assets that we have within the portfolio and what's happened over the 5 years. Well, 5 years ago -- if you have a measure of modernity, 5 years ago, 83% was modern. Post 2010, 5 years later, it's 84% because as I've said already, we have been selling some of the older buildings. And longevity of income over the 5 years has only dropped by 2.5 years because these older buildings obviously had longer -- had shorter leases. And of course, we also now have much more mature homes because we've had them a bit longer. And then in terms of the quality of the home, we are big advocates for modern purpose-built homes that have wet rooms in all cases. And that's the situation we find ourselves in today. We were at 95%. We're delighted that we're now at 99% of the beds, and that provides really good facilities to care for our seniors in a holistic and dignified manner. It's sad that there aren't more of these across the sector, but we are delighted that over the life of our fund, it's grown from 14% of the beds to 33% of the beds. And we would predict in the next 10, 15 years that, that will grow to 2/3 of the beds, and that is wholly appropriate. And we've spoken about the MSCI index. Here is some more of the detail in relation to that. This is looking at it over 10 years. You'll see that this portfolio has outperformed that index consistently over the 10 years. We're #2 in the index over the 10-year view, #1 over 2023 with a 60% cumulative compounded outperformance over that period. So we are thankful for that. I remember when I first started all of this about 15 years ago, somebody saying to me, well, Kenneth, we'll see how this works out over the long term. Let's review it in 10 years, and here we are more than that. And we're very thankful that, that is the situation we are in and very much our intent going forward. Through the year, we have done some developments. We completed three in Holt, in Dartford and in Weston-super-Mare. The Weston-super-Mare is an operationally net zero home, which just completed in June. So in the coming years, we should get some interesting data about the use of solar panels, heat pumps, EV panels, batteries to provide power and energy to the home. And we have two further developments underway, one in Olney and one in Malvern, both around about the 60 beds and both of these complete in the next month or two. We then have some slides about the sector itself. The sector has a regulator, Care Quality Commission. And we have not been content with the way in which the sector has been regulated for a fair number of years. And some of that came to a head this spring where there was something called the Dash review, and they opined that the regulator was not fit for purpose. The CEO of the regulator resigned, the interim CEO acknowledged shortcomings. And just to give you a kind of view of how pathetic, I think that's the appropriate term, the regulator has been, in the last quarter, they only did 200 inspections for over 9,000 homes. We did 200 inspections for our 100 homes in each year. So the regulator has really let us all down. Target hosted a roundtable on the regulator recently. And there is a really good opportunity, we believe, to establish appropriate standards, physical and operational and in writing, which the regulator did not really have. And we believe there may be a possibility that in future, they will consider the physical quality of the building rather than just the operational aspects. And we think that will be really important in terms of improving the physical quality of the buildings coming towards the kind of product that we have. And then a little comment on the government, the NHS and social care. So we have a new government and there seems to be a strong recognition from the Health Secretary about the need of help for the private sector in the NHS. If they stay with the status quo in social care, it will inevitably lead to more private pay. We are really well positioned to benefit from that. Social care has always been a lower priority compared to the NHS. And private pay, we think, will naturally flow into it. And is there sufficient wealth for that? Well, on average, the over 65s, that's GBP 2.6 trillion of net worth. So yes, there is. We're in a good place for that. And then we have some slides on the physical properties because this is a REIT. You own a business that has invested in hard assets that you could go and live in yourself. Your seniors might like to live in a property like the picture you have there from a home in Dartford. But a little bit more about the quality of the real estate that your company owns. Look at the green box on the left-hand slide. That's the purpose built in the 2000s and compare that to the listed peer average and to the average of care homes across England and Scotland. The red blocks are conversions or conversions plus extensions, classically with trip hazards, classically with extra stairs or narrower corridors, just not really long-term fit-for-purpose and definitely without wet rooms. Remember, 67% of the beds with no wet rooms. And then we have another slide in terms of this whole issue of wet rooms. The Target Healthcare REIT, almost 100% with wet rooms. The listed peer average, they have a little bit of green there. They will speak about en-suites. But remember, the en-suites have no shelving facility, only a WC and a wash hand basin. So we are passionate about providing dignity to our seniors. We believe they need to be well looked after. And then there's a slide here about deal volumes. Consistent demand for modern purpose built, typically competitive pricing around about the 6% level and quite different to the subprime. In other words, the product that does not have wet rooms, that have these poor en-suites or have many conversions. And one or two of the big institutional buyers in America still buy that, and are in the public domain saying that the typical pricing on that is 10% net initial yield. So very different product to the prime product that your company has. A little more comparison for you so that you know what we -- how we compare to others. Our net initial yield at 6.2%, average value per square meter, about GBP 3,000, average rent per square meter, about GBP 195. And on the bottom line, you'll see the listed peers where the net initial yield is at about 6.5%, and you'll see the values also, and we will leave you to ponder on all of that. So what is the backdrop to all of this? Well, I've spoken many times about the number of over 85s doubling in the coming couple of decades. That is the reality. This portfolio has great inflation-linked rental uplifts, and it has got real longevity, 26.5 years of income in front of us. So that's our presentation, and we'll be delighted to go on to answer any questions that you have. And Gordon and I will try and take these together.

Perfect. Kenneth, Gordon, if I may just jump back in there, thank you very much indeed for your presentation this morning. [Operator Instructions] But just while the team take a few moments to review those questions that were submitted already, I just like to remind you that a recording of this presentation, along with a copy of the slides and the published Q&A, can be accessed via your investor dashboard. Gordon, Kenneth, as you can see there, we have received a number of questions throughout your presentation this morning. And thank you to all of those on the call for taking the time to submit their questions. But guys, at this point, if I may just hand back to you just to read out those questions and give your responses where it's appropriate to do so. And if I pick up from you at the end, that would be great. Thank you.

Thank you, [ Jake ]. Yes, We've got three or four questions coming in so far. So I think we can cover those. The first question, I will direct to Kenneth, but it's about the portfolio now having a heavier concentration in the Southeast of the U.K. What are our future plans for geographic diversification? Are there any particular regions within the U.K. that we see as offering better returns compared to the average? Kenneth?

So yields tend to be a little tighter in the Southeast. But actually, we have never bought assets with a plan to be in any particular region. Rather that we have looked for value within any 10-minute drive time because our care home competes with its very local market. We don't put our loved ones into a care home 2 hours away because typically, the visit is a shorter visit, and a 10-minute drive time works well for that. So there is a bit more yield as you go further and further away from London. And I can tell you there would be a lot more yield if my investment team would let me buy in the north of Scotland, but they don't think that there is good institutional demand for care homes up there. I come myself from the north of Scotland. So we have one home in -- well, we have one home in Aberdeenshire, and we have a few homes in Scotland, but generally, we aim to buy all over United Kingdom. We were at one stage in Northern Ireland and weren't seeing a good operational quality there and ultimately came out of that. So today, we're in Wales, Scotland and England.

So largely agnostic on any particular region. It's all about the local demand and within the 10-minute drive time of a home as to whether it makes a good investment or not.

It's all about the local competition in that 10-minute drive time. And part of our philosophy is if you can have the best-in-class home in that 10-minute drive time, you will get a better proportion of private pay residents, you will have staff delighted to work in really good working conditions, staff feeling that they can provide dignified care because of wet rooms, all building up to a good operational business.

I'll very quickly answer the next question. [ Roger ] is asking about, on the chart comparing ourselves against the other listed property companies, he does not see one particular company he's looking for. That company does sit in there within the average of those listed peers. Roger, so very much included within that one. There's only really two listed peers investing in care homes in the U.K. outside of us. So it's representative of that portfolio, I think. The next question is, what are our future development plans. How will these be financed given discount to NAV and the restrictions that places on share issuance? I think probably two stages of answering that. One, the existing development commitments we do have, have been largely funded by the proceeds of the disposals we've made over the last 18 months and a little bit of debt. So we paid down as much flexible debt as we can. We have a few million left to fund the completion of the two assets that we are currently building, and we'll draw a bit more debt to fund those. And then beyond that, I think looking at any wider developments or acquisitions, I think we're also very much a wait and see where the market lands, where the cost of funding lands and what the appropriate capital allocation is for the business right now, we're exploring a number of options there as to what the best thing to do for shareholder returns and for the long-term future of the business are. So Kenneth addressed that to some degree in the...

Yes. No, I think you've covered that adequately.

Thank you. And just reading through next one, rent cover for mature homes is strong, but how do you assess the long-term financial resilience of tenants in the sector. And I think particularly noting staffing levels and challenges to that, are there any particular concerns we have over tenants staffing levels and their outlook? I'll pass to Kenneth to...

Yes. No, that's -- I'm happy to have that one. We are seeing our operators stay stably profitable with good access to labor. As I said earlier, if you have the best-in-class home, it's usually a better place to work because you've got better facilities. And then the government brought in the visa scheme to allow people to come in and there is continued availability even with some of the changes to the visa scheme. So whereas 3 years ago, I would have spoken to you about labor shortage and that being challenging, that is no longer the position with the care home market, and we're much more content with that. If you have a portfolio of 100 homes, there's always going to be a home that isn't working properly. And that is always something that we are working on. But across the vast majority of the homes, we're in a really good place.

Yes. And I think the other point top line on revenue, Kenneth showed you the slide of the average weekly fee per residents increasing slightly ahead of inflation because of the strength of the quality of the homes that we offer and the environment and the services for residents as well as the sort of the private pay element. So I think the top line should be covered by our tenants operating well, taking in the right residents at the right fees and making sure that they're covering the cost well. So there's plenty of headroom there in that rent cover for any cost increase from staffing challenges as they grow the top line as well. Next question is an interesting one, and Kenneth is about to jump on it there. So I'll let him.

A satisfaction survey for the residents, yes, there is. It's called carehome.co.uk, go and have a look at it on the web. Our scores are up about 9.6 out of 10. It's actually something that we get around night -- every Friday night, we get a summary of all of the commentary on all of our homes, and it's something that we review on a weekly basis.

Yes. And we're making sure that is according and consistent with our own visits. So Kenneth said we're doing over 200 visits to our homes every year, so 5 or 6 a week. And obviously, our health care directors are speaking to residents, speaking to their families, speaking to the staff in the homes as they walk around and see what's going on. And clearly, we want -- they are making their own assessment of how happy residents are in the homes to the extent that they're able to as well. So the consistency we see between the two is generally compelling.

And the next question is how do you think care homes will evolve over the next 15 to 20 years. We think -- there are about 450,000 beds, and only 32% of these beds are fit for purpose. We think there will be a fundamental reconfiguration of these beds because I think all of us on this call will understand what a wet room is and understand the need for a shower, especially for residents who have continence issues. So where do we think this will go? We're absolutely clear that there will be more and more and more wet rooms across the sector over the next 15 to 20 years and the people who are invested in the poorer quality have a lot of thinking to do.

Two questions. Next two questions are kind of growth and forward-looking. I will cover the first one, which is how do we see dividends growing over the next 3 to 5 years as a percent. Obviously, I'm not going to give you a percentage, I'm not going to make a forecast, but what we're aiming to do is pass on that rental growth that we will receive from our rents -- from our leases, I should say, control costs, and make sure we're running the company efficiently and hopefully pass that on by way of dividend growth as well. We've got a well-covered dividend. Earnings are -- have grown this year in difficult conditions and should grow in future years as that rental growth comes through. So we're certainly expecting to maintain a progressive dividend. And then the kind of associated question is really about the growth of the business and the portfolio over the next few years in terms of owning more homes. I'll let Kenneth.

Yes. And we're 10 or 11 years old, and we had about 100 homes and we've sold 8 or 9. So that tells you that we can easily grow at 10 homes a year. And the current value of buying a new home, that's GBP 150 million of new capital per year. So there is good opportunity to do further growth as the share price continues to recover.

Yes. So all, of course, subject to returns relative to the cost of capital, equity, but that is easing somewhat and hopefully will continue to do so. I think we've got one final question. We've covered it to some degree already, but it's quite a specific question. So how is the minimum wage affecting our costs? I think what we've seen is we welcome clearly our tenants passing that on. Most of our carers, I think, are paid ahead of minimum wage, deserve to be paid more. There is headroom within our tenants' P&Ls for slightly higher cost basis. So as wage growth grows, they should be able to cover that with increased resident fees. So it shouldn't have too big an impact on profitability.

Thank you for all your questions. It's been absolute privilege to invest in the sector and be in the vanguard of leading and bringing modern purpose-built homes to care for our seniors in an appropriate way what you and I would like to have if we were in that situation, and we can only do it with your support. So thank you for your questions and your interest.

Perfect. Kenneth, Gordon, that's great. Thank you very much indeed for being so generous of your time then addressing all of those questions that came in from investors this morning. 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. Kenneth, I was just going to ask you for a few closing comments, but I feel like you may have just well delivered those. But unless there's anything further to add there, so what I'll do is I'll redirect those on the call for their feedback, which I know is particularly important to yourself and the company. So Kenneth, so is there anything further to add at this point? As I say, if not, I'll redirect those on the call for their feedback.

Yes. No, we are, as I say, delighted to have the opportunity to improve the quality of care for our seniors. That's all part of our mission and the mission of this business as well as creating long, stable income. Thank you.

Perfect, 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 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.