No peace assured for investors in retirement care industry

By Brian Gaynor

Most investors believe the retirement care industry has huge growth potential. This has been prompted by the performance of Metlifecare and the entry of prominent businessmen into the sector.

Other cashed-up entrepreneurs are also looking at the industry.

A shareholder at the recent Trans Tasman annual general meeting caused a buzz of excitement by suggesting the beleaguered property company should invest in retirement villages.

The number of people aged 65 or over is expected to rise from 423,000 in the 1996 census to 1.145 million by 2051. The industry is relatively undeveloped with only 2.8 per cent of the elderly living in retirement villages compared with 5.5 per cent in Australia and 15 per cent in the United States.

If the North American trend is duplicated, the retirement home population will leap from 13,000 to 170,000 over 50 years.

These projections are incredibly bullish, but other factors could impact on investment returns.

The industry has an extremely low barrier to entry. Almost anyone can set up a retirement village and the optimistic outlook for the sector is attracting new operators. History is strewn with high-growth industries which have given poor returns because of low barriers to entry.

A high percentage of the industry's profitability is generated from the sale of new and existing property units. Thus retirement village operators are heavily dependent on the residential property market, because elderly people need to sell their existing home before they buy into a village.

The potential for large property profits is also attracting developers.

Retirement care is a long-term industry and the rise in elderly Americans living in villages - from 3 to 15 per cent - has taken nearly 50 years. The growth rate in New Zealand is unlikely to be smooth. Periods of oversupply will have a negative effect on earnings, particularly from property operations.

Government health expenditure, regulatory issues and taxation legislation favour the industry. But any changes to these could reduce future investment returns.

Investors now have the opportunity to buy shares in three listed retirement village operators: ElderCare (formerly New Zealand Petroleum), Metlifecare and the new public offering Ryman Healthcare.

The mood at last week's New Zealand Petroleum meeting, which approved the backdoor listing of ElderCare, was upbeat. Directors were optimistic and said ElderCare was less reliant on property development profits than most operators.

This has been true in the past but the company has an extremely aggressive property development strategy which is expected to make a large contribution to profit growth. ElderCare, with just 152 units, plans to develop 500 new apartments and villas.

The group's income and profit forecasts are also very aggressive. Total operating revenue is forecast to increase from $5.5 million in the March 1999 year to $20.9 million in the 12 months ended May 31, 2000 and net profit from $395,000 to $4.1 million.

After the meeting, Evan Christian, a director, argued that the $16.3 million acquisition price was a steal and that he, Eric Watson and the other ElderCare shareholders had come out on the wrong end of the transaction.

There is no sympathy for this point of view because the $16.3 million price tag has been based on shares issued to the vendors at 15c each. At ElderCare's current market price of 54c, the vendor's consideration is worth more than $65 million for a company with historic earnings of just $395,000.

ElderCare's 54c share price also makes a mockery of some of the analysis in Grant Samuel's appraisal report, which was based on a forecast post-acquisition share price of between 19c and 24c.

ElderCare is a growth-oriented company with no plans to pay a dividend. Shareholders should have an exciting ride in the short term. Longer term, the company could overextend itself and be vulnerable to an oversupply of retirement facilities and a soft residential property market.

Metlifecare, which was listed in 1994 after the issue of shares to the public at 85c each, is well known to the investment public.

The company's net profit has steadily increased since 1995 and the consensus forecast for the year ended December 31, 1999 is $11.75 million compared with actual earnings of $8.5 million in 1998.

Metlifecare is the largest of the three companies in terms of facilities and revenue and its plans are modest compared with ElderCare and Ryman.

Its relatively low price/earnings ratio and proven track record suggest its share price performance will be less volatile than the other two longer term.

Ryman Healthcare is a South Island company well know for its inhouse property development expertise. An aggressive property expansion programme has made a strong contribution to profit growth in recent years.

Ryman is now expanding its North Island operations. The company has a vigorous strategy and expects to sell or resell 183 residential units this year compared with 142 last year and an estimated 60 units in 1997-98.

The average unit price is expected to rise from $114,000 in 1998-99 to $144,000 this year, reflecting the company's greater penetration into the North Island. Earnings are forecast to surge from $6.2 million in the March 1999 year to $14.1 million in 1999-2000.

Ryman has 80 million shares and will issue a further 20 million shares at an indicative price range between 150c and 180c. In addition, the original shareholders will sell 10 million existing shares at the same price, which will give the public a 30 per cent shareholding.

Just over two years ago Direct Capital purchased a 25 per cent holding in Ryman for $7.5 million and the same shareholding is now worth between $30 million and $36 million at the indicative price range. This increase is not justified by profit performance.

Direct Capital will recoup at least half its initial outlay by selling 2.5 million of the 20 million Ryman shares it holds.

Ryman's two key executives, John Ryder and Kevin Hickman, have a proven track record, but the issue price is too high particularly at the upper end of the price range.

As the indicative price range already anticipates an expected surge in earnings for the current year existing - rather then the new - shareholders will be the main beneficiaries of the improved performance.

The issue price would cause less concern if Ryman was certain of another year or two of robust profit growth.

Unfortunately, this is not assured, because of the low barriers of entry to the industry, the aggressive expansion plans by many existing and new operators, the importance of property development profits and the sector's high dependency on a strong residential property market.