Aiming for transparency from listed retirement village operators
For years now, Jarden's head of research, Arie Dekker, has been urging the listed retirement village operators to improve their disclosure, particularly on cash flow.
It is strikingly unusual in the New Zealand market for an analyst to stand up to companies and to persist over such a prolonged period in efforts to persuade them towards better disclosure.
Unfortunately, it took a near catastrophe, namely Ryman Healthcare's $902 million capital raising in February and the realisation of why that raising was necessary, to shake the sector up sufficiently to understand that Dekker's advocacy on better disclosure was in their own best interests.
The Ryman debacle continues to overhang the sector; absent what we learnt in February, I doubt the rest of the sector would have been so badly beaten up by the share market.
Back in August, Summerset led the recognition that the best answer was better disclosure in its first-half results, although it still didn't go all the way and reveal what its banking covenants were.
However, it has now promised to do so when it reports its annual results in February.
Both Oceania Healthcare and Arvida have also gone down the track of better disclosure, but still have some way to go.
Wrong basis for dividends
Arvida, for example, continues to base its dividend policy on underlying profit, and Dekker expressed his disappointment about this.
“We have been clear that dividends in the sector should have no reference to a measure of profitability that is on the way out on the back of serious flaws in its representation of profitability in the sector,” Dekker said in his note on Arvida's results.
“Arvida should pay a dividend that reflects cash operating earnings (a judgement to make on how to adjust for buyback activity) and any delivered cash recycling out of development. If cash is not being recycled, then this should be taken into account when deciding whether to allocate operating earnings,” he said.
“We are disappointed Arvida did not suspend the dividend, particularly on the back of very weak cash generation.”
That underlines the fact that we now know both Ryman and Oceania have been cash flow negative for years and have been effectively borrowing to pay dividends, a practice that is clearly unsustainable.
Oceania has now sensibly suspended its dividends while it addresses trying to clear the $422 million worth of unsold apartments it had on its books at Sept 30, including $109 million completed more than 12 months earlier.
Praise for better visibility
Dekker did praise Arivda on providing greater visibility on its interest cover ratio (ICR), even though it showed “a marked deterioration,” which “validates calls for sector-wide visibility.”
But Ryman decided to come clean on cash flow in its results earlier this week, even though what it revealed was rather horrifying, not so much for what it revealed about the current situation, but about where it was this time last year.
It generated free cash outflow to the tune of $158.4 million in the six months ended Sept 30, but that was down from the $296.9 million outflow generated in the previous first half.
Which sounds like Mr Micawber's recipe for misery.
And yet Ryman's board was still proposing to pay out $44 million in first-half dividends last year,
Let's highlight how bad that was; the company said then that the payout represented 31.7% of underlying profit, making it sound conservative, but we now know the company was nearly $300 million cash flow negative in those six months.
It did end up getting Craigs Investment Partners to underwrite the dividend, but a more responsible board would've suspended the dividend and saved itself the underwriting fee.
But still, this was very much a psychological barrier broken at Ryman – it had previously prided itself on never having asked shareholders for more capital since listing in 1999.
An ossified shibboleth
This became ossified to the point of stupidity, so getting the dividend underwritten was a significant step in shaking off this legacy.
One positive sign is that the board has undergone significant changes with Fulton Hogan chair Dean Hamilton coming in as chair and former NZX chair James Miller and former Virtus Healthcare chief executive Kate Munnings becoming directors.
Dekker was complimentary, describing the reset as “a major step forward,” but he continues to demand further improvements on disclosure.
“This will be a journey and we believe there is more work to do but, importantly, it looks like Ryman is committed to making decisions on the right factors.”
In particular, Ryman will no longer base the dividend – it won't be paying any until the 2026 financial year, at the earliest – on underlying profit but on free cash flow.
Chief executive Richard Umbers said repeatedly in a conference call with analysts that the the emphasis on underlying profit “has been too prominent,” and that after this year, Ryman won't be using it when it provides guidance on future results.
Cause of Ryman's woes
Ryman's financial woes centre on decisions to start building too many high-rise villages at once – decisions made before Umbers joined the company in October 2021.
The plunge in house prices since about that time and the rampant inflation of building materials and labour costs haven't helped either.
It currently has 14 sites under construction at a cost of $4.32 billion and they're expected to be in the red to the tune of $430 million when completed, with $370 million of that coming from five NZ sites that were affected by severe weather events and covid-related delays.
Umbers explained that, given the amount Ryman has already invested, “it very much justifies that we go on and complete those sites, even if we're not happy with the overall profile of capital recycling across those sites.”
Despite the capital shortfall, these sites are expected to deliver incremental cash flow of more than $1 billion from September of this year.
In particular, he noted that the characteristics of some sites mean “frankly, we won't be doing that type of development again.”
In a simplistic sense, the problem with high-rise apartment buildings is that nobody can move in until the entire building is completed, tying up very large capital sums in the meantime.
No bloodbath on NZX
With broad-acre development of villas and townhouses, you can sell each dwelling as they're completed, meaning a much faster recycling of the capital invested.
Another thing Umbers is focusing on is improving the financial performance of existing villages and, to that end, was able to report positive cash flow from existing operations of $49.2 million compared with the cash outflow of $14 million in the previous first half.
While Ryman has no reason to be overjoyed at the share market's reaction to its disclosures, at least it was no bloodbath.
The shares closed at $5.30 the day before it reported, fell 8 cents on the day, and had recovered to $5.40 on Thursday. That compares with net tangible asset backing of $6.836 at Sept 30, so the market has priced in a lot of bad news and then some.
Incidentally, the results also showed that capital repayments on existing units after the occupants had left (usually that means they've died or moved on to more intensive care) rose to $152.7 million at Sept 30, up from $138.9 million at March 31.
On Charlie Munger's wisdom
Those are units Ryman will onsell to new residents, so that money should be recoverable, but it does demonstrate what the industry has been saying that the larger village operators are able to, and do, repurchase units in a timely fashion rather than insisting on the residents' heirs having to wait until the unit is sold for their inheritance.
Pleasingly, Dekker himself doesn't feel he's suffered any negative consequences from being so outspoken on the need for better disclosure.
“I think generally companies are pretty good at dealing with more robust analysis of their businesses.”
But Dekker hasn't been without his critics, including, unfortunately, me; a few years ago, I accused him of not understanding the retirement village proposition.
The type of retirement villages the NZ operators build and run have significant differences from other types of property.
In particular, would-be residents make the decision based on need, making the villages a type of essential service delivered through property.
That is still true, but it was me who hadn't understood that, as with any business, the cash flow has to make sense.
To quote the great Charlie Munger, who sadly died this week at age 99: “Every time you hear ebitda, just substitute it with bullshit.”
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