Oceania Healthcare says its bankers won't let it tell the market what its banking covenants are, and the interest coverage ratio (ICR) one in particular.
An ICR is a measure of how many times operating earnings cover the company's interest bill, and the rapid increase in interest rates globally has made breaches of such covenants much more likely.
A complicating factor is that there are different ways of calculating this ratio, such as whether or not capitalised interest is included, but we know none of these details about Oceania's covenants.
When it released its results on Wednesday, chief financial officer Kathryn Waugh said Oceania had met all its banking covenants, not just the ICR one, but acknowledged that analysts and investors want more information.
She promised she would be discussing the matter with its bankers.
“We've tried to be as open and transparent as we can,” Waugh said.
However, she let slip that Oceania had been disclosing such details a couple of years ago.
The 2021 annual report detailed not just the ICR covenant, but a loan-to-valuation covenant, and a couple of others.
So, why were Oceania's bankers OK with the company revealing such details at a time when interest rates were so low that nobody really cared, but are opposing transparency now when investors know how much it can matter?
Unhappy Dekker
Jarden analyst Arie Dekker wasn't happy about this, saying that it was “very problematic” that banks are preventing the company from disclosing such information to shareholders, who, after all, are the owners of Oceania.
Dekker noted that the banks had been doing what hindsight now suggests was reckless lending (my words; Dekker said poor and too much lending) to companies such as Oceania.
Certainly, Oceania did provide more detail than previously of how it proposes to recycle cash and to get its gearing, 37.7% at Sept 30, down to more comfortable levels.
Gearing at March 31 was 36.6%, up from 28.6% a year earlier, and it has kept rising mainly because, as Craigs Investment Partners analyst Stephen Ridgewell puts it, Oceania has “an ocean of unsold stock.”
At Sept 30, Oceania had $422 million worth of unsold apartments including $109 million completed more than 12 months earlier.
That's in the context of Oceania's market capitalisation at yesterday's 68 cents share price being $492.4 million.
Incidentally, the net asset backing of the shares at Sept 30 was supposed to be $1.40 each, more than double the share price, which show how much the market believes that number.
“In our view, free cash generation from its existing assets does not support book value,” Ridgewell said.
Borrowing to pay dividends
Essentially, Oceania has been borrowing to pay dividends, something that is obviously unsustainable – Ridgewell estimates it's been cash flow negative for several years.
Oceania has now suspended its dividend and Dekker is assuming Oceania won't be paying dividends for another two years.
He has been campaigning for the retirement village sector to cease basing their dividends on underlying net profit, which has proved to have a tenuous relationship with cold, hard cash.
Its now obvious that Ryman has also been borrowing to pay dividends – its chief executive Richard Umbers admitted earlier this year that the company had been cash flow negative for years.
Dekker argues that dividends should be paid only out of free cash flow.
I find it had to disagree with that and can't see how these companies can justify using the underlying net profit calculation any longer.
Ridgewell notes it's taking Oceania about 2.5 years to sell new apartments, “by far the slowest in the sector.”
Summerset, which appears to be the best-placed company among the listed retirement village operators, takes less than six months.
Back in August, Summerset chief executive Scott Scoullar said much the same thing about the bankers not wanting the company to disclose covenant details.
Uncomfortable bankers
The bankers were already uncomfortable with the amount of disclosure his company had provided, Scoullar said.
I suspect the bankers' problem is that they didn't want it to be public how differently they have been treating the companies in the sector.
Summerset, the least exposed appears to have enjoyed more generous covenants than other retirement village operators.
As the old adage goes, bankers are happy to lend you an umbrella when the sun is shining but they want the umbrella back as soon as it starts to rain.
In its half-year results, Summerset went a long way towards providing additional disclosure about debt, cash flow and how it plans to recycle capital.
Scoullar has since told me that the company will be providing more details, including details of the covenants, when it announces its full-year results in February.
This is an admirable response to the strife fellow retirment village operator Ryman Healthcare got itself into in February, and a recognition that investors should be better informed about the risks faced by companies in which they own shares.
But what on earth were these companies' directors thinking when they allowed bankers to have so much sway over what could be dislcosed to shareholders?
The regulator's view
I wondered what the regulators have to say about this.
NZ Regco chief executive Joost van Amelsfort says NZX listing rules and guidance is that if an issuer breaches a financial covenant, and if that's material, they should disclose it.
But there's no prescribed obligation for companies to disclose the types of financial covenants they agree to, or their specific terms, and he's not aware of other jurisdictions having such requirements either, van Amelsfort says.
“Some issuers have taken a proactive approach in disclosing that information in the notes that accompany financial reporting of their debt profile. Others don't provide that information – as you've flagged, in some cases, that appears to be a result of the contractual terms of the banking facilities/arrangements that an issuer has entered into with its bankers,” he says.
“That said, I consider that disclosure of information on applicable financial covenants and their ratios by issuers can be beneficial to existing and prospective investors as part of a mature investor relations strategy, even if those details don't in isolation comprise 'material information.'
“The practice enables a deeper understanding of issuers' liability profiles, as well as the possible implications of performance, on an issuer's capital management planning.”
I'm with Dekker
I'm with Dekker on this; the Ryman fiasco in February opened everyone's eyes to how important such details are and how hefty the price tag could be if any banking covenants were breached.
It cost Ryman's shareholders $902 million in fresh equity because the company had realised it was likely to breach its covenants.
Unlike its bankers and other local lenders, it's US private placement investors refused to relax its then undisclosed covenants and the upshot was Ryman had to raise $902 million to “make whole” the USPP investors, paying them the full amount they would have received if the placement hadn't been repaid early.
Of the amount raised, $30 million went to costs, $874 million went to repaying the USPP compared with the book value of $708.6 million, and Ryman got to keep just $30 million.
However, it does look as if market forces are going to change this treating shareholders like mushrooms, now that investors are aware of these issues.
When Ryman announced in September that it had extended its bank facilities, it disclosed that the banks had agreed to amend its ICR covenant.
Instead of the previous covenant being based on earnings before interest and tax (ebit), the new one is based on adjusted ebit, depreciation and amortisation (ebitda) and the interest costs on the repaid USPP facility won't be included.
The actual numbers
It also provided the actual numbers, and said the ICR covenant level was left at 1.75 times through to March 31, 2025, rising to 2 times at Sept 30, 2025 and then to 2.25 times thereafter.
No doubt we'll get more details when Ryman reports its first-half results next Wednesday.
Arvida, which reports next Tuesday, has also had to seek a relaxation of covenants from its bankers.
But when it announced at the end of October that it had restructured its banking facilities, it said only that interest costs on the development facility wouldn't be included in calculating the ICR, but didn't say what the actual ICR covenant was.
On a more positive note, Forsyth Barr analyst Aaron Ibbotson agreed that the Oceania results were “weak,” but also highlighted a couple of positive aspects.
The companies sales of occupation rights agreements (ORAs) at $129 million in the latest six months were $10 million above its previous record in the first half of the 2021 financial year and were 90% above the very weak second half of the 2023 financial year.
The company has also sold two care sites, which Ibbotson estimates were broadly breaking even, at or marginally ahead of book value.
It's also likely that Oceania is now at peak debt, although Ibbotson reminds us the company did say the same thing six months ago.
Amendment: While Arvida’s October update didn’t specify the ICR, an announcement in March did: “The ICR is amended to 1.75x for the next four financial reporting periods to and including 30 September 2024 and is calculated based on an adjusted EBITDA with all interest cost included. All development gains are now included in the calculation.”
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NZ Regco is wrong. Banking covenants are important and disclosable information. The question is it relevant and liable to be disclosed. Then when should it be disclosed. If one is well within its banking covenants then it is likely not that relevant. However if covenant compliance becomes more marginal then it may affect the share value if it was known to the market. In that case it is a disclosable matter even if covenants have not (yet?) been breached. Dirk Hudig
The company is in breach of its covenants and bankers do not want the breach amount disclosed. Neither does the company. RV’s model is unsustainable and they simply do not know what to do.