Aged care an investor danger zone

PORTFOLIO POINT: Australia’s growing numbers of retirees are a tantalising market, but a frustratingly difficult one for investors.
Two million Australians are over 70 and that number is set to double in the next 20 years; well-heeled baby boomers are choosing to use their super for lifestyle rather than legacy; improvements in healthcare and medicine are lengthening life-spans and making people more active for longer.

With fundamentals like these, it’s no wonder that retail and institutional investors alike are continually seduced by the prospects of Australia’s burgeoning aged care and retirement industries. On closer inspection, however, the risks to investing within this theme are legion. And just as old age might not be all lawn bowls and piña coladas, aged care, retirement villages and nursing homes all have risks and pitfalls for investors.

Old people mean big business for many companies, but depending on where they are situated in the spectrum of services their profitability seems to change. At the coalface of providing housing services to the elderly are Becton Group, FKP Property, Stockland and Prime Retirement. Lend Lease Primelife, Sunnycove and Babcock & Brown are some of the other big names in retirement villages. But as the share and managed fund performance of some of these companies has demonstrated, retirement villages and nursing homes can be tricky businesses (see panel, below).

Further down the food chain, listed companies Healthscope, Sigma Pharmaceuticals and Primary Health Care provide medical services to the elderly. Their performance hasn’t necessarily been stellar, but they have fared better than many of the companies involved in property. Companies in the retail chemist space such as Australian Pharmaceutical Industries and specialist medical technology firms such as Cochlear and ResMed (see our previous story Strong vital signs) are by no means immune from recessionary effects, but may be safer bets.

Leveraged to an ageing population with more comprehensive health and medical needs and, importantly, indirect beneficiaries of government subsidies and Medicare, their products tend to be used regardless of the economic climate. A case could even be made for investing in caravan maker Fleetwood Corporation, or the New Zealand-listed Tourism Holdings Ltd, which both cater for the ubiquitous “grey nomads”. Until shares turned south in the second half of 2008, Fleetwood was a consistently strong performer on the ASX.

The scope for aged care and retirement sector investments is thus large, but to succeed at stock or fund-picking within the sector, a range of issues need to be examined. Despite growing demand for retirement housing – as boomers sell the family home and look for a sea change or an inner-city apartment – companies such as Lend Lease Primelife, Australia's biggest retirement home builder, have had terrible troubles in the past.

Babcock & Brown Communities is no longer, and the efforts of Gold Coast developer MFS to get in on the action through the struggling Village Life brand also failed. The industry fundamentals of Primary Health Care failed to prevent its shares from falling from over $13 in February 2007 to about $5.15 today and while it might look as if the number of slow-moving campervans on the road is rising, with unpredictable oil prices and uncertainties in the motor vehicle industry globally, even that industry may not exactly be a recession-proof: Fleetwood is currently at $3.67, down from $9.84 at one stage last year.

Ed Butler, a senior analyst with industry research firm IBIS World, is however optimistic about one area: nursing homes. “There’s always demand for this sector and it’s not something that government funding will cut anytime soon,” he says. “We also found that individual company misfortunes are not necessarily reflective of a greater trend.”

IBIS looks at the fundamentals of 500 different industries and in a recent report found that nursing homes had one of the lowest risk ratings across the entire economy. Just a few industries such as, intriguingly, veterinary services, dairy cattle farming, libraries and cheese manufacturing were seen as being safer.

The same could be said of childcare, which, like nursing and retirement accommodation, has a high constant demand and strong government support. But unlike childcare, which, as ABC Learning has shown, is nigh impossible to monetise, some institutional fund managers have demonstrated that with no small degree of skill, nursing homes and retirement villages can deliver dollars.

Suited best to institutional investors, the margins and revenues on aged care may not be huge, but in the case of APN’s Melbourne-focused Retirement Properties Fund they can mean a 15% per annum average return. The fund manager at RPF, Steven Lawford, says that structuring and asset selection is critical.

“Our fund is 10 years old, it was put together by Howard Brenchley (APN's chief investment officer) and the income stream is derived from deferred management fees whereby lumpy cash flow is streamlined.” Generally the retirement industry’s fees come from an “exit fee”, which, naturally, only happens once in a resident’s lifetime: when they move out or pass on. If the average resident only leaves after 10–12 years this means that a robust financial structure and credit rating must be in place to synthetically produce returns based on future “lumpy” exit fees. Large groups such as APN can do this easier than others and for them, retirement investments can work.

Indeed, despite an awful year for property trusts, APN’s model of investing in five highly occupied villages across suburban Melbourne delivered a growth in net asset value of 6.5% over 2007-08. While debt could be an issue for the fund in 2009 (at June 30 last year it held $28.6 million in assets against $14.1 million in liabilities), leverage is certainly not as pronounced as in other areas of the property industry.

“It's a factor of the ways that we did it at inception, we bank our cash flow monthly,” says Lawford. “The villages are all proven and profitable in the sense that the deferred management fees cover the rent.” AMP, through its 95% interest in Principal Aged Care, Macquarie, in partnership with FKP and UK health insurer BUPA Group (which owns HBA and MBF) are other institutional players active in the sector.

Aged care and retirement home operators that have looked to appeal directly to the retail investor have not fared as well. Although institutional investors such as APN, or not-for-profits like the Uniting Church (UnitingCare runs about 5% of Australia’s nursing homes, one of the largest concentrations, according to IBIS World), may succeed, companies that take retail investors closer to the coalface have had problems; companies like the former incarnation of Lend Lease Primelife, or Sunnycove’s Village Life.

A lot of the problem lies with the fundamental exit fee-based business model. But the problem many investors face otherwise lies with the operating companies. And as with any industry, the economic and market conditions may be fantastic, but only the competence of the management and the fundamentals of the company will create a return on investment.

If you do want to invest in Australia’s silver-haired population, careful company and fund selection is not just important, it’s critical. While investments in the sector can work for large institutional investors, and while innovative medical companies can produce great returns for retail investors on the stockmarket, there are plenty of ways to lose money by blindly trying to turn silver into gold. The story below is a cautionary tale.