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Primary Health Properties - healthy end to transformational year

Nicholas Hyett, Equity Analyst | 12 February 2020 | A A A
Primary Health Properties - healthy end to transformational year

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No news or research item is a personal recommendation to deal. All investments can fall as well as rise in value so you could get back less than you invest.

Primary Health Properties Ordinary Shares

Sell: 138.20 | Buy: 138.60 | Change -2.20 (-1.56%)
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Underlying earnings per share rose 5.8% in 2019 to 5.5p. That reflects rental increases, acquisitions from previous years and lower costs following synergies from the MedicX acquisition.

Underlying net asset value per share rose 2.7% to 107.9p.

The full year dividend rose 3.7% to 5.6p.

The shares were broadly unmoved following the announcement.

View the latest Primary Health Properties share price and how to deal

Our view

It's been a transformational year for Primary Health Properties (PHP).

The merger with rival MedicX has hugely increased PHP's size. That's created opportunities for cost savings, both in the cost of debt and operating costs. That should provide a long term shot in the arm for profits. As a REIT, PHP has to pay out the vast majority of profits as a dividend so benefits will ultimately feed through to investors' pockets.

Looking to the future we think PHP has several features which underpin long, term income paying potential. Investment in out-of-hospital care, which includes the GP and community healthcare services which use PHP's properties, is set to run ahead of wider NHS spending. Meanwhile the increased interest in mega-surgeries which bring together multiple primary care services bodes well for PHP's purpose built properties.

With 90% of the group's rent roll funded by the NHS or its Irish equivalent, we view the group's tenants as lower risk. An average lease length of 12.8 years should mean rental income is secure for years to come.

There are some good reasons for caution too though. Loan-to-value is high by industry standards at 44.2% - and that means that, while neither look likely at the moment, an uptick in interest rates or widespread increases in rental arears would be painful. LTV could fall as the group invests in new assets at lower multiples, but that will take time.

The very fact of the group's REIT structure also means investors are likely to be asked to fork out extra cash from time-to-time. Because REITs have to pay out most of their profits it's difficult for them to fund growth organically. That means they often sell shares to fund new acquisitions, potentially diluting existing shareholders.

However, the biggest challenge facing investors in our opinion is a PE ratio of 26.6, which is well above the long term average. A high share price has also driven the yield down to 3.6%, below the market average, with only modest growth in the future. That means that although we continue to see PHP as potentially interesting for income seeking portfolios, investors will need to take a long term view, and be prepared for ups-and-downs along the way.

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Full Year Results

Net rental income rose 51.4% to £115.7m - driven by the merger with MedicX. Looking beyond the impact of the merger, rent reviews completed during the year saw rents rise 1.9% on average.

PHP successfully delivered £4m of cost savings following the MedicX merger, driving the group's overall cost ratio down to 12% (2018: 14.3%) and administrative cost ratio down to 0.4% (2018: 0.6%). The group also reduced its average cost of debt by 0.5 percentage points to 3.5%.

The overall portfolio was valued at £2.4bn at the year end, up 2.1% adjusting for the merger. PHP finished the year with occupancy rates of 99.5% and a Weighted Average Unexpired Lease Term (WAULT) of 12.8 years. 90% of the rent-roll was funded by government bodies.

Underlying profit before tax rose 2.2% to £75.9m, although that does not include a non-cash impairment of £138.4m relating to the revaluation of MedicX's properties and other acquisition costs. If these are included the group reported a loss of £71.3m.

Net debt at the year-end stood at £1.1bn, representing a loan-to-value (LTV) of 44.2% (2018: 47.8%). Total undrawn loan facilities stood at £356.6m.

The group currently has an acquisition pipeline worth £160m, of which £44m is in due diligence.

Find out more about PHP shares including how to invest

Unless otherwise stated estimates, including prospective yields, are a consensus of analyst forecasts provided by Thomson Reuters. These estimates are not a reliable indicator of future performance. Yields are variable and not guaranteed. Investments rise and fall in value so investors could make a loss.

This article is not advice or a recommendation to buy, sell or hold any investment. No view is given on the present or future value or price of any investment, and investors should form their own view on any proposed investment. This article has not been prepared in accordance with legal requirements designed to promote the independence of investment research and is considered a marketing communication. Non-independent research is not subject to FCA rules prohibiting dealing ahead of research, however HL has put controls in place (including dealing restrictions, physical and information barriers) to manage potential conflicts of interest presented by such dealing. Please see our full non-independent research disclosure for more information.