Primary Health Properties PLC: Preliminary results for the year ended 31 December 2022

• Primary Health Properties PLC, , the FTSE 250 healthcare real estate investment company, has made two noteworthy announcements since we last reported on the company (on 14th December 2023).
• The key highlight is that
• Accordingly, we note that the degree of risk associated with an investment in Primary Health Properties is medium, and remain of the view that the valuation of the company is attractive, which is supported by a prospective yield of 6%.

Announcements

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Risks

As with any investment, investing in Primary Health Properties carries a level of risk. Overall, based on the company's adjusted beta (i.e. 0.531), the degree of risk associated with an investment in Primary Health Properties remains relatively medium.

Valuation

The key things that we continue to be impressed by the stock are as follows: 1) dividend growth every year since inception (i.e. for 27 years); 2) 89% of rents are covered by government national health bodies of the UK and Ireland, supporting 99.7% occupancy rates and minimal tenant defaults or similar unplanned costs; 3) the lowest cost ratio (costs / rental income) in the whole of the UK REIT (real estate investment trust) space, with an EPRA (European Real Estate Association) cost ratio at 10.5%; 4) 95% of group debt is hedged for almost eight years; 5) a quarter of rent roll is explicitly linked to inflation, and management argues that the balance is effectively linked to inflation through replacement cost; 6) headroom to continue growing the portfolio of health centres; and 7) an improving rental growth outlook, with rent reviews and asset management projects completed in the first half of this year adding £1.8m or 1.3% on a like-for-like basis.

Full-year results

• Profit and loss
• Balance sheet
• Cash flow
• Other
  • d its financial results for the year ended 31st December 2022.
  • 27th year of continued dividend growth.

Acquisition

The company has acquired Axis Technical Services Limited, an Irish property management business, and signed a long-term development pipeline agreement to provide access to a strong pipeline of future primary care projects in Ireland.

Axis Technical Services Limited, currently manages a portfolio of over 30 properties, including the majority of PHP's Irish portfolio, and the acquisition gives the group a permanent presence on the ground, further strengthening its position in the country and relationship with the Health Service Executive ("HSE"), Ireland's national health service provider. The acquired company also provides fit-out, property and facilities management services to the HSE and other businesses located across Ireland.

As part of the acquisition, PHP has signed an agreement with Axis Heath Care Assets Limited ("Axis"), a related company owned by Axis Technical Services Limited, which gives PHP the option to acquire Axis's development pipeline over the next five years. Axis is one of Ireland's leading developers of primary care properties having developed five properties over the last five years which have been acquired by PHP. It also has a strong pipeline of projects with an estimated gross development value of €50m.

PHP currently owns a portfolio of 20 assets in Ireland valued at €261m.

Risks

As with any investment, investing in Primary Health Properties carries a level of risk. Overall, based on the company's adjusted beta (i.e. 0.531), the degree of risk associated with an investment in Primary Health Properties is relatively 'medium'.

Here, to estimate the adjusted beta, we used the iShares MSCI World ETF to represent the market portfolio; and in terms of the time period and frequency of observations, we used five years of monthly data (i.e. 60 observations in total), which is supported by a study and is the most common choice. The beta value in a future period has been found to be on average closer to the mean value of 1.0, and because valuation is forward-looking, it is logical to adjust the raw beta so it more/most accurately predicts a future beta. In addition, here, we have assumed that for an investment to be considered 'medium' risk, it must have a beta value of between 0.5 and 1.5. Further information about the beta ratings can be found in the appendix section of this report.

For us, currently, the biggest risk to the valuation of the company relates to macro-economic factors, in particular unexpected and sudden changes in inflation and interest rates movements.

Valuation

Research suggests that in terms of estimating the expected return of an investment over a period of 12-months or more, the approach that is more/most accurate is the absolute valuation approach, so that's the approach that we suggest using to determine the estimated value of the company.

What's the expected return of an investment in Primary Health Properties using the absolute valuation approach?

Accordingly, we estimate that the expected return of an investment in Primary Health Properties Plc over the next 12-months is 59%. In other words, an £100,000 investment in the company is expected to return £159,000 in 12-months from now. The assumptions used to estimate the return figure can be found in the table below.

Assuming that a suitable return level in the 12 months is 10% and Primary Health Properties Plc achieves its expected return level (of 59%), then an investment in the company is considered to be a 'suitable' one.

What are the assumptions used to estimate the return figure?

Key inputs

Description	Value	Commentary
Which valuation model do you want to use?	Discounted cash flow	Research suggests that in terms of estimating the expected return of an investment over a period of 12-months or more, the approach that is more accurate is the absolute valuation approach, so that's the approach that we suggest using to determine the estimated value of the company.
Which type of discounted cash flow model do you want to use?	Dividend discount model	The dividend discount model (DDM) is one of the most common discounted cash flow models.
How many distinct stage of growth do you want to use?	One stage	For simplicity, we have used the one stage pattern here.
What is the expected constant growth rate in dividends?	3%	We note that the gross domestic product (GDP) growth rate in the last 20 years (2001 to 2022) is around 3% per year for the global economy, and around 2.25% for the United Kingdom. Over the last 10 years, the median dividend growth rate of the company is 2.78% and the mean is 3.47%.
Which forecasts to use for the one-year ahead expected dividend amount?	Proactive Investors	Here, we have used the forecasts of Proactive Investors.
What is the required return on equity?	7%	For estimating the required return on equity, we used the Capital Asset Pricing Model (CAPM), which provides an economically grounded and relatively objective procedure for required return estimation, and, therefore, it has been widely used in valuation. The calculation of the required return on equity (and the reasons behind the calculation) can be found in the table below.
What's the current value of the company?	108.9 pence per share	As at 12th December 2022, the current value of Primary Health Properties Plc is 108.9p per share.

Cost of equity (%)

Input	Input value	Additional information
Risk-free rate (%)	3.55%	Here, the risk free rate is the US 30 year treasury bond, and is calculated as at 12th December 2022.
Beta	0.531	Here, to estimate the adjusted beta, we used the iShares MSCI World ETF to represent the market portfolio; and in terms of the time period and frequency of observations, we used five years of monthly data (i.e. 60 observations in total), which is supported by a study and is the most common choice. The beta value in a future period has been found to be on average closer to the mean value of 1.0, the beta of an average-systematic-risk security, than to the value of the raw beta; because valuation is forward looking, it is logical to adjust the raw beta so it more accurately predicts a future beta.
Equity risk premium (%)	7.98%	Research suggests that for the region of equity risk premium, it's best to use one that is the same or similar to the region of the beta market portfolio. Here, the region of the beta market portfolio is the world/global, so we have used the world/global region for the equity risk premium, and is calculated as at 5th January 2023.
Cost of equity (%)	7.81%	Cost of equity = Risk-free rate + Beta x Equity risk premium.

Sensitive analysis

The three main inputs that result in the greatest change in the expected return of the Primary Health Properties Plc investment are, in order of importance (from highest to lowest):

1. The discount rate (the default multiple is 7.81%);
2. The dividend growth rate (the default multiple is 2.78%); and
3. The dividend per share forecast (the default forecast is 6.69 pence per share).

The impact of a 30% change in those main inputs to the expected return of the Primary Health Properties Plc investment is shown in the table below.

Primary Health Properties investment expected return sensitive analysis

Main input	20% worse	Unchanged	20% better
Discount rate	4%	58%	233%
Dividend per share	11%	58%	106%
Growth rate	28%	58%	106%

Appendix

Cap rate valuation

A key, and common, way to value real estate is by dividing the estate's net operating income by the estate's capitalization rate (or cap rate, for short), and we note that the cap rate is similar to the net initial yield (NIY).

The net initial yield (NIY) and investment portfolio valuation of PHP is 4.82% and £2.796 billion, respectively, equating to a net rental income of £135 million.

We note that a £5 million improvement in net rental income (from £135 million to £140 million) equates to a £109 million improvement in the valuation of the portfolio, all other things being equal. Similarly, a half a percentage point reduction in the net initial yield (from 4.82% to 4.32%) equates to a £329 million improvement in the valuation of the portfolio, again, ceteris paribus. We anticipate that any improvements (in the valuation of the portfolio) will translate to an almost identical increase in the valuation of the company. So, for example, if the improvement in the property valuation is £329 million, then the company valuation will also increase by £329 million.

Net initial yield against net rental income

	3.50%	4.00%	4.50%	5.00%	5.50%	6.00%
125.0	3,571	3,125	2,778	2,500	2,273	2,083
130.0	3,714	3,250	2,889	2,600	2,364	2,167
135.0	3,857	3,375	3,000	2,700	2,455	2,250
140.0	4,000	3,500	3,111	2,800	2,545	2,333
145.0	4,143	3,625	3,222	2,900	2,636	2,417
150.0	4,286	3,750	3,333	3,000	2,727	2,500

Peers

Peers

Company name	Bloomberg ticker	Primary exchange	Market capitalisation (GBP)	BF P/FFO	Yield (%)	Interest cover (x)	Total debt/total capital
Primary Health Properties PLC	PHP LN	United Kingdom	1,459m	0.168	5.95%	N/A	46%
Assura PLC	AGR LN	United Kingdom	1,578m	--	5.77%	3.77	41%
Aedifica SA	AED BB	Belgium	2,660m	14.8279	4.75%	5.91	43%
Target Healthcare REIT PLC	THRL LN	United Kingdom	477m	--	8.78%	8.35	25%
Cofinimmo SA	COFB BB	Belgium	2,340m	11.3873	7.12%	7.80	44%
Impact Healthcare Reit PLC	IHR LN	United Kingdom	404m	0.1111	6.51%	N/A	22%

Dividends

Over the last 10 years, the median dividend of the company is 2.78% and the mean is 3.47%.

Dividends

Year	Q1	Q2	Q3	Q4	Total	Growth (%)
2022	1.625	1.625	1.625	1.625	6.5	4.84%
2021	1.55	1.55	1.55	1.55	6.2	5.08%
2020	1.475	1.475	1.475	1.475	5.9	5.36%
2019	1.4	1.4	1.4	1.4	5.6	3.70%
2018	1.35	1.35	1.35	1.35	5.4	2.86%
2017	1.31	1.31	1.31	1.32	5.25	2.44%
2016	1.28125	1.28125	1.28125	1.28125	5.125	2.50%
2015	0	2.5	0	2.5	5	2.56%
2014	0	2.4375	0	2.4375	4.875	2.63%
2013	0	2.375	0	2.375	4.75	2.70%
2012	0	2.3125	0	2.3125	4.625

Risk rating

Risk rating

Rating	Beta
Low	Equal to or below 0.5
Medium	Between 0.5 and 1.5
High	Equal to or above 1.5

References and notes

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