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 2022). For us, the key highlight of the announcements is that the company posted a 4.8% jump in its dividend for the 12-months ended 31st December 2022, meaning that the company has grown its dividend every year since its incorporation (i.e. 27 years). Accordingly, we remain confident in our chosen valuation approach (i.e. the dividend discount, Gordon growth model), and based on our underlying assumptions, continue to view the valuation of the company as attractive, which is supported by a prospective yield of 6%.

Announcements

ccc

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 influenced the assumptions of our model include: 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
  • For the 12-months ended 31st December 2022, rental income improved by 5.8% to £154.1 million (FY21: £145.6 million). Direct property expenses margins increased by 2.1 percentage points to 8.2% (FY21: 6.1%), leading to net rental income improving by 3.5% to £141.5 million (FY21: £136.7 million). Mainly due to a decrease in the valuation of the properties (by £64.4 million), operating profit decreased by 70% to £70.4 million (FY21: £236.7 million). However, driven by an increase in the valuation of the company's convertible bond (by £28.7 million), profit after tax decreased by less, by 59.8%, to £56.3 million (FY21: £140.1 million).
  • Adjusting for revaluation gains and losses, profit on the sale of land and property and other things, diluted adjusted earrings per share jumped by 4.9% to 6.4p (FY21: 6.1p).
  • The net initial yield increased by 18 basis points to 4.82% (FY21: 4.64%), equating to a net initial rental income of £135 million.
• Balance sheet
  • Total assets remained more-or-less unchanged at £2,864.5 million (FY21: £2,853.1 million), with the investment properties value almost the same at £2,796.3 million (FY21: £2,795.9 million), cash down by 13% at £29.1 million (FY21: £33.4 million) and derivative interest rate swaps up by 4x to £19.6 million (FY21: £5.2 million).
  • Total liabilities increased by 2.15% to £1,382.3 million (FY21: £1,353.2 million), as total debt increased by 1.9% to £1299.4 million (FY21: £1275.2 million). The loan to value (LTV) ratio increased by 2.2 percentage points to 45.1% (FY21: 42.9%).
  • Overall, net assets decreased by 1.18% to £1,482.20 million (FY21: £1,499.9 million). Based on the International Financial Reporting Standards (IFRS), which essentially excluded own shares held, IFRS net assets (both basic and diluted) decreased by 1.42% to 110.9p per share (FY21: 112.5p per share). Net debt increased by 2.3% to £1270.3 million (FY21: £1241.8 million).
• Cash flow
  • Adding back non cash items to net income, net cash flow from operating activities decreased by 16.2% to £117.6 million (FY21: £140.4 million). The largest non-cash item is the revaluation on the property portfolio, at a loss of £64.4 million (FY21: gain of £110.2 million).
  • Net cash flow used in investing activities decreased by 68.7% to £45.8 million (FY21: £146.4 million), mainly due to the company spending less (than the previous year) to acquire and improve investment properties (£74.8 million vs. £129.6 million) and receiving more from the disposal of properties (£27.5 million vs. £0.3 million).
  • Net cash flow used in financing activities increased by 20.9% to £76.9 million (FY21: £63.6 million), driven by lower debt financing (£48.8 million vs. £82.8 million) and higher dividend payment (£81.6 million vs. £74.4 million). The dividend per share improved by 4.8% to 6.5p (FY21: 6.2p), equating to a dividend cover of 102%, dividend yield of 6.0% and 27 years of continued dividend growth.
• Other
  • The results demonstrate the company's predictable cash flows and progressive dividend policy.
  • With the majority of the company's debt is fixed or hedged for a weighted average period of just over seven years, a strong control on costs and just one development on site, the company has a limited exposure to further cost increases and development risk.
  • The demographic of the UK and Irish populations is ageing and growing, and PHP continues to be well placed to help deliver and modernise the real estate infrastructure required to meet the expected increase in healthcare in primary care and community settings.
  • The portfolio's metrics continue to reflect the group's secure, long-term and predictable income stream with occupancy at 99.7% (31 December 2021: 99.7%), weighted average unexpired lease term (WAULT) of 11.0 years (31 December 2021: 11.6 years) and 89% (31 December 2021: 90%) of income funded by government bodies.
    

Financial and operational highlights

Income statement metrics			Year to 31st December 2022			Year to 31st December 2021	Change
Net rental income				£141.5m		£136.7m	+3.5%
Adjusted earnings				£88.7m		£83.2m	+6.6%
Adjusted earnings per share				6.6p		6.2p	+6.5%
IFRS profit for the year					£56.3m	£140.1m	-59.8%
IFRS earnings per share				4.2p		10.5p	-60.0%
Dividends
Dividend per share				6.5p		6.2p	+4.8%
Dividends paid				£86.7m		£82.4m	+5.2%
Dividend cover				102%		101%
Balance sheet and operational metrics			31st December 2022			31st December 2021	Change
Adjusted NTA (NAV) per share			112.6p			116.7p	-3.5%
IFRS NTA per share			110.4p			112.5p	-1.9%
Property portfolio
Investment portfolio valuation			£2.796bn			£2.796bn	-2.2%
Net initial yield ("NIY")			4.82%			4.64%	+18 bps
Contracted rent roll (annualised)		£145.3m				£140.7m	+3.3%
Weighted average unexpired lease term ("WAULT")		11.0 years				11.6 years
Occupancy		99.7%				99.7%
Rent-roll funded by government bodies		89%				90%
Debt
Average cost of debt		3.2%				2.9%	+30 bps
Loan to value ratio	45.1%					42.9%
Weighted average debt maturity - drawn facilities		7.3 years				8.2 years	-0.9 years
Total undrawn loan facilities and cash		£325.9m				£321.2m

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. With the growth rate of the company's dividend relatively constant, we suggest valuing the business using the dividend discount model approach (rather than the free cash flow valuation approach).

Accordingly, we estimate that the expected return of an investment in Primary Health Properties Plc over the next five years is 82%, which equates to an annual return of 12.67%. In other words, an £100,000 investment in the company is expected to return £182,000 within five years 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 12.67%), 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?	4%	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. Given that the company mainly operates in the UK and the size of the company's leverage (LTV is 45%), we expect the company's dividends to grow by more than UK GDP growth.
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?	8.16%	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 22nd February 2023, the current value of Primary Health Properties Plc is 108.9p per share.

Cost of equity (%)

Input	Input value	Additional information
Risk-free rate (%)	3.92%	Here, the risk free rate is the US 30 year treasury bond, and is calculated as at 22nd February 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 (%)	8.16%	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 8.16%);
2. The dividend growth rate (the default multiple is 4.00%); and
3. The most recent full-year dividend per share figure (the default forecast is 6.50 pence per share).

The impact of a 10% 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	10% worse	Unchanged	10% better
Discount rate	52%	82%	126%
Dividend per share	63%	82%	100%
Growth rate	66%	82%	101%

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

	2022 (£m)	2021 (£m)
Rental income	154.1	145.6
Direct property expenses	-12.6	-8.9
Net rental income	141.5	136.7
Administrative expenses	-9.6	-10.5
Revaluation (deficit)/gain on property portfolio	-64.4	110.2
Profit on sale of land and property	2.9	0.3
Total revaluation (deficit)/gain	-61.5	110.5
Operating profit	70.4	236.7
Finance income	0.9	0.8
Finance costs	-41.2	-35.9
Early loan redemption finance cost	-	-24.6
Termination payment and goodwill impairment on acquisition of Nexus	-	-35.3
Nexus acquisition costs	-	-1.7
Fair value loss on derivative interest rate swaps and amortisation of hedging reserve	-1.9	-1.8
Fair value gain on convertible bond	28.7	3.4
Profit before taxation	56.9	141.6
Taxation charge	-0.6	-1.5
Profit after taxation	56.3	140.1
Other comprehensive income:
Items that may be reclassified subsequently to profit and loss
Fair value gain on interest rate swaps treated as cash flow hedges and amortisation of hedging reserve	4.5	4.5
Exchange gain/(loss) on translation of foreign balances	3.2	-3.4
Other comprehensive income net of tax	7.7	1.1
Total comprehensive income net of tax	64	141.2
IFRS earnings per share
Basic	4.2	10.5
Diluted	2.2	9.8
Adjusted earnings per share
Basic	6.6	6.2
Diluted	6.4	6.1

	2022 (£m)	2021 (£m)
Non-current assets
Investment properties	2,796.30	2,795.90
Derivative interest rate swaps	19.6	5.2
Fixed assets	0.4	0.3
	2,816.30	2,801.40
Current assets
Trade and other receivables	17.8	17.6
Cash and cash equivalents	29.1	33.4
Developments work in progress	1.3	0.7
	48.2	51.7
Total assets	2,864.50	2,853.10
Current liabilities
Deferred rental income	-29.2	-28.3
Trade and other payables	-32.6	-40
Borrowings: term loans and overdraft	-2.3	-2.2
	-64.1	-70.5
Non-current liabilities
Borrowings: term loans and overdraft	-682.5	-700.2
Borrowings: bonds	-614.6	-572.8
Derivative interest rate swaps	-12.5	-0.8
Head lease liabilities	-3.2	-4.5
Deferred tax liability	-5.4	-4.4
	-1,318.20	-1,282.70
Total liabilities	-1,382.30	-1,353.20
Net assets	1,482.20	1,499.90
Equity
Share capital	167.1	166.6
Share premium account	479.4	474.9
Merger and other reserves	416.7	413.5
Hedging reserve	-11.1	-15.6
Retained earnings	430.1	460.5
Total equity 1	1,482.20	1,499.90
Net asset value per share
IFRS net assets - basic and diluted	110.9	112.5
Adjusted net tangible assets2 - basic	112.6	116.7
Adjusted net tangible assets2 - diluted	114.5	118.6

	2022 (£m)	2021 (£m)
Operating activities
Profit on ordinary activities after tax	56.3	140.1
Taxation charge	0.6	1.5
Finance income	-0.9	-0.8
Finance costs	41.2	35.9
Early loan redemption finance cost	-	24.6
Termination payment and goodwill impairment on acquisition of Nexus	-	35.3
Nexus acquisition costs	-	1.7
Fair value loss on derivatives	1.9	1.8
Fair value loss on convertible bond	-28.7	-3.4
Operating profit before financing costs	70.4	236.7
Adjustments to reconcile Group operating profit before financing to net cash flows from operating activities:
Revaluation loss/(gain) on property portfolio	64.4	-110.2
Profit on sale of land and property	-2.9	-0.3
Long Term Incentive Plan ("LTIP")	-	0.2
Effect of exchange rate fluctuations on operations	-	-
Fixed rent uplift	-0.9	-1.2
Tax paid	0.2	-0.4
(Increase) in trade and other receivables	-0.7	-0.3
(Decrease)/increase in trade and other payables	-12.9	15.9
Cash generated from operations	117.6	140.4
Net cash flow from operating activities	117.6	140.4
Investing activities
Payments to acquire and improve investment properties	-74.8	-129.6
Receipts from disposal of properties	27.5	0.3
Cash paid for acquisition of Nexus, including fees	-	-18.2
Cash acquired as part of merger	-	0.4
Interest received on development loans	1.5	0.7
Net cash flow used in investing activities	-45.8	-146.4
Financing activities
Proceeds from issue of shares	-	-
Cost of share issues	-0.1	-0.1
Term bank loan drawdowns	161.6	335.6
Term bank loan repayments	-175.7	-252.8
Proceeds from bond issues	62.9	-
Loan arrangement fees	-3.5	-2.7
Purchase of derivative financial instruments	-	-1.9
Early loan redemption finance cost	-	-24.6
Swap interest received	1.4	-
Non-utilisation fees	-2	-1.8
Interest paid	-39.8	-40.9
Bank interest received	-	-
Equity dividends paid net of scrip dividend	-81.6	-74.4
Net cash flow from financing activities	-76.9	-63.6
Decrease in cash and cash equivalents for the year	-5	-69.6
Effect of exchange rate fluctuations on Euro-denominated loans and cash equivalents	0.7	-0.6
Cash and cash equivalents at start of year	33.4	103.6
Cash and cash equivalents at end of year	29.1	33.4

References and notes

ccc