Primary Health Properties PLC Q&A with Hardman & Co (LON:PHP)

Hardman & Co

Primary Health Properties PLC (LON:PHP) is the topic of conversation when Hardman and Co’s Research Analyst Mike Foster caught up with DirectorsTalk for an exclusive interview.


Q1: Mike, what can you tell us about Primary Health Properties?

A1: It’s a FTSE250 stock now, PHP raised £115 million new equity in April this year and that graduated it to the FTSE250. In its name, Primary means GP surgeries, it is important to be clear that even large medical facilities as GPs work increasingly in consortia, so the size is not what you see in converted old houses. These facilities can and do take pressure off A&E and hospitals and at much more effective costs, we’ll return to this point, but several NHS plans are in place to expand the number of sorts of modern large facilities. They are being developed but the pace shows signs of accelerating.


Q2: How would you say investors regard the stock at the moment and what should they expect for the future?

A2: The total returns, so that’s share price plus dividends, have been well over 10% a year over the past 5 years, investors have seen 22 years dividend increases, the number 1 performance there in the whole UK real estate sector.

So, it’s no surprise that the long-term share price performance has been one of steady out performance of the property sector. It’s outperformed the FTSE REIT sector by 20% since 2009, as its secure base versus the rest of the sector became obvious, at that stage, to investors. In 2014, the rest of the sector started to catch up as higher beta stocks came to the fore but since mid-2014 the sector index has risen by 10%, PHP by near 30%, as it has continued its stable progress.

Turning to the future, the outlook centers around exactly what REITs are designed for which is secure growing dividends and PHP is set to continue growing dividend per share. We estimate 3% a year but the risk is actually definitely on the upside there.


Q3: So, secure and growing dividends seems to be the top of the agenda for Primary Health Properties, how are they managing this?

A3: The leases are contractually upwards only, rises in recent years have been below inflation but is upwards only and this is set subtly to change for the better, more on that later on. The income therefore secure and rising, management costs are efficient and a large component, interest costs, are set to get more efficient to get lower. There’ll be further falls as some of the more expensive debt matures in 2019.


Q4: But the dividend is uncovered?

A4: This was due to the fundraise growth in April, and it was for growth, and growth raises efficiencies so enhances Dividends per Share in the medium term.

So, on paper, the 2018 dividend covers 98% but actually in cash paid terms, it remains over 100% so it doesn’t dip below that even in this low year after the fundraise, that’s because of the timing in the rise in the numbers of shares. For 2019, our estimates are for it to be 103% covered and by 2020, that rises to 108% so it’s very resilient.


Q5: What can you tell me about the fundraise and investment of these proceeds?

A5: So, it was for growth. The £115 million raise was oversubscribed and day one it paid down debt, with progressive investment of the proceeds. We estimate around £100 million a year rate of deployment so as not to overpay or buy the wrong type of asset quality or size, we think they’ll manage £100 million a year. There are many buyers out there, insurance companies and pension funds look for these sorts of long-term real returns, but PHP has developer partners, and with a bit of patience, it remains in the driving seat in finding new assets.

For PHP, the new developments are becoming a larger proportion of the assets required, around 50% and they’re acquired at a more attractive yield. PHP development partners are seeing more schemes being approved by the NHS which also helps to improve the rental growth across the sector in the future.


Q6: So, you’re saying that because of the underlying supply or demand for their specialist properties, you see rents rising and dividend growth accelerating?

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A6: Yes. Primary Health Properties have worked hard to do themselves a favour over interest costs, they are reducing, and they are now expanding buying in Ireland, but a real driver is the developers’ build costs and the need for expansion in number of modern GP surgeries. So, here we’re talking about the long-term scope for rents and, as I said earlier, they’ve been growing around or slightly below RPI inflation, but they are going to rise a little bit faster from now on.

So, why is that? In a nutshell, developers’ costs to build fell in the 2009/2010 global slump but PHP rents, as I said already, are contractually up only. So, it’s taken a few years for the developers’ costs to rise back up far enough for the incremental rent rises to be required to make the developer’s calculation of potential profit to work. So, their costs fell, rents kept going up and now because their costs have risen back up quite strongly, they do need rents to rise a bit faster.

So, with cost inflation now having caught up, the developers do need to get higher rent to make their sums stack up and that’s good medium-term news for PHP, the rent collector.


Q7: What can you tell me about the company valuation?

A7: They are trading above NAV, Net Asset Value, it’s a well bid sector in the real market, looking at how the assets are trading so pension funds, overseas and domestic investors are very active buyers so there is actually a portfolio effect and PHP’s large quality £2 billion portfolio is attractive.

What I’m saying is expect that there will be a buyer coming in to take the company private, we’re certainly not expecting that but if you look at the valuation, it’s wrong really to just look at adding up all the individual properties, there is a value of having them altogether and the value is the expertise PHP brings, the efficiencies, and just have that benefit of size.

The dividend yield compares well to other secure income REIT’s, it’s in line with the average but the PHP risk, we consider, is less than the other REIT’s on average because its track record all says is unequalled and it has political proofing, there is cross party support for investing in the NHS. So, the dividend yield, in line with others, is reflecting a stock with much lower risks we think than the others.


Q8: Are there any other risks and how do you see them?

A8: The main risk actually is relative, will investors go for riskier stocks with more potential for development profits – PHP does no development – or general market rent rises were the economy to boom? That’s up to the listener to gage.

PHP’s gearing is secure and modest and it’s now at 45%, it actually has fallen to a little bit below that following the equity raise and it’s at 40.5% excluding a convertible stock. We do see reinvestment and prudent secure increase in debt still to very secure modest levels and it’s important, on the risks, to be aware that these are long-term leases with the upward only rent and that the assets are 99% plus occupied.


Q9: Finally, how do you summarise the outlook for Primary Health Properties?

A9: This is a safe stock, we consider, both on the assets and the dividends, the dividend yield in line with others but we do see the others as having somewhat greater risks potentially.

The share premium to NAV is justifiable, we believe, with regard to the assets themselves and there’s also the very long successful track record of outperformance and the prospects for dividends so on the dividends, I think that’s quite important for this sort of stock in the sector.

Dividend per Share growth of 3% per annum seems, to us going forward, extremely secure and by 2020 we see the dividend cover at 108%, so there is real scope to grow dividends a little faster at that stage, perhaps 4% or something by that date.

The point is the very long track record of the dividend growth is in place, unbroken, and that 3% dividend growth is a very secure prognosis with the risks on the upside.

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