Primary Health Properties PLC (LON:PHP) is the topic of conversation when Hardman and Co’s Analyst Mike Foster caught up with DirectorsTalk for an exclusive interview.
Q1: What is Primary Health Properties?
A1: PHP purchases modern standing stock, in primary medical properties – doctors’ surgeries. The strategy is focused tightly on this sector, investing in the UK for 24 years. Those 24 years have seen unbroken dividend growth. It’s quick to say but an incredibly powerful attribute.
A year ago, it acquired a similar REIT – called MedicX, with just over £800m assets – which made PHP over half as big again. On top of this, three years ago, PHP extended into the Republic of Ireland (RoI), and since then around a third of its asset purchases have been into that country. We are not alone in seeing the proportion of assets in Ireland growing towards 15% of the total in the foreseeable future.
Q2: You mention the importance of the Irish and the MedicX factors although Ireland is only 7% of assets and you say MedicX was similar. What is the attraction?
A2: The fundamental attraction is that these ensure the dividend growth is set to continue. Visibility of growth in dividends is high, and so too is growth in rents. Rents grew 1.4% in 2018 and 1.9% 2019. We estimate rental inflation of just over 2.0% in 2020 and sustained levels trending to over 2.5% subsequently. Note that rents are contractually upwards only. This is in marked contrast to IPF ‘All property’ consensus for 0.4% 2019E and 0.6% 2020E, after 0.9% rental growth in 2018.
Q3: So, rents in this sector have good accelerating rates of growth and that’s on top of good news regarding Ireland and the corporate expansion at MedicX. Can you tell us more on Ireland and MedicX?
A3: Ireland is 7% of assets and around a third of assets being bought are in Ireland. Irish assets yield a little more and the cost of debt finance (Euros) is below Sterling. So that compounds up and geared returns for Irish assets are around 55% higher in Ireland than in the UK at the moment. That is not to say that the UK assets aren’t pulling their weight. On their own the support a growing dividend. Ireland adds further. And MedicX helps in a number of ways. It had slightly higher debt costs and the larger joint business is a more attractive proposition to banks who lend on finer rates. There’s been some early benefit but more to come. And now the ratio of costs to rents is the lowest among all UK REITs through economies of scale.
Q4: Where does this leave dividends?
A4: We believe there is scope for the dividend per share to accelerate. The full year dividend increase was 3.7%. When we last spoke eighteen months ago, our estimates for dividend per share growth were 2.5% to 3% a year in 2018, 2019 and 2020. Our 2020 estimate is 5.4%. The first quarter 2020 dividend which is already paid is 5.4% above the 2019 comparable.
Q5: Why have you raised estimates for dividend growth?
A5: First, the business is hitting all the right metrics, investing at the net initial yields it had guided investors to and at the speed it had indicated it would. PHP is setting strong expectations and meeting them. In addition, there are the boosts from Ireland and MedicX we discuss but the underpinning factor is that PHP enters into long leases (typically 15 to 20 years) upwards only with the overwhelming weight of lease income being government backed. These in effect are government-backed indexed assets.
Q6: Can you summarise the risks to investors?
A6: We consider both the operational and the valuation risks are manageable. Occupancy is typically ca. 99.8%. Debt maturity is over eight years, from a wide variety of bank and bond sources. 2018 and 2019 DPS cash cover was over 100%. Interest cover is 2.7x, and the average unexpired lease length is 12.8 years. Property – even this sector – can be cyclical in nature. While Primary Health Properties and market interest rates are falling, they can move in a cyclical nature. In a way, the major risk is that other sectors could bounce. Retail has fallen along way. We don’t think it would be sensible to compare the two and so one looks at the rating. Shares trade on a dividend yield of just over 4%. Several REITs yield over 5%. But for the higher covenants and guaranteed rent rises that is not much of a premium. The PHP dividend yield is a long long way above index linked gilts.