Finally! I executed my first share purchase since the beginning of this crisis. I bought some Ryman shares @ NZD 10.45. It is a relatively small position now (~2%) and I aim to buy more if situation becomes favourable again.
Ryman Healthcare is a company that I have been following for more than one year now. I really started to do work on the company in Nov 2019. It is the largest retirement village operator in New Zealand. Globally, retirement villages are typically average businesses but there is one little quirk about retirement villages in New Zealand that completely transforms the economics of the business. For most real estate asset developers, there are really two ways to generate profits – either sell the assets for a profit upon completion or rent the property to collect the fixed income. For example, most residential property developers would sell the asset upon completion while shopping mall developers often choose to rent the retail property as the long term rental growth would generate a higher return over time. The IRR is better if the property is sold upon completion while the rental model has lower IRR initially and can be more profitable over the long-term if rental growth is respectable.
But is there a business model in which the property is sold immediately upon completion while also retaining the right to collect rental payment over time? You know, have the cake and eat it too.
Turns out that is exactly Ryman’s business model.
It builds retirement villages and “sells” elderly folks the right to live in their villages. The resident pays a deposit that is roughly equal to the value of the retirement unit. Ryman would charge up to a maximum of 20% of the deposit value as a management fee and the residents are granted the right to live in the retirement unit for as long as they wish to. At the point of exit, the resident is paid back 80% of the original deposit. In reality, most residents only stay in the retirement villages for 6-7 years on average because the average entrance age is more like 75+. This business model allows Ryman to recycle capital on day one through the deposit (great for IRR) while retaining the ability to collect fixed payment through the form of the management fee.
So why do the elderly folks chose to move into a retirement village? Many elderly folks find it very hard to maintain their large house as they get older. Property management service provided by the village operators relieves them of these chores. Another important motivation is a change in life circumstances such as the passing of one partner. Many prefer to live in a close-knit community than living alone. There is the hospitality aspect of living in retirement villages. There are weekly drinks, movies, field trips, exercise classes, and parties. It is kind of like living in a hotel with strong healthcare capability. Finally, a move into a retirement village helps to release equity in their home which can be used to finance their lifestyle.
New Zealand has a rapidly ageing population which will see the 75+ population grow by ~3.5% for the next 10 years. The supply of retirement village is growing 5% and hence the penetration of retirement village is growing. The retirement village sector is ramping up supply to meet the growing demand; I would keep a vigilant outlook on the pipeline of new supply. However, Ryman should continue to do well relative to its peers because its villages offer better value for money. Ryman charges 4% management fee p.a. capped at 20% while most competitors charge 5-6% management fee p.a. capped at 25-30%. Furthermore, people will always want the best care and safest pair of hands to take care of them in the twilight of their lives. They also need to trust operators that don’t take advantage of them when their mental and physical states are not in the best shape.
Hence Ryman’s competitive advantage comes from its reputation as a high-quality care provider and a trust-worthy retirement village operator. It offers a continuum of care model for its residents where independent units (normal houses with minimal care provided) and care centres (including hospital care) are on the same site. Elderly folks are not the most flexible bunch. Ryman pays its care staff above market rate to provide premium care and a strong culture of care.
The market also clearly acknowledges Ryman’s superior quality as its valuation is twice of its peers such as Summerset, Oceania and Arvida. Despite the valuation premium, I prefer Ryman over its peers as a strong culture of care is the best protection for long term franchise value. For example, I have found Summerset to have a mercenary attitude as compared to Ryman. This is not to say I will not invest in Summerset. Just that I think the valuation premium is at this moment reasonably justified. While I believe that Ryman is the best operator in the sector, the entire sector is likely to do well given the favourable economics of the business model.
If I am asked to buy the entire business (which I do sometimes fantasize about), I would value Ryman in a similar manner to an asset management company in that it clips ~3% of the total capital base. The capital base is generated by resident deposits. If I assume that Ryman builds out its existing landbank in the next 5 years without adding to the land bank, it would be able to generate, in my estimation, ~NZD 200m of incremental earnings. Note I exclude new sales gain from this analysis. Putting on a 25x earnings multiple, it would imply a share price of ~NZD 12. I think 25x is reasonable because the capital base enjoys 2-3% of house price growth even if there is no unit growth. This is comparable to the 4-5% rental yield in New Zealand. Of course, in reality, Ryman will maintain its land bank for growth beyond 2025. Hence our entry price is a very attractive one.
Now let me address the elephant in the room – can Ryman survive current pandemic?
- Ryman’s care revenue is well protected even in a national lock-down as the residents still live in the care centre. New residents are allowed to be admitted because these are typically need-based demand. Of course, there will be stringent isolation protocols in place
- Ryman’s care revenue more or less covers the fixed cost of the entire company. So they have liquidity to cover fixed cost even in a prolonged lock down situation
- New sales activity will cease but the company has a lot of leeways to stop existing construction projects to conserve cash. As of Sep 2019, the capital commitment is NZD 150m.
- Resale activity will cease too and this would impact Ryman’s ability to repay resident deposits on exit. Typically, Ryman promises to repay the deposit within six months after which Ryman will pay ~1-2% interest on the deposit. Legally, Ryman has three years to repay the resident. Even if we assume that COVID-19 lasts for 3 years (super unlikely in my view), Ryman can sell the apartment to pay back the resident
- It has roughly NZD 300m of liquidity headroom in an NZD 1.9bn credit facility. The credit facility is secured with underlying assets.
- According to the company, there are two main covenants – interest rate cover and gearing ratio
Given the above facts, it seems that Ryman has a very high probability of surviving this crisis.
The demand for Ryman product is mostly like to be delayed and not lost. Hopefully, we should see a reasonable demand recovery.
There is a risk with house price deflation in the event that we go into a recessionary environment coming out of this pandemic. Even though Ryman’s units usually sold at a discount to comparable houses in the same market, it would still impact Ryman because elderly folks need to sell their house to afford a Ryman unit.