Medicx Fund — Update 7 June 2016

Medicx Fund — Update 7 June 2016

Medicx Fund

Martyn King

Written by

Martyn King

Director, Financials

Medicx Fund

Continuing to find opportunities

FY16 interim results

Real estate

7 June 2016

Price

86.50p

Market cap

£327m

Net debt (£m) as at 31 March 2016

311.6

Shares in issue

378.0m

Free float

100%

Code

MXF

Primary exchange

LSE

Secondary exchange

N/A

Share price performance

%

1m

3m

12m

Abs

(2.5)

(1.1)

5.8

Rel (local)

(4.9)

(2.4)

13.9

52-week high/low

90.5p

77.2p

Business description

MedicX Fund is a specialist investor in primary care infrastructure. It holds a portfolio of properties, let mainly to government-funded (NHS) tenants (87%) and pharmacies on GP surgery sites (8%). It now has two properties under development in the Republic of Ireland, where the lead tenant (60-75%) will be the Irish government HSE (4%).

Next events

Q3 ex-dividend

18 August 2016

Analysts

Martyn King

+44 (0)20 3077 5745

Julian Roberts

+44 (0)20 3077 5748

Andrew Mitchell

+44 (0)20 3681 2500

Medicx Fund is a research client of Edison Investment Research Limited

In H116 MedicX Fund continued to selectively add assets, despite a highly competitive UK investment market, and it maintains a strong investment pipeline in both the UK and Republic of Ireland. Profit progression during the period was limited by the time between drawing on funding and income generation from investment; as this unwinds, earnings growth should pick up, supported by the new management fee structure. As a long-term investor in modern primary care properties in the UK and the Republic of Ireland, the fund should benefit from growing demand to meet healthcare needs. Leases are long, substantially government backed, and funded by fixed rate debt (c 52% LTV) of similar duration, underpinning secure cash flows to support the 6.8% prospective yield.

Year end

Revenue (£m)

PBT*
(£m)

EPS*
(p)

DPS
(p)

Yield
(%)

EPRA NAV/
share (p)

DCF/share
(p)**

09/14

29.5

10.7

3.1

5.80

6.7

65.4

93.4

09/15

33.7

13.5

3.7

5.90

6.8

70.8

94.9

09/16e

36.1

13.8

3.7

5.95

6.8

71.1

95.8

09/17e

40.4

15.1

4.0

6.00

6.9

71.7

Note: *PBT and EPS are normalised, excluding asset revaluations, performance fees and exceptional items. **Investment adviser’s DCF value/share. 09/16e DCF value is as last reported at 31 March 2016.

Earnings and dividend growth with cover following

EPRA earnings were lower than H115 but ahead of H215, and we expect progress as recent investments contribute more fully, with management fees fixed by the new arrangement. With a pipeline of £144m, we continue to look for £60m of new investment this year and £75m in FY17. Our EPRA NAV forecast is slightly increased due to H116 gains from yield compression; further gains are possible but not assumed in our forecasts. Our EPRA earnings forecasts are slightly reduced (higher non-management fee expenses and increased shares in issue from treasury sales), delaying dividend cover improvement (to 66.8%) until FY17.

Growth opportunities in UK and Ireland

Ageing populations, growing healthcare needs, an underinvested primary healthcare estate and general acceptance of the need for more integrated primary care services in the community, supports the long-term growth outlook in both the UK and Ireland. Both require modern, purpose-built, flexible premises of the sort in which the fund invests. In the UK, there is financial and political support for NHS planning that should soon see an acceleration of new development spending. Ireland offers investment opportunities at attractive investment yields, while the HSE estate strategy is delivered.

Valuation: Secure and growing property income

MedicX has locked in secure long-term cash flows and, barring unforeseen circumstances, a dividend of 5.95p is indicated for FY16 (5.9p in FY15). The Investment Adviser’s DCF value per share of the fund’s predictable cash flows is currently 95.8p and the H116 EPRA NAV is 71.2p (as at 31 March 2016).

Summary of H116 interim results and developments

MedicX Fund continued to selectively add assets in H116, despite a highly competitive UK investment market, and maintains a strong investment pipeline in both the UK and Republic of Ireland. Profit progression during the period was limited by the time gap between drawing on funding and income generation from investment but as this unwinds earnings growth should pick up, supported by the new management fee structure that fixes payments until assets grow by an additional c £193m from the H1 level. The fund sees good prospects for growth in Ireland, where yield differentials are materially ahead of those that can be earned in the UK, and anticipates an increase in the pace of UK open market rental growth as the pace of NHS approved new developments accelerates to meet growing GP demand.

The investment portfolio has increased to £589.0m from £553.5m at 30 September 2015 (FY15). The average unexpired lease term is little changed at 15.7 (15.8 years) and the average age of the properties has increased to 7.6 years (7.2 years). The portfolio comprises 151 properties of which 144 are operational and fully let and seven are under construction and expected to complete within the next 12 months. The annualised rent roll has now reached £36.7m.

Committed investment during H1 FY16 was £27.4m (similar to FY15 as a whole). Of the eight new property investments, six (£18.6m commitment) were completed and let and two (£8.8m) were by way of forward funding agreements. Two properties previously under construction were completed in the period and one more subsequently. All were delivered within budget on fixed-price contracts. The Investment Adviser has access to a strong pipeline of potential future acquisitions in both the UK and Ireland, with a fully developed value of £144m, subject to contract.

Rents receivable grew by 7% (or by £1.1m) to £17.7m in H1 FY16 compared with the same period last year. Measured by tenant type, income was 87% reimbursed by the NHS, while an additional 8% was represented by pharmacy operations that are co-located with medical centres. An additional 4% represents other tenants including the Irish HSE.

Rent reviews are effectively upwards but are currently modest. Open market reviews (72% of the rent roll) produced an average 0.8% increase, continuing the recent trend. Fixed uplifts (1.8% average) and RPI linked uplifts (1.9% average) remain somewhat higher at the present time. The average portfolio increase achieved over the six month period was 1.2% pa. The Investment Adviser expects an acceleration of open market rental growth over the next six to 12 months as the gradual pick-up in new development schemes highlights the extent of recent building and land cost inflation.

Compared with the same period in FY15, total income increased by 5.0% while total expenses increased by 7.1%. H115 revenues were unusually high relative to rent roll reflecting the pattern of rent review settlements so, comparing H116 with H215, total income was up 7.5% while total expenses, partly reflecting the impact of a higher number of property transactions, increased 10%. There should be an increase in operational gearing as the advisory fees paid to the Investment Adviser (56% of total H116 administrative expenses) will be pegged in absolute money terms, rather than increasing with AUM until property assets equal or exceed £782m. At that point the new tiered fee schedule agreed with the Investment Adviser will apply, including a reduction in the fee level applied to incremental asset growth. Normalised EBITDA (excluding valuation gains and other one-offs) increased to £14.4m or by 7.0% compared to H215 and 4.6% compared to H115.

Underlying earnings on an EPRA basis (which excludes valuation movements, performance fees and fixed-debt break costs) were slightly lower compared with H115 (£6.8m versus £7.0m in H115) due to the time gap between debt raising (and an increase in net financial expenses) and income generation from the investment, particularly for the development assets. Compared with H215 (£6.4m) EPRA earnings grew. EPRA earnings per share was 1.8p (2.0p in H115 and 1.7p in H215.

Statutory earnings benefitted from a £4.1m revaluation gain on investment properties compared with £12.8m in H115, when the yield decline was greater. This more than accounts for the lower statutory profit of £10.8m for the half year compared to £18.7m for the comparative period. The portfolio has been externally valued on a net initial yield of 5.36% compared with 5.46% at the end of FY15.

NAV per share, on an EPRA basis, increased to 71.2p per share in H116 compared with 70.8p at the end of FY15. EPRA NNAV, which adjusts the value of fixed rate debt to market, declined to 60.3p from 62.7p. The notional, non-cash negative fair value adjustment to the nominal value of fixed rate debt increased to £36.4m from £25.2m as gilt rates declined further. On unchanged assumptions, the Investment Adviser’s discounted cash flow NAV per share was 95.8p versus 94.9p at the end of FY15.

Net debt ended H116 at £311.6m. Adjusted gearing was up slightly to 52.3% (FY15: 50.2%), still close to the long term target of 50% and well below the self-imposed ceiling of 65%. The average cost of debt remains 4.45% and the average unexpired term of drawn debt is 14.5 years. In addition to its fixed rate funding MedicX has a £25m revolving loan facility which it is currently in the process of renegotiating. 8.4m shares were sold from treasury during H116 at a significant premium to NAV, and a further 2.5m shares (at 86p) since the period end.

Market developments

Demand for attractive primary healthcare properties has remained strong, with valuation yields further compressed in H116. While this is a positive for NAV, it does make it more expensive to acquire assets and new income streams, particularly in the UK. This is especially the case for larger assets and portfolios and in this environment the fund has continued to be selective, taking a disciplined approach focused on single assets and forward funding developments. As we show in Exhibit 1 below, positive funding conditions have maintained a healthy spread between income and long term funding costs.

Exhibit 1: Property yield versus average cost of long-term borrowing (%)

Source: Company data, Edison Investment Research. Note: Data to 31 March 2016.

There are growing indications that NHS demand for new, purpose built, primary healthcare facilities will soon accelerate, and MedicX believes that its close working relationships with preferred developers and provider groups leave it well positioned to benefit.

Meanwhile, the fund’s entry into the Irish market offers additional opportunities at an increased yield. For a description of the Irish market opportunity please see our note of February 2016. Two development funding investments have been made so far and two are in solicitors’ hands and going through the legal process. Although there was a small positive currency impact in H116, MedicX continues to negotiate local euro funding, which will provide a significant hedge for future Irish values and returns.

The UK will remain the core of the portfolio, with Irish investment not intended to exceed 15% of the portfolio value.

While cross-political backing for NHS planning (which puts increasing focus on primary care) is very positive for long-term growth, more immediately the Investment Adviser identifies the response of GPs as a strong impetus for change. With many existing GP practices operating out of cramped, unsuitable premises, too small to provide the extended services, hours, training and education that is being demanded, the trend towards merging and forming federations or provider groups appears to be accelerating. With this and government plans to add some 10,000 additional clinical staff, including c 5,000 additional GPs, comes increased demand for large, modern, purpose-built facilities. All clinical commissioning groups have been tasked with preparing local estates strategies. Not all have been published yet but these evolving strategies promise to underpin this expansion of service delivery and provide strong opportunities for long-term investors in required facilities such as MedicX.

Valuation and performance

In FY15, EPRA NAV total return (the increase in NAV plus dividends) was 17.2%, although total shareholder return (dividends plus share price movement) was -0.4%, affected by a low share price towards the end of the year. In H116 the share price has fully recovered, with a total shareholder return of 16.9% in the six months to 31 March 2016 (of which 3.5% was attributable to dividends). EPRA NAV per share, adjusted for dividends, increased by 4.7% in H116. Whereas conditions in the mainstream commercial property market have become a little less certain in recent months, with the UK EU referendum and a slowdown in inwards property investment clouding the outlook, the primary care sector enjoys high income visibility and security. The sector benefits from effectively full occupancy, long leases and the UK government as the de-facto tenant of c 90% of properties (in Ireland government income will be 60-75%). Income forms a higher proportion of returns than for the commercial sector in general and both income and capital returns are less volatile in primary healthcare than other sectors. The fund’s costs are relatively certain because it uses an external manger and does not have the risks associated with being an operator or developer of property. The rising dividend, supported by the security of income, despite not being fully covered by EPRA earnings, forms a substantial part of the total return and there is a scrip dividend alternative for shareholders who prefer to take their returns in new shares.

Attractive 6.8% yield

MedicX pays a high proportion of total return in the form of quarterly dividends and has indicated that it expects to pay an aggregate 5.95p per share for the current year, barring unexpected circumstances. At c 6.8% prospective, the dividend yield is a key attraction of the stock. The dividend policy is progressive (19% aggregate, unbroken dividend growth since the fund was launched in 2006).

FY15 saw cover increase to 63.3%, up from 53.6% in FY14. H116 was 63% and the Investment Adviser is indicating that full-year cover will be slightly below 2015 level as the funds received from the recent loan note issue are deployed into income-generating assets. We are now forecasting 62.4% cover in FY16 and 66.8% in FY17. Underlying dividend cover as calculated by the Investment Adviser adjusts to reflect the completion of properties under construction, assuming full rent, incremental interest costs and other expenses. This was 71% in H116 compared with 67% in H115 and 68% for 2015 as a whole.

We forecast underlying EPRS earnings in FY16 to represent a return of 5.3% on average. This measure excludes valuation movements from earnings, but revaluation does increase the asset base to which they are compared.

In April the directors approved a quarterly dividend of 1.4875p per share in respect of the three months to 31 March, which will be paid on 30 June.

EPRA NAV per share 71.2p

H116 EPRA NAV per share, which adjusts the IFRS net assets to exclude the impact of deferred tax not expected to crystallise, was 71.2p, up from 70.8p at the year end. At a price of 87.0p, this puts the shares on a P/NAV of 1.22x.

Our forecasts do not assume any further valuation yield compression beyond the 5.36% net initial yield as at 31 March. Although yields have already fallen from c 6% in 2009 (see Exhibit 1), given continuing investor enthusiasm for primary care assets and the expectation that rental growth will accelerate over time a further decline is entirely possible. The Investment Adviser estimates that if valuation yields were to decline by 50bp, the EPRA NAV would increase by c 16p per share, to 87.2p.

Adviser’s discounted cash flow value 95.8p

The Investment Adviser undertakes a regular DCF valuation of the portfolio (see the Investment Adviser’s report in the annual report for full details). The DCFs assume a long-term average 2.5% per year increase in individual property rents at their respective review dates. Residual values are based on capital growth at 1% a year from the current valuation until the expiry of leases (when the properties are notionally assumed to be sold), and assuming the current level of borrowing facilities. The DCF uses a discount rate of 7% for completed occupied properties and 8% for those under construction, giving a weighted average 7.06% (a premium to the 31 March 2016 20-year gilt yield of 2.32%).

At the end of H116 the DCF valuation was £359.8m or 95.8p per share.

The long-term rent growth assumption in the DCF is above the current average level of increases being achieved, although as explained above these are expected to increase as new development activity picks up. The Investment Adviser calculates that for the DCF calculation to equal the 31 March 2016 share price of 87.5p, it would be necessary to assume 1% pa rental growth or a weighted average discount rate of 8.0%, or no capital growth over the forecast period.

It is worth noting that the stated NAV and EPRA basis NAV both capture the deduction for purchasers’ costs that is applied by the external valuer in its portfolio valuation. This amounted to £38.7m at 31 March 2016 or 10.3p per share. This is a notional deduction from the fully appraised value of the properties to allow for costs such as stamp duty that a buyer of any property would potentially face on full or part liquidation of the portfolio.

Adding this 10.3p back to the 71.5p EPRA NAV takes the latter much closer to the DCF value per share.

Financials

H116 revenues were consistent with our forecasts and we have made only minor adjustments to this year and next. Despite fixing management fees at the current level until portfolio assets exceed £782m, other administrative expenses were ahead of our assumptions in H1 and, along with slightly more shares than we had assumed (through ongoing treasury share sales), this leads to a small reduction in the FY16 EPS estimate, which largely flows through to FY17.

Our practice is to anticipate only the revaluation gains that are likely to arise from rental growth, with no assumption for changes in valuation yields. The continued H116 compression in yields produced valuation gains in excess of our assumption and this drives the increase in NAV per share estimates in both FY16 and FY17.

Exhibit 2: Estimate revisions

Revenue (£m)

EPS (p)

DPS (p)

EPRA NAV per share (p)

EPRA NNNAV per share (p)

Old

New

% change

Old

New

% change

Old

New

% change

Old

New

% change

Old

New

% change

09/16E

36.2

36.1

-0.4%

3.82

3.70

-3.2%

5.95

5.95

0.0%

70.5

71.1

0.8%

62.6

60.3

-3.7%

09/17E

40.0

40.4

0.9%

4.11

4.00

-2.5%

6.00

6.00

0.0%

71.2

71.7

0.6%

63.4

60.9

-3.9%

Source: Company data, Edison Investment Research

Our forecasts are based on £60m of new commitments in FY16 (H116 £27.4m) and £75m in FY17. We have assumed c 200bp of additional yield spread after financing on Irish investments versus those in the UK. Average rental growth is assumed to increase to 1.5% in FY17 after 1.2% in FY16.

Our balance sheet projections assume that portfolio growth is funded by additional debt, taking forecast net debt to £343m by the end of FY16 at an assumed similar average cost to the existing debt. This would take the ratio of net debt to portfolio value to 54.8% in FY16 and 59.8% in FY17. Both are below the board’s upper limit of 65% but above the longer-term target of c 50%. Our forecasts do not include additional sales of treasury stock beyond the 2.5m shares sold at 86p on 1 June 2016, although these are highly likely. We estimate that there are around 14m treasury shares remaining in excess of likely scrip dividend requirements through to the end of 2017. At the current share price, these could raise an additional c £15m in cash for investment and would reduce the FY16 net debt to portfolio value to 52.8%. Given the improving outlook for asset acquisition it is possible that MedicX will seek additional equity funding during our forecast period. Given the premium to NAV at which the shares trade it would seem reasonable to assume NAV accretion from such a move and we expect MedicX to pay careful attention to managing the potential drag on cash earnings from any time lag in investing proceeds.

Exhibit 3: Financial summary

Year end 30 September

£'000s

2013

2014

2015

2016e

2017e

PROFIT & LOSS

Revenue

 

 

25,537

29,488

33,669

36,094

40,376

Cost of Sales

(413)

(666)

(902)

(956)

(990)

Gross Profit

25,124

28,822

32,767

35,138

39,386

EBITDA

 

 

20,616

23,664

27,255

29,252

33,515

Operating Profit (before GW and except.)

 

 

20,616

23,664

27,255

29,252

33,515

Intangible Amortisation

0

0

0

0

0

Revaluation of investment properties

248

11,649

25,603

7,574

9,467

Investment advisory performance fee / loss on disposal of property

(240)

(1,888)

0

31

0

Operating Profit

20,624

33,425

52,858

36,857

42,982

Net Interest

(10,959)

(12,989)

(13,736)

(15,439)

(18,341)

Profit Before Tax (norm)

 

 

9,657

10,675

13,519

13,813

15,174

Profit Before Tax (FRS 3)

 

 

9,665

20,436

39,122

21,418

24,641

Deferred tax on fair value movements in property values

(299)

(264)

(3,293)

(151)

0

Profit After Tax (norm)

9,656

10,675

13,520

13,815

15,177

Profit After Tax (FRS 3)

9,366

20,172

35,829

21,267

24,641

Average Number of Shares Outstanding (m)

263.4

341.4

361.3

373.6

379.2

EPS - normalised (p)

 

 

3.7

3.1

3.7

3.7

4.0

EPS - FRS 3 (p)

 

 

3.6

5.9

9.9

5.7

6.5

Dividend per share (p)

5.70

5.80

5.90

5.95

6.00

Dividend cover

63.8%

53.6%

63.3%

62.4%

66.8%

BALANCE SHEET

Fixed Assets

 

 

426,649

502,906

553,479

622,530

711,777

Intangible Assets

0

0

0

0

0

Tangible Assets

399,502

492,252

544,490

611,624

696,777

Properties under construction

27,147

10,654

8,989

10,906

15,000

Current Assets

 

 

38,067

39,306

63,688

37,281

38,366

Stocks

0

0

0

0

0

Debtors

11,004

8,181

6,778

7,280

8,364

Cash

27,063

31,125

56,910

30,000

30,000

Current Liabilities

 

 

(19,994)

(56,714)

(20,862)

(18,200)

(20,910)

Creditors

(18,865)

(23,866)

(18,966)

(18,200)

(20,910)

Short term borrowings

(1,129)

(32,822)

(1,896)

0

0

Financial derivatives

0

(26)

0

0

0

Long Term Liabilities

 

 

(273,732)

(254,798)

(342,208)

(376,933)

(461,476)

Long term borrowings

(272,615)

(253,485)

(336,412)

(371,003)

(455,546)

Other long term liabilities

(1,117)

(1,313)

(5,796)

(5,930)

(5,930)

Net Assets

 

 

170,990

230,700

254,097

264,679

267,757

Net Assets excluding goodwill and deferred tax

 

 

171,832

231,764

258,428

269,160

272,237

NAV/share (p)

62.2

65.1

69.6

69.9

70.5

EPRA NAV/share (p)

62.5

65.4

70.8

71.1

71.7

Est. value/share of Fund's long-term fixed rate debt (p)

6.3

-0.4

-6.9

-9.6

-9.6

EPRA NNAV/share including benefit of long-term debt (p)

68.5

64.7

62.7

60.3

60.9

CASH FLOW

Operating Cash Flow

 

 

18,515

23,639

23,362

27,604

35,141

Net Interest

(11,495)

(11,342)

(13,210)

(15,288)

(18,341)

Tax

0

0

0

0

0

Capex

0

0

0

0

0

Acquisitions/disposals

(30,428)

(42,161)

(23,316)

(61,022)

(79,780)

Financing

(1,757)

55,577

6,119

10,349

0

Dividends

(13,610)

(16,759)

(19,247)

(21,235)

(21,564)

Net Cash Flow

(38,775)

8,954

(26,292)

(59,593)

(84,544)

Opening net debt/(cash)

 

 

189,206

246,681

255,182

281,398

341,003

HP finance leases initiated

0

0

0

0

0

Other items (including debt assumed on acquisition)

(18,700)

(17,455)

76

(12)

0

Closing net debt/(cash)

 

 

246,681

255,182

281,398

341,003

425,546

Source: Company data, Edison Investment Research

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Frankfurt +49 (0)69 78 8076 960

Schumannstrasse 34b

60325 Frankfurt

Germany

London +44 (0)20 3077 5700

280 High Holborn

London, WC1V 7EE

United Kingdom

New York +1 646 653 7026

245 Park Avenue, 39th Floor

10167, New York

US

Sydney +61 (0)2 9258 1161

Level 25, Aurora Place

88 Phillip St, Sydney

NSW 2000, Australia

Wellington +64 (0)48 948 555

Level 15, 171 Featherston St

Wellington 6011

New Zealand

Research: Metals & Mining

KEFI Minerals — Update 7 June 2016

KEFI Minerals

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