Religare Health Trust (RHT) value that bind or blinds?

Religare Health Trust (RHT) value that bind or blinds?    

For the past few weeks I have been looking at health related securities, be it First REIT, Parkwaylife REIT, Raffles Medical, Biosensor etc. And then one afternoon while watching an amusing documentary on YouTube about how brushing your teeth with lemon grass can make it whiter; an advertisement popped up and Religare Health Trust came into view. 

When I took a quick look at RHT, its investment story was much sexier as compared to the rest of the previous health care related securities. Well some investors might say that reading RHT’s prospectus was like an equivalent to reading the Kama sutra.  But as the saying goes.  “If it sounds too good to be true, it probably is; that ‘Kama’ might just be a b****"

So in this post I shall list down the reasons why this business trust is inherently attractive to value investors like me and some of points to take note of while investing in this business trust

The basics

Religare Health Trust (RHT) is an integrated healthcare delivery provider in the Pan Asia-Pacific region. RHT is a business trust with a portfolio that consists of healthcare assets in India.

Listed on SGX mainboard September 25^th 2012; raised over $SGD500 million, of which 95% of the proceeds will be utilized to fund the initial portfolio consists of 11 clinical establishments (S$714mn), four greenfield clinical establishments (S$29mn) and two hospitals managed and operated by RHT (S$5mn), which are all geographically diversified across India. Their auditor; Ernst & Young LLP.

An update, RHT has now (as of July 25^th 2013) 11 Clinical Establishments worth $737m, 4 Greenfield Clinical Establishments worth $31m 2 hospitals managed and operated by RHT worth $5m. Greenfield means “yet to build”

Their Singapore office address is at #11-20 UOB Plaza 2, 80 Raffles Place

The attractive points

Country/Industry attractiveness: Many RHT reports starts of by saying that India's healthcare sector is set for growth, driven by rising disposable income as well as increased healthcare awareness. India aging population growing by 24.4%, huge healthcare demand/supply gap, growing affluence of 7.8% CGAR from 2013 to 2015, the average lease terms of healthcare assets long term 10-18 years (RHT’s average lease is 15 years- with the view of renewing for another 15 years) and so on. Healthcare is a defensive sector that should be cash generating in all times and so on. Much has been said about the attractiveness of the country and industry, but can RHT capture this growth? My take is, somewhat likely- do continue reading

RHT policy positioning: RHT is positioned to benefit from a rise in India's healthcare revenues via its current fee structure which allows it to share into underlying hospital revenues. With a based service fee consisting of fixed quarterly payments with 3% escalation per annum- upward revision for any capex/ expansion and a variable Service Fee consisting of 7.5% of the Fortis Operating Companies’ Operating Income for each quarter simply enable RHT to capturing the growth of the hospitals through a fixed fee and the sharing of operating profits. But is their assets (hospitals, clinics etc) well located? Just like investing in a REIT, the location of where the building is, the catchment area, potential new supply in the area, façade, size, age of the hospital, the income growth in that area and whether the asset provides a need or a want to the targeted customers is vital to how a REIT will perform. I did due diligence on this part and this is what I have found

RHT asset positioning: Because I am now actively looking for a career, I cannot simply take off to India and visit all 17 properties diversified all over India. If I could, I will, but luckily there is something called google maps and I used it to my advantage by checking the location of every single properties that RHT has acquired. What I looked out for is city or factory activities near the clinics (the foundation of health care demand), whether it is easily accessible- be it high ways, roads, etc (the convenience factor) and the current competitors in the area. I like most of the assets that RHT bought, moreover during the AGM held on july 25^th 2013, the management was questioned on their knowledge and ability to pick good yield accretive assets in India; I was satisfied with their answers, nonetheless. However there were still some buying decisions that bothers me, which I will elaborate further under the “the un-attractive points)   

RHT asset organic growth: Recall that RHT has a variable fee component; 7.5% of operating fees. This means that, if more beds are built per clinic or hospitals, more income can be derived for the unit holders assuming that there is demand for such beds.  A quick observation reviews the following; RHT has about 1870 potential beds (yet to be installed) and 3197 installed beds (just built).  Revenues from FY 12 to FY 13 have increased on average about 15-16%, lowest 7% which is in Nodia and highest 55% in Shalimar Bagh.

Low Gearing:  As of July 25^th 2013, RHT gearing is 8.9%, which is low as comparison to peers (Like First REIT , Parkwaylife). RHT has an estimated “debt room” (means can borrow, but doesn’t mean it will or able to borrow) of about 350million. Cost of debt is 4% for RHT. This is one of the points excited me greatly, because financially; RHT has yet to leverage effectively to increase its NAV and DPU. RHT’s has target gearing of 30%-40%, about S$250mn to S$400mn of debt headroom could be deployed to finance the capital expenditure. Comparing with other related securities Ascendas India Trust has a gearing of 33.0%, Parkway Life REIT 36.4% and First REIT 15.9%;

   

Strong sponsor:   One of the key risks in investing in healthcare REITs is the idea of counter party risk; such that the master lease agreements are only as safe as the strength of the counterparty, example if Lippo Karawaci collapses First REIT I think will collapse as well, as the former contributes 90% of First REIT’s revenue. Likewise for RHT, Fortis Healthcare is the sponsor and looking at the sponsors balance sheet and business health, I find the following. As of March 31, 2012, Fortis operated its healthcare delivery network in India, Australia, New Zealand, Hong Kong, Vietnam, Singapore, Mauritius, Dubai, Sri Lanka and Canada with 75 hospitals, over 12,000 beds, over 600 care centers, 191 day care specialty centers and over 210 diagnostic centers. On April 27, 2011, it acquired Escorts Heart Institute and Research Centre Limited. Over the last five years (FY07-12), Fortis Hospitals have delivered an organic CAGR of 21%. Fortis also has 28.0% stake (220.7 mn units) in RHT 

Foreign exchange risk: No longer a concern as forward contracts were used hedge the currency risks until March FY 2015

Attractive yields and ratio comparable:  At a share price range of 0.85- IPO 0.9- highest 0.98 cents, taking into account 100% distribution payout over Forecast Year and Projection Year. Sponsor distribution waiver over Forecast Year and Projection Year, the expected yields for FY2014 would be around 9.2% at 0.85 share price, 8.8% at IPO share price and 8.1% at a share price of 0.98 cents. Comparatively First REIT’s yield is around 6.3-7% and Parkway is around 4-5%. RHT’s NAV per unit is $0.91 thus PTB would range between 0.93 or 0.98 or 1.1   

Now for the unattractive points:

Country attractiveness gives raise to concentration risks: 

The initial portfolio is located in India, which exposes RHT to country concentration risks. RHT’s hospital occupancy can fall in the event of a downturn in India’s healthcare sector, political strive and therefore adversely impact RHT’s revenue and depreciation in property value of RHT’s portfolio. In addition country's attractiveness is very dependent on how India's economy is doing in general; why? Because RHT target market is the (if im correct) middle to upper class patients. With the onset of current weakness, high current a/c deficient, government refusal to improve on productivity and protectionist policies, it brings into question the expected growth of the middle income people in India.    

Questioning the Industry attractiveness/ asset positioning: There is a popular idiom that says that you can attract more flies with honey than vinegar, but I say that you can catch even more files with manure than vinegar or honey!  You see, every analyst report on RHT I’ve read, attempts to persuade investors by starting off with  rosy complements on how very attractive the healthcare industry that RHT is in, that there is lots of growth, lots of demand and so on. But if you dig a little deeper, you will find that every hospital or clinic that RHT has bought is either near another competing hospital or clinic. And it’s not just one or two hospitals or clinics that competes with fortis, there are as much as 6-10 of competitors vying for patients. Like for example; when I looked at Fortis Malar Hospital on No 52, First Main Rd, Gandhi Nagar, Adyar there is another 6 other hospitals within a radius of 10kms (see figure 1) and when I google map hospitals in Chennai”, I got a ton of other clinics and hospitals, popping up like chicken pox in the same area (see figure 2). The question I would ask myself is, how is RHT going to compete with so many competitors like Vijaya Hospital; Apollo Hospital, Manipal Hospitals and and to a lesser extent, government-owned hospital, smaller private hospital groups and new entrants; and if they are able to compete effectively with these competitors how do I tell?

I answer my own question, by placing a small sticky note on their annual report saying “check their occupancy rate and operating margins- there has to be an increase!” 

Figure 1:

Figure 2:

Figure 2 notes: One way to tell whether the hospitals are well maintained, is to check the car park of the building; if that is well maintained, so will be the rest of the hospitals! What I found out is in India, just like Indonesia, if you are from the middle class, going to a public hospital when you are ill is not an option. The public hospitals are crowded; people from all over India come to government hospitals (cause it is cheaper)  so you have people camping all over the corridors, on the staircases, they bring their families and their extended families. So for the middle to upper classes, going to a public hospital is not likely as the que is very long as well.

From the prospectus, it says that the there is a yield waiver period; that the sponsor will not take their entitlement on the 100% net property income distribution payout for both FY13 (Mar) and FY14 (Mar). I am quite certain that this policy acts as a sweetener to potential investors to buy into RHT’s IPO. But from FY15 onwards, hear this… there will be no more sponsor waiver and the payout drops to 90%.

So let’s assume that, RHT is able to meet the forecasted dividends for FY2014 at ~9.6%. Assuming they sustain revenue into FY15, and taking into account -2.5% when sponsor waiver lapses, and payout drops to 90%, the dividend then falls to 7.1% from FY 15 onwards.

By stripping out the distribution wavier, RHT’s yield drops to 7.1%. So Is 7.1% an attractive yield? I look at an immediate alternative, the India 10 year government bond, yielding around 8%.  Wouldn’t the latter be a better alternative? Some argue that RHT yield can continue growing and that the government bond cannot. So a lot depends on RHT’s utilization of debt and whether its hospitals can perform as they claim to be in their prospectus. But if RHT cannot deliver its promises, man! Unitholders are left with quite a bad bargain.

On valuation

CIMB securities research indicated a IV of $1.07 (as of June 2013), the valuation method used was pro-forma income statement with a Gross Property Revenue of $SGD 146m and a distributable profit of $SGD 67.49m by march FY2016. One thing to take note of, is that by next year FY2014, the CIMB analyst expects RHT to deliver a core EPS growth of 174% and if RHT cannot deliver this promise, the IV will fall. An overall analysis of the CIMB analyst’s valuation method and on its IV of $1.07 per share for RHT, I would say it’s either a conservative or she doesn’t know what she is doing. Some readers might question me, why the analyst bashing again? Simply because in FY2014, the analyst forecasted a Distributable Profit of $SGD 46.56million out of  $SGD 66.24 million Net Property Income; this represents only a 70% payout policy for FY2014; but recall that in the prospectus the agreement was a 100% of the net property income for FY 2013 and FY 2014? Perhaps I’m wrong with some accounting definitions; but until someone corrects me, a target price of $1.07 is not a reliable price I would base RHT on.

How I would value RHT is simply giving it a unit price range. For RHT’s upper bound ( the optimistic case- how much RHT unit price can go up to) I would use first REIT’s PTB multiple by an estimated no. of years RHT can reach first REIT’s standard, while adjusting the NAV (by taking out 100% of the intangibles) for RHT’s lower bound (the pessimistic case-how much RHT unit price can fall).  

Let me explain further,

For RHT’s upper bound, I would use First REIT’s latest PTB multiple and multiply it to RHT’s net asset value in 4 years’ time. Why use First REIT? Cause environment which First REIT’s properties are on, the way the management fees are structured as well as the strategies used to acquire properties is very similar to that of RHT, to me RHT could be another young First REIT if you will.

Why 4 years? Cause it took First REIT’s management about 4 years (not considering 2008) to build that reputation, to show results, to meet or exceed expectation and again confidence with investors in order to garner a unit price of $1.225 (as of July 2013) which represents a PTB multiple of 1.36 times.

Applying the law of conservatism, let just assume that in 4 years’ time, RHT net asset value per share is  just $1 (currently it’s 0.90), I take 1.36 times multiply by $1 and get $1.35 per share in 4 years’ time. I discount $1.36 by a discount rate of 10% and added in the dividends for the next 4 years (using the CIMB forecasted dividends FY2013: 0.03, FY 2014: 0.082, FY2015: 0.081, FY2016: 0.085) I get an upper bond IV of $1.25.

So in a nutshell; RHT’s unit price can reach $1.25 provided is can deliver its results, give investors the confidence, such that in 4 years’ time the unit price is worth $1.35 and it delivers 4 years of dividends 0.03, 0.082, 0.081 and finally 0.085 by 2016. Then RHT’s unit price is thus worth $1.25  

For RHT’s lower bound share price; this is how derived it

I took RHT’s Net assets as of march 2013: $SGS 714,510,000

Less off its Intangible assets: $SGD 149,594,000 divided by

Total shares: 788,131,944 and get

An adjusted NAV of $SGD 0.716

In a nutshell, I still think RHT is a 'potentially' great REIT to buy into, however do note that if the latter cannot deliver, it means that the intangibles such as the “name of having Fortis on its hospital front” has little or no value to me and it’s unit should be worth around $SGD 0.716. It could go even lower if, RHT’s competitors take the bulk of the market share. 

As of 28th August 2013: RHT is now at $0.755. The good news is, that most of the economic woes of India should be priced into $0.755

Verdict: Buy with caution