Primary Health Properties (PHP LN) is one of the UK's leading investors in modern primary healthcare facilities with a portfolio that currently has 514 primary healthcare facilities valued at £2.8 billion. A large portion of the healthcare facilities are GP surgeries, with other properties let to National Health Service (NHS) organisations, Ireland's national health service provider - the Health Service Executive (HSE) - as well as pharmacies and dentists. The properties are let on long-term leases, backed by a secure underlying covenant where most of the rental income is funded directly or indirectly by a government body.
PHP's growth arises mainly from rent reviews and asset management projects (extensions, refurbishments and lease re-gears) which boosts income, extend lease terms, and avoids obsolescence. PHP and its development partners are focused on achieving the highest Building Research Establishment Environmental Assessment Method (BREEAM) standards in the UK or nZEB (nearly zero energy buildings) in Ireland, as well as the highest energy ratings.
In terms of the current trading environment, management has noted that rentals have firmed and believes that PHP will be a medium-term beneficiary of the current inflationary environment, both through open market and index-linked reviews. In particular, the significant increases in construction costs, together with historically suppressed levels of open market rental growth in the sector, will be significant pull factors to future growth, especially as the NHS seeks to deliver new, larger primary care facilities and modernise the existing estate. Furthermore, many primary care facilities and occupiers will need to deal with the backlog of procedures and demand which has built up over the last three years and the increasing pressures being placed on the healthcare systems in the UK and Ireland.
The board believes that the secondary listing can contribute to liquidity in the group's shares through its increased profile in the South African market, where several investors have already shown strong interest in investing in PHP, driven by its high-quality, government-backed income stream and robust operating model.
PHP (market cap of ~R27.3 billion) will be the JSE's fifth-largest property share after Shaftesbury, Nepi Rockcastle, Growthpoint and Hammerson.
Acquisition of Axis Technical Services and Ireland's first Enhanced Community Care (ECC) facility
The group successfully completed the acquisition of Axis Technical Services in January 2023, an Irish property management business, and signed a long-term development pipeline agreement for future primary care projects in Ireland.
Axis manages a portfolio of over 30 properties, including the majority of PHP's Irish portfolio, and the acquisition gives the group a permanent presence on the ground and provides fit-out, property and facilities management services to the HSE and other businesses located across Ireland.
PHP has the option to acquire Axis' development pipeline over the next five years. Axis has developed five properties over the last five years, all of which have been acquired by PHP. Axis Health Care Assets has a pipeline of projects with an estimated gross development value of €50 million.
More recently, the group agreed to acquire Ireland's first ECC for €29.64 million (this is the group's largest single Irish acquisition to date). The property is fully let to the HSE on a 25-year lease and benefits from five yearly, compounded annually, Irish CPI indexed rent reviews. The government led ECC programme is a €240 million initiative to enhance and increase community-based health services aimed at reducing pressure on hospital services in Ireland. The building will provide a variety of services primarily to support elderly care and those suffering from a variety of chronic diseases including cardio, respiratory and endocrine issues.
Results for the first half ended 30 June 2023
PHP delivered another round of robust results despite ongoing volatility in the economic and interest rate outlook. Trading metrics across the portfolio remain strong, with a long weighted average unexpired lease term (WAULT) of 10.6 years (December 2022: 11 years), high occupancy at 99.6% (December 2022: 99.7%), and 89% (December 2022: 89%) of rent being securely funded by the UK and Irish governments.
Rental growth has continued to improve, with rent reviews over the period generating an extra £2.2 million (June 2022: £1.5 million), up 9.9% over the previous passing rent equivalent to 4.4% on an annualised basis (June 2022: 6.1% uplift or 3% annualised). Rent reviews for the full year are expected to generate more than £4 million (2022: £3 million) in incremental income. This will be driven by the impact of inflation on both index-linked and open market value (OMV) reviews, continuing the positive trend in growth seen over the last couple of years.
The company distributed a total of 3.35 pence per share in the six months to 30 June 2023, equivalent to 6.7 pence on an annualised basis, which represents an increase of 3.1% y/y and the 27th year of consecutive dividend growth. Looking ahead, the company intends to maintain its strategy of paying a progressive dividend, which is paid in equal quarterly instalments, and covered by underlying earnings in each financial year.
As a result of the deteriorating interest rate environment and economic outlook, the group has adjusted the acquisition pipeline and paused investment activity until the economic and interest rate outlook becomes clearer. The group currently has one development underway and consequently very limited exposure to further build cost inflation and development risk.
The loan-to-value ratio stood at 45.6% (December 2022: 45.1%), which is in the middle of the targeted range of between 40% and 50%. Liquidity headroom totalled £314.4 million (December 2022: £325.9 million). The group has valuation headroom across its various loan facilities with values needing to fall by around £1.2 billion or 42% before the loan-to-value covenants are impacted.
Summary Investment Case
Risks
Outlook and valuation
Growth in the immediate future will continue to be focused on increasing income from the existing portfolio, with management remaining upbeat about the positive moves seen in rental growth in the first six months of 2023. The favourable dynamics of higher inflation and increased build costs combined with a demand for new primary care facilities and the need to modernise the estate will continue to increase future rental settlements.
In the current environment, Ireland continues to be the group's preferred area of future investment activity, with ambitions to grow the Irish portfolio to around 15% (June 2023: 8%) of the total portfolio. The acquisition of Axis, in January 2023, gives the group a permanent presence in Ireland, an important strategic move as it seeks out new investment, development and asset management opportunities, and tries to strengthen the relationship with the HSE as the leading provider of modern primary care infrastructure in the country.
With an improving rental growth outlook, a strong control on costs resulting in one of the lowest cost ratios in the sector, and most of the PHP's debt either fixed or hedged for a weighted average period of just under seven years, management remains confident that the group will see further improvements in the second half of the year.
The company is trading on a forward distribution yield of ~7.8% and a 22% discount to net asset value (NAV), which appears attractive. Based on consensus, the average fair value comes in at 105.29 pence which is reflective of 21% upside potential. We like the quality of the portfolio (enhanced by its defensive characteristics), the experienced and innovative management team, as well as its long-term focus combined with prudent risk management.
