Generation Healthcare REIT All about spread Event

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1 AUSTRALIA GHC AU Price (at 04:51, 14 Feb 2015 GMT) Neutral A$1.60 Valuation - Sum of Parts A$ month target A$ month TSR % +5.1 Volatility Index Low GICS sector Real Estate Market cap A$m day avg turnover A$m 0.1 Number shares on issue m Investment fundamentals Year end 30 Jun 2014A 2015E 2016E 2017E Revenue m EBIT m Reported profit m Adjusted profit m Gross cashflow m CFPS CFPS growth % PGCFPS x PGCFPS rel x EPS adj EPS adj growth % PER adj x PER rel x Total DPS Total DPS growth % Total div yield % Franking % ROA % ROE % EV/EBITDA x Net debt/equity % P/BV x GHC AU vs ASX 200 Prop, & rec history Note: Recommendation timeline - if not a continuous line, then there was no Macquarie coverage at the time or there was an embargo period. Source: FactSet, Macquarie Research, February 2015 (all figures in AUD unless noted) 16 February 2015 Macquarie Securities (Australia) Limited Generation Healthcare REIT All about spread Event GHC reported 1H15 underlying operating EPS of 4.8cps, up 4% on the pcp and ahead of our 4.5cps forecast on the back of lower than expected interest expense. Impact Lifts FY15 earnings guidance. As detailed in our recent report, Listed property sector - What if?, we were of the view that GHC would be on track to exceed previous operating EPS guidance of 9.2cps (we were forecasting 9.4cps going into the result) and this has come to fruition with GHC upgrading its FY15 EPS guidance to 9.6cps which is up ~4% on the pcp on the back of lower debt costs. Portfolio metrics soften a little. Occupancy of the portfolio has fallen from 99.5% at June 2014 to 98.6% at December, reflecting the roll-off of the rental guarantee at the Leading Healthcare Facility at Bendigo with like-for-like rental growth of +2.7% in line with FY14. Tenant retention across the portfolio remains high at 87.6% albeit down slightly from 89.1% in FY14. Income certainty remains high with a portfolio WALE of 11.6 years (from 11.3 years at June 2014) and a manageable 28% of portfolio leases expiring to end FY16. Whilst income risk rises in FY17 when 21% of leases expire, we note that this year will benefit from earnings accretion from the delivery of developments. Developments tweaked, may need some equity funding but spread very attractive. Delivery of GHC s development pipeline will be highly earnings accretive (we estimate ~12% of FY15 EPS) given an incremental cost of debt of ~4% and targeted property income yields on cost of ~8.5% (ie a spread of ~4.5%). The development of the Epworth Freemasons Cancer Centre and the Frankston Private expansion can be comfortably debt funded, however we believe stage 2 of the Casey Private Hospital may require equity but given a current EPS yield of ~6% and a likely NPI yield from the development of >8%, even equity funding the deal will ultimately be earnings accretive, albeit timing with equity becomes important given the period of construction in which the asset does not contribute earnings. Otherwise on the development front, the timing of the Cancer Centre has slipped marginally on the back of development approvals and the cost of the Frankston expansion has increased ~10% due to an increase in the scope of the project. Importantly, the targeted yields on cost remain unchanged at 8.5%. Earnings and target price revision EPS: FY %, FY16-0.1%, FY17-4.6%. Lower debt costs in FY15 but higher in FY17 as longer dated hedging has been put in place. Price catalyst 12-month price target: A$1.59 based on a DCF methodology. Catalyst: Commencement of Casey stage 2 development. Action and recommendation Neutral. GHC is a well run property trust with strong organic growth prospects, value add development opportunities and acquisition opportunities, although the share price is already trading around our DCF valuation and further development or acquisitions would likely require additional equity. Please refer to page 6 for important disclosures and analyst certification, or on our website

2 Fig 1 GHC 1H15 result ahead of expectations The good The not so good The interesting 1H15 result ahead of expectations. GHC reported a 1H15 statutory net profit after tax of $7.9m. Operating income which excludes AIFRS adjustments as well as the performance fee was $8.4m or 4.8cps, up ~4% on the pcp and ahead of our 4.5cps estimate. FY15 earnings guidance raised. Whilst we were expecting GHC to be able to exceed previous operating EPS guidance of 9.2cps (we were forecasting 9.4cps going into the result), GHC have provided FY15 operating EPS guidance of 9.6cps, predominately on the back of lower debt costs. Developments are very earnings accretive in a low interest rate environment. Delivery of the trusts development pipeline remains a source of value creation for GHC. Indeed with an incremental cost of debt of ~4% and developments that are expected to yield ~8.5%, delivery of the Epworth Freemasons Cancer Centre and the Frankston Private Expansion will deliver significant earnings accretion (we estimate ~12%) in addition to revaluation gains on completion. St John of God underpins another accretive development. St John of God Healthcare (SJOG) has entered into a non-binding MoU for Stage 2 of GHC s Casey development in southeast Melbourne. Stage 2 is a six-operating theatre, 190-bed facility with further consulting space and a 350-car underground car-park. The hospital will replace SJOG s old 70-bed Berwick private hospital located just down the road. The stage will cost $120m (Stage 1, a specialist cancer centre is $19m) GHC s share is ~$50m. Source: Macquarie Research, February 2015 Some asset values fall. In terms of the property revaluations recognised, a substantial increment was recognised on the recently completed Casey Specialist Centre development (+26%) but The Australian Red Cross Blood Service building in Brisbane saw a 1.3% devaluation given the Baulderstone lease expiry and likely departure in FY17 (allowance for incentives, downtime, etc) and the Pacific Private Clinic in Southport saw a 2.4% devaluation on the back of upcoming lease expiries. NTA growth accordingly modest. NTA rose only $0.01ps to $1.08ps from $1.07ps at June 2014 as very modest property revaluations, representing ~1% of previous values was largely offset by a negative mark-to-market of derivatives and the accrual of the performance fee. We expect further upward pressure on these valuations as valuers reduce cap rates across the assets. Some operating metrics soften. Occupancy of the portfolio has fallen from 99.5% at June 2014 to 98.6% at December reflecting the roll-off of the rental guarantee at the Leading Healthcare Facility at Bendigo with likefor-like rental growth of +2.7% in line with FY14. Tenant retention across the portfolio remains high at 87.6% albeit down slightly from 89.1% in FY14. Casey Stage 3, an expansion to the Stage 2 hospital could begin in ~3 years, but is dependent on Stage 2 becoming fully operational and running smoothly before GHC and St John of God would proceed. Another equity raising likely at some point. While GHC could debtfund its current development pipeline and Casey Stage 2 with debt while remaining within covenants, it would reach ~48% gearing on our calculations before any further property revaluations; above management s target range of 40-45%. As such we expect that the RE may be prudent and raise equity in the medium term, albeit the DRP provides proceeds to fund the current development pipeline. 1H15 result ahead of our expectation GHC reported a 1H15 statutory net profit after tax of $7.9m. Operating income which excludes AIFRS adjustments as well as the performance fee was $8.4m or 4.8cps, up 3.9% on the pcp. The result was ahead of our 4.5cps estimate. In summary: Net property income of $11.9m is up 29% on the pcp and was directly in line with our forecast on the back of acquisitions and positive rental reviews; Net finance costs of $2.5m were well down (~32%) on the pcp despite a higher debt balance on the back of debt refinancing undertaken which have resulted in a significantly lower interest rate for GHC. Net interest costs were lower than we had forecast and the reason for 1H15 EPS being ahead of our forecast. In the six months to 31 December 2014, GHC underperformed the S&P/ASX300 REIT index by ~6% and after taking into account the makeup of underperformance in 2H14, a $2.0m performance fee has been accrued in the half. We continue to highlight that performance fees are not captured in the trust s definition of operating income but it will dilute operating income in future periods on the back of the units issued. 16 February

3 Fig 2 1H15 operating EPS 4.8cps, up 4% on the pcp 1H14A 2H14E FY14A 1H15A % change on pcp Net property income A$m % Finance costs A$m % RE fees A$m % Other expenses A$m % Net operating income A$m % Rental straight lining A$m nmf Property revaluations A$m nmf MTM of derivatives A$m nmf Performance fee A$m nmf Other A$m nmf Net profit after tax A$m % EFPOWA # m % Net operating income per share Acps % DPS Acps % Source: Company data, Macquarie Research, GHC, February 2015 NTA rose only $0.01ps to $1.08ps from $1.07ps at June 2014 as very modest property revaluations, representing ~1% of previous values was largely offset by a negative mark-to-market of derivatives and the accrual of the performance fee. In terms of the property revaluations recognised, a substantial increment was recognised on the recently completed Casey Specialist Centre development (+26%) but The Australian Red Cross Blood Service building in Brisbane saw a 1.3% devaluation given the Baulderstone lease expiry and likely departure in FY17 (allowance for incentives, downtime, etc) and the Pacific Private Clinic in Southport saw a 2.4% devaluation on the back of upcoming lease expiries. Overall, the weighted average cap rate of the property portfolio has remained largely unchanged at 8.24%. Fig 3 Nice development value uplift but partly offset by a couple of falls Revaluations A$m Casey development 4.2 ARCBS -1.0 Pacific Private -0.7 Other 1.2 Total revaluation 3.7 Source: Company data, Macquarie Research, GHC, February 2015 Reported net operating cash flow of $7.6m, equating to 4.3cps is below operating income of 4.8cps but ahead of the 4.2cps distribution declared and in line with our expectation and we continue to expect FY15 and FY16 distributions will be covered by operating cash flow and broadly in line with free cash flow. Casey Stage 2 development could need some equity Delivery of the trusts development pipeline remains a source of value creation for GHC. Indeed with an incremental cost of debt of ~4% and developments that are expected to yield ~8.5%, delivery of the Epworth Freemasons Cancer Centre and the Frankston Private Expansion will deliver significant earnings accretion in addition to revaluation gains on completion. 16 February

4 Fig 4 GHC development pipeline Fig 5 Committed developments >10% EPS accretive Full year pro forma (A$m) Incremental NPI 3.8 Incremental interest -1.8 Net change to earnings 2.0 FY15E operating income 17.1 Accretion 11.9% Source: GHC, February 2015 Source: Macquarie Research, February 2015 GHC are also working through their proposed development of stage 2 at Casey Private Hospital in Southeast Melbourne. St John of God Healthcare (SJOG), a not-for-profit healthcare service provider, has entered into a non-binding Memorandum of Understanding for this stage. Stage 2 is a six-operating theatre, 190-bed facility with further consulting space and a 350-car underground car-park. The hospital will replace SJOG s old 70-bed Berwick private hospital located just down the road. The stage will cost $120m (Stage 1, a specialist cancer centre is $19m). SJOG will pay for the fit-out of Stage 2, costing ~$30m, with both parties splitting the remaining $90m. GHC will need to start funding the ~$50m total spend from the end of FY15, when construction of the stage is tentatively set to begin. Targeted completion is in CY17, we have assumed midway through in our forecasts. Based on our estimates in the table below, GHC could debt-fund its entire contribution to Stage 2 and remain comfortably within its LVR and ICR metrics; however, gearing would reach ~48% on our calculations (before assuming any further positive revaluations), above management s target range of 40-45%. As a point of reference, a ~$15m equity raising would bring gearing back down below 45% (which could be largely funded via the DRP). Similarly, a ~10% revaluation of the property portfolio would see gearing back below 45%. Fig 6 Gearing reaches ~48%, above management s target range of 40-45% with no property revaluations A$m 31-Dec-14 Existing dev. Spend Pro forma Casey Stage 2 Pro forma Assets Cash Investment properties Equity accounted investments Other assets Total assets Liabilities Debt Other liabilities Total liabilities Equity Gearing 33.3% 41.3% 48.2% Source: Company data, Macquarie Research, August February

5 FY12A FY13A FY14E FY15E FY16E FY17E FY18E Income NPI A$m Other income Total income A$m Expenses Interest expense A$m (8.0) (7.6) (6.4) (5.7) (7.2) (8.7) (10.1) Trust & other expenses A$m (1.5) (1.6) (1.8) (2.3) (2.8) (3.2) (3.4) Total expenses A$m (9.5) (9.2) (8.2) (8.0) (10.0) (11.9) (13.5) Profit before tax A$m Tax expense A$m OEI A$m Reported net profit after tax A$m /- adjustments to derive statutory profit A$m (3.2) (0.7) Reported statutory profit A$m Per share data EPS A cps EPS growth % 25.5% 4.0% 5.5% 2.7% 7.2% 14.1% FFO A cps FFO growth % 25.5% 4.0% 5.5% 2.7% 7.2% 14.1% DPS A cps DPS growth % 9.9% 9.0% 5.0% 5.0% 5.0% 5.0% Cashflow statement 0.0% 0.0% 0.0% 0.0% 0.0% Cash flow from operations EBITDA A$m Net interest A$m (8.1) (8.1) (7.5) (7.2) (8.4) (10.4) (11.0) Change in working capital A$m Tax paid A$m Other A$m (0.7) (0.3) (0.3) (0.3) Net operating cash flow A$m Cash flow from investing A$m Asset sales A$m Asset purchases A$m - (24.3) (30.5) (14.1) Capex- Maintenance A$m (0.7) (0.8) (1.0) (1.1) Capex - development A$m (4.3) (2.8) (20.4) (15.6) (57.5) (35.0) - Other A$m - (2.1) (8.4) (0.4) (5.3) - - Net investing cash flow A$m (4.3) (29.2) (59.2) (30.9) (63.6) (36.0) (1.1) Cash flow from financing Issue of equity A$m Debt movement A$m (9.5) Distributions paid A$m (4.0) (4.2) (5.8) (11.5) (15.6) (16.8) (18.0) Other A$m - - (1.9) Net financing cash flow A$m (11.5) Net cash flow A$m 0.7 (0.2) 1.3 (1.6) 10.9 (6.3) 9.4 Balance sheet Total current assets A$m Total non current assets A$m TOTAL ASSETS A$m Total current liabilities A$m Total non current liabilities A$m TOTAL LIABILITIES TOTAL EQUITY A$m Source: Company data, Macquarie Research, February February

6 Important disclosures: Recommendation definitions Macquarie - Australia/New Zealand Outperform return >3% in excess of benchmark return Neutral return within 3% of benchmark return Underperform return >3% below benchmark return Benchmark return is determined by long term nominal GDP growth plus 12 month forward market dividend yield Macquarie Asia/Europe Outperform expected return >+10% Neutral expected return from -10% to +10% Underperform expected return <-10% Macquarie First South - South Africa Outperform expected return >+10% Neutral expected return from -10% to +10% Underperform expected return <-10% Macquarie - Canada Outperform return >5% in excess of benchmark return Neutral return within 5% of benchmark return Underperform return >5% below benchmark return Macquarie - USA Outperform (Buy) return >5% in excess of Russell 3000 index return Neutral (Hold) return within 5% of Russell 3000 index return Underperform (Sell) return >5% below Russell 3000 index return Volatility index definition* This is calculated from the volatility of historical price movements. Very high highest risk Stock should be expected to move up or down % in a year investors should be aware this stock is highly speculative. High stock should be expected to move up or down at least 40 60% in a year investors should be aware this stock could be speculative. Medium stock should be expected to move up or down at least 30 40% in a year. Low medium stock should be expected to move up or down at least 25 30% in a year. Low stock should be expected to move up or down at least 15 25% in a year. * Applicable to Asia/Australian/NZ/Canada stocks only Recommendations 12 months Note: Quant recommendations may differ from Fundamental Analyst recommendations Financial definitions All "Adjusted" data items have had the following adjustments made: Added back: goodwill amortisation, provision for catastrophe reserves, IFRS derivatives & hedging, IFRS impairments & IFRS interest expense Excluded: non recurring items, asset revals, property revals, appraisal value uplift, preference dividends & minority interests EPS = adjusted net profit / efpowa* ROA = adjusted ebit / average total assets ROA Banks/Insurance = adjusted net profit /average total assets ROE = adjusted net profit / average shareholders funds Gross cashflow = adjusted net profit + depreciation *equivalent fully paid ordinary weighted average number of shares All Reported numbers for Australian/NZ listed stocks are modelled under IFRS (International Financial Reporting Standards). Recommendation proportions For quarter ending 31 December 2014 AU/NZ Asia RSA USA CA EUR Outperform 51.80% 58.06% 45.07% 44.42% 60.54% 46.81% (for US coverage by MCUSA, 5.29% of stocks followed are investment banking clients) Neutral 31.80% 27.37% 30.99% 50.10% 35.37% 33.51% (for US coverage by MCUSA, 3.08% of stocks followed are investment banking clients) Underperform 16.39% 14.57% 23.94% 5.48% 4.08% 19.68% (for US coverage by MCUSA, 0.44% of stocks followed are investment banking clients) GHC AU vs ASX 200 Prop, & rec history (all figures in AUD currency unless noted) Note: Recommendation timeline if not a continuous line, then there was no Macquarie coverage at the time or there was an embargo period. Source: FactSet, Macquarie Research, February month target price methodology GHC AU: A$1.59 based on a DCF methodology Company-specific disclosures: GHC AU: The preparation of research on was funded by ASX in accordance with the ASX Equity Research Scheme. This research was prepared by Macquarie Securities (Australia) Limited and not by ASX. ASX does not provide financial product advice. The views expressed in research pertaining to do not necessarily reflect the views of ASX. No responsibility or liability is accepted by ASX in relation to this report Macquarie Group Limited together with its affiliates beneficially owns 1% or more of the equity securities of Generation Healthcare REIT. MACQUARIE CAPITAL (AUSTRALIA) LIMITED or one of its affiliates managed or co-managed a public offering of securities of in the past 12 months, for which it received compensation. This report was prepared solely by Macquarie Securities Limited. ASX did not prepare any part of the report and has not contributed in any way to its content. The role of ASX in relation to the preparation of the research reports is limited to funding their preparation, by Macquarie Securities Limited, in accordance with the ASX Equity Research Scheme. ASX does not provide financial product advice. The views expressed in this research report may not necessarily reflect the views of ASX. To the maximum extent permitted by law, no representation, warranty or undertaking, express or implied, is made and no responsibility or liability is accepted by ASX as to the adequacy, accuracy, completeness or reasonableness of the research reports. MACQUARIE CAPITAL (AUSTRALIA) LIMITED or one of its affiliates managed or co-managed a public offering of securities of in the past 24 months, for which it received compensation. Important disclosure information regarding the subject companies covered in this report is available at Date Stock Code (BBG code) Recommendation Target Price 12-Jan-2015 GHC AU Neutral A$ Aug-2014 GHC AU Neutral A$ Jun-2014 GHC AU Neutral A$ Feb-2014 GHC AU Neutral A$ Dec-2013 GHC AU Neutral A$1.20 Target price risk disclosures: GHC AU: Any inability to compete successfully in their markets may harm the business. This could be a result of many factors which may include geographic mix and introduction of improved products or service offerings by competitors. The results of operations may be materially affected by global economic conditions generally, including conditions in financial markets. The company is exposed to market risks, such as changes in interest rates, foreign exchange rates and input prices. From time to time, the company will enter into transactions, including transactions in derivative instruments, to manage certain of these exposures. 16 February

7 Analyst certification: The views expressed in this research reflect the personal views of the analyst(s) about the subject securities or issuers and no part of the compensation of the analyst(s) was, is, or will be directly or indirectly related to the inclusion of specific recommendations or views in this research. The analyst principally responsible for the preparation of this research receives compensation based on overall revenues of Macquarie Group Ltd (ABN , AFSL No ) ( MGL ) and its related entities (the Macquarie Group ) and has taken reasonable care to achieve and maintain independence and objectivity in making any recommendations. General disclosure: This research has been issued by Macquarie Securities (Australia) Limited (ABN , AFSL No ) a Participant of the Australian Securities Exchange (ASX) and Chi-X Australia Pty Limited. This research is distributed in Australia by Macquarie Equities Limited (ABN , AFSL No ) ("MEL"), a Participant of the ASX, and in New Zealand by Macquarie Equities New Zealand Limited ( MENZ ) an NZX Firm. Macquarie Private Wealth s services in New Zealand are provided by MENZ. Macquarie Bank Limited (ABN , AFSL No ) ( MBL ) is a company incorporated in Australia and authorised under the Banking Act 1959 (Australia) to conduct banking business in Australia. None of MBL, MGL or MENZ is registered as a bank in New Zealand by the Reserve Bank of New Zealand under the Reserve Bank of New Zealand Act Any MGL subsidiary noted in this research, apart from MBL, is not an authorised deposit-taking institution for the purposes of the Banking Act 1959 (Australia) and that subsidiary s obligations do not represent deposits or other liabilities of MBL. MBL does not guarantee or otherwise provide assurance in respect of the obligations of that subsidiary, unless noted otherwise. This research is general advice and does not take account of your objectives, financial situation or needs. Before acting on this general advice, you should consider the appropriateness of the advice having regard to your situation. We recommend you obtain financial, legal and taxation advice before making any financial investment decision. This research has been prepared for the use of the clients of the Macquarie Group and must not be copied, either in whole or in part, or distributed to any other person. If you are not the intended recipient, you must not use or disclose this research in any way. If you received it in error, please tell us immediately by return and delete the document. We do not guarantee the integrity of any s or attached files and are not responsible for any changes made to them by any other person. Nothing in this research shall be construed as a solicitation to buy or sell any security or product, or to engage in or refrain from engaging in any transaction. This research is based on information obtained from sources believed to be reliable, but the Macquarie Group does not make any representation or warranty that it is accurate, complete or up to date. We accept no obligation to correct or update the information or opinions in it. Opinions expressed are subject to change without notice. The Macquarie Group accepts no liability whatsoever for any direct, indirect, consequential or other loss arising from any use of this research and/or further communication in relation to this research. The Macquarie Group produces a variety of research products, recommendations contained in one type of research product may differ from recommendations contained in other types of research. The Macquarie Group has established and implemented a conflicts policy at group level, which may be revised and updated from time to time, pursuant to regulatory requirements; which sets out how we must seek to identify and manage all material conflicts of interest. The Macquarie Group, its officers and employees may have conflicting roles in the financial products referred to in this research and, as such, may effect transactions which are not consistent with the recommendations (if any) in this research. The Macquarie Group may receive fees, brokerage or commissions for acting in those capacities and the reader should assume that this is the case. The Macquarie Group s employees or officers may provide oral or written opinions to its clients which are contrary to the opinions expressed in this research. Important disclosure information regarding the subject companies covered in this report is available at 16 February