Primary Health Properties Interim Results To End-June 2012

The interim results included 6% growth in rental income y-o-y, on the back of rent reviews that averaged 2.7% pa and acquisitions, but lower profit and EPS due to higher finance charges on new debt. The first seven months of 2012 have seen £175m of debt refinance, an £18m equity issue and a £75m retail bond issue in July. That puts c £130m of headroom in place to be used to fund acquisitions, with income surpluses increasing dividend cover. Our assumptions – c £60m pa of acquisitions this year, £50m pa in FY13 and 2.5% pa at rent reviews – push cover up to 74% in FY13 vs 67% this year. The group sees potential to scale up faster and close the gap in FY14. The pipeline of new assets – £49m currently in solicitors’ hands – on top of £16m so far this year, could see it beat our growth target. Acquisitions should be EPS accretive, as net initial yields being achieved are generally between 5.75% and 6.25% pa, ahead of incremental debt costs.

Interim results: Lower profit reflects debt margin increase
Rents were higher, in line with increased portfolio scale and reviews, but underlying interim profit fell to £4.4m (H111: £5.4m) due to higher average debt costs resulting from increased margins after recent debt refinancing. We estimate the average cost of debt at 5.1% pa currently (FY11: 5.02%) if all facilities were fully drawn, including the new £75m retail bond, although incremental debt is available at LIBOR plus 2.5%, currently below 4% pa all-inclusive. We have adjusted forecasts for this and ‘cash-drag’ as new funds await deployment. There is c £157m of undrawn debt and cash – £130m headroom for acquisitions net of a £27m loan maturity, with c £10m commitments to fund and £49m of assets in solicitors’ hands.

NHS reforms expected to drive demand for new assets
Recent NHS reforms seek to increase patient choice and shift budget responsibility towards GPs. The process is expected to move more patient services into local communities and devolve non-critical care and diagnostic activities from general hospitals, both of which will need an upgrade to existing primary care facilities. That should increase demand for the kind of modern, specialist premises funded by PHP.

Valuation: 5.3% dividend yield, 378p mid-year DCF
We see the yield as the key to the valuation, even though the dividend is uncovered. We anticipate another 0.5p pa dividend increase in FY13e, so prospective yields of 5.3% at the current share price this year, 5.5% next. Any shortfall will be met from cash/debt (reducing NAV/share) until cover is restored. Mid-year EPRA NAV/share was 314.9p (FY12: 318.7p), the manager’s DCF of future cash flows 378p/share.

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