Vital slumps as market reacts
Like a car hitting a patch of black ice, units in listed property trust Vital Healthcare took a nasty swerve the other day.
The sudden drop from $1.40 to $1.23 on June 25 left skid marks on the unit price graph after management, presumably distracted by a text message or something, gave a vague statement to the stock exchange saying unit holders were about to be asked for money.
The absence of detail was naturally a bit freaky for some investors. After all, having to stump up an unspecified amount of cash for an unspecified purpose, through a mechanism that can drop the share price, is not everyone's idea of good news.
Fortunately Vital Healthcare quickly got its hands back on the wheel and clarified the terms of the deal the next day - a one for 10 rights issue to raise up to $39 million at a price of $1.275 a unit. The money would go towards paying back debt and helping finance further acquisitions.
The information was received with relief and Vital's units recovered their grip to trade last week around $1.39.
Alongside the capital raising, Vital said its property assets had been revalued upwards by $10m in the year to June and were now worth $625m, increasing net tangible assets per unit by 3c on a year earlier.
Since Vital's NTA last June was 98c, that means its NTA at balance date this year would be $1.01.
Clearly, the market price of the units is a substantial premium to the asset value.
Indeed, Vital has been trading at a bigger premium than the other listed property vehicles. A Korda Mentha report in April ranked Vital at the top of its peers with a premium of 38 per cent, well above the next ranked players - Argosy, Kiwi Income, Precinct and Property for Industry - at 19 per cent.
One reason for the high valuation is the stability of Vital's tenancies. The trust owns 24 properties in New Zealand and Australia occupied by medical care providers, including Ascot Hospital in Auckland and Allamanda Hospital in Southport on the Gold Coast.
These customers have specialised property needs and will tend to stay put when they find a suitable location - Vital's properties are 99.5 per cent occupied with a weighted average lease term of 12 years, which means the business should have reliable cash flows for a long time.
Over the past four quarters the trust has paid cash distributions totalling 7.7c a unit, which at the current unit price implies a cash yield of about 5.5 per cent.
What we have here, then, is a business using a period of unit price strength to reduce its debt, which at last balance date was $278m.
And as Chris Byrne of Craigs Investment Partners commented in a research note dated June 26, "reducing gearing from about 45 per cent to provide balance sheet capacity makes sense".
With the stock trading around his target price of $1.36, Byrne rates Vital Healthcare a "hold". However, the other side of Vital's healthcare niche is that when tenancies come up for renewal the stakes are high - if a hospital operator walks away from a property there tend to be few waiting to move in. A particular concern for some is the lease expiry in 2018 of Allamanda Hospital, one of Vital's biggest assets and the single biggest lease expiry in the next 20 years.
Not only is this a big deal, Allamanda's occupier is Healthscope, a heavily indebted operator of hospitals and medical centres owned by private equity funds under the control of Carlyle Group and TPG. As of December 31, Healthscope carried debts of A$2 billion, with senior debt of A$1.1b maturing in 2015.
This doesn't mean Allamanda is likely to be a problem, but it does mean the risk of a major disruption is not negligible.
Another issue investors may consider is the relatively light trade in Vital stock, partly due to the 20 per cent stake held by Canadian company NorthWest, the trust's external manager. Daily volume is often well below 100,000 units.
NorthWest has permission from the IRD to extend its ownership of Vital to 25 per cent while retaining the fund's tax-advantaged PIE status. It has also filed a restricted transfer notice to enable its stake to go up to 25 per cent.
It's reasonable to assume NorthWest will mop up unsold rights in the capital raising, so liquidity is unlikely to improve and the position of the external manager will be entrenched.
Moving right along, another property fund with a capital raising on the go is Argosy, which is raising $86m with a rights issue of one share for 10 at 89c - about the same as the company's net asset value of 88c.
The money will be used to help finance Argosy's purchase of two Auckland properties - the Progressive Enterprises distribution centre in Mangere ($74m) and Vector's head office in Newmarket ($22m).
With Argosy shares trading last week around 97c, Craigs analyst Byrne thinks the rights issue is a good move.
"With circa $100m in committed [capital expenditure] over the next 18 months, ARG has taken the opportunity to raise equity at [net tangible asset value] to reduce gearing to 35 per cent. We think this is prudent."
Byrne has a target price for Argosy of $1.05 and rates it a "buy".
Like Vital, Argosy has offered a respectable yield over the last year paying unimputed dividends totalling 6c a share - about 6 per cent gross.
Where to from here?
Analysis published in May by Byrne suggested the price premium on property funds would shrink, but mainly because book values of their assets would rise to meet the market.
"The [listed property vehicle] sector's pricing to NTA generally leads actual asset values by about one-and-a-half years. So the gap may close over the next 12-24 months. This is backed up by some recent transactions which suggest valuers may soon be sharpening their pencils."
Looks like a straight flat road ahead.
Tim Hunter is deputy editor of the Fairfax Business Bureau.
Sunday Star Times