Aged care – The squeeze is on!


Aged Care

In July’s Health Postcard, we outlined the challenges facing residential care providers. Three months on, we’ve taken a look at the ASX 2016 reporting season to gauge how the listed operators have responded to these challenges, hopefully resulting in improved confidence in growth prospects. In particular, we focus on:

- How operators would manage the impact of the government’s ACFI cuts, that bite in earnest from late 2017?

- How might operators reverse shrinking EBITDA margins with operating costs growing at rates above the paltry increases in regulated income receipts?

- What are the consequences for the carried value of real estate and goodwill that dominate providers’ balance sheets?

These challenges impact the entire industry, just as substantial, fresh capital is required to build new residences and refurbish existing ones, to meet demand. For instance, over the last 10 years 36,000 new beds were added, however 70-80,000 more are required over the next decade. On top of that, one quarter of existing stock (another 50,000) needs to be either substantially refurbished or redeveloped.

The recent profit announcements by listed operators were overshadowed by continued negative reporting of Estia, and the Department of Health’s (DoH) 2 September 2016 release of narrowly framed guidance on charging of additional fees. Unfortunately, the listed operators chose to mostly remain silent on new revenue measures and were marked harshly by investors. In the short-term sentiment is unlikely to recover, while the market sees uncertainty of growth, and the potential for further haphazard Government announcements which appear to be misaligned with the industry. 

Challenge #1 – replacing lost ACFI

The impact of lost ACFI revenue will usually mean an equivalent hit to the operator’s EBITDA line. Once grandfathering of the ACFI changes ends (probably late 2018), the baseline ACFI cut per day is minimum $20/resident but often $30 or more, depending on the resident profile that existed previously. Assuming the minimum, the loss to EBITDA is $7,300 per resident per annum. This is a whopping 63-70 percent of EBITDA for a second quartile profit performer per ACFA data, and a 122 percent to 133 percent impact on third quartile performers. 

In addition, opportunities for providers to charge for the provision of new services and for capital asset replenishment were impacted by the DoH’s 2 September 2016 announcement.

Challenge #2 – reversing contracting margins

Putting the ACFI cuts to one side, in 2017 the rate of increase in regulated operator payments (the daily care fee and ACFI together make up 85 percent-100 percent of operator revenue) continues to be well below the rate of increase in standard operating costs such as wages, utilities and consumables. The increase in government payments of about 1.3 percent compares to 3.5-4 percent annually for operating costs.

Operator strategies to improve margins include:

- The provision of hotel style services;

- A continued focus on growing occupancy;

- Room price growth in line with median house price growth; and

- Growing bed numbers without increasing overheads.

Challenge #3 – managing the potential impact of lower asset values

Aged care residences are revalued at least once every three years. Revaluations undertaken in 2015 or in early 2016 would have enjoyed a positive rub off from frenetic acquisition activity that drove up prices. Since then Estia’s issues have come to the fore and the ACFI cuts were announced. Valuers may now be looking to adjust assumed earnings and the cap rate.  

A simple, hypothetical example (ignoring RADs) demonstrates the potential impact on an 80-bed residence acquired in 2015, debt funded at 65 percent LVR. It has lost 30 percent of capital value and is now at 93 percent LVR:

Was:     $18,000 EBITDA at 13.75%                                           $10.47m                              

Now:     $13,000 EBITDA at 14.25%                                            $7.30m


Observations for advisers and lenders

Guided by the Government’s Aged Care Roadmap, the aged care industry is now part way through a journey of far reaching reform. Ultimately, the industry will transform into a largely deregulated one where operators and care recipients agree on services and price.

In our view, operators will need to adapt their business model from where it presently is, into one offering care and distinctive hotel services. When the squeeze is on, we believe that 'doing nothing' is not an option.