Retirement Home Operators: The Investment Dream Of Young And Old Investors

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Includes: BKD, KRMDF, ORPEF
by: Schmitt Jean-Christophe

Summary

European retirement home market is a secular growth market protected by high barriers to entry.

15% growth rate for the next couple of years with stable margins.

Korian has the best profile, cheap valuations and a new committed management team.

Before delving into the details of the elderly care industry (retirement home), I would like to highlight a few bullet points that sum up the dynamics of the sector:

- Visible growth driven by demographics

- High barriers to entry for new competitors because of regulation (very difficult for an operator to obtain a license to build a new capacity, contract tender favors large players, high standards…)

- Resilient business model

- Market share gain driven by government outsourcing and market under-penetration

The European retirement homes market is a market with a steady pace of growth driven by demographics. The over-80 population is expected to increase by 4%/year in the next 15 years. Moreover, privately-operated facilities could grow faster as they will likely gain market share from public structures. Why? State's budgets are under pressure so they tend to outsource more and more. Public capital is constrained at a time of growing demand. This trend is ongoing and it should continue, since the private sector accounts for just ~30% of the total market.

The business model is resilient because the growth is not correlated to any economic cycle. Moreover, the pace of growth is highly predictable because it depends on the ageing population.

Let's have a look to the EPS growth of the 2 main companies in this sector between 2005 and 2015:

GAAP EPS

2006

2007

2008

2009

2010

2011

2012

2013

2014

Korian

0.42

0.84

0.65

0.47

0.76

0.67

0.68

0.83

0.89

Orpea

0.81

1.03

1.21

1.47

1.59

1.82

1.79

2.08

2.08

Click to enlarge

The constant average growth rate over the period is 9.8% for Korian (OTC:KRMDF) and 12.5% for Orpea (OTC:ORPEF). In the past, Korian had some difficulties integrating acquired businesses, that's why the growth profile is less stable than Orpea.

Please note that they never realized a loss (and we are looking at GAAP numbers not pro-forma or any kind of manipulated earnings). Even more outstanding is the fact that Orpea managed to grow every year, except in 2012 (-1.7%).

One of the main advantages of private operators is the ability to choose which part of the population they want to serve. As you can imagine, they decided to focus on the wealthy part of the population, which allows them to avoid competition with public and non-profit facilities and because their clients are more willing to pay premium services (high margin services).

So far, we have described a non-cyclical sector delivering a decent and visible growth. Textbooks would say that it should attract new entrants who could pressure the sector profitability but in this case, we are lucky because the sector is protected by high barriers to entry. Firstly, regulation prevents new entrants because new licenses are difficult to obtain and are usually given to companies with a strong track record.

Moreover, standards of care are very high and growing so it becomes increasingly more expensive for companies to comply with them. Last but not least, governments are unable to build new capacity since they have to pay almost all the costs per resident in public facilities while they subsidize only a part of the costs in public facilities. Governments are not very enthusiastic to open new facilities because this would pressure even more their budget.

All the above reasons allow private companies to operate at full capacity and since stays in this kind of facilities are usually of short duration (People tend to wait until the last moment before putting someone of their family in a facility), companies retain significant pricing power. In fact, operators are not allowed to increase prices for a room, which is already occupied by a patient, but as soon as the room is free, they can increase the tariffs. That's why high turnover is positive, especially given that the average occupancy rate is around 90%.

There are some pure players listed in the US like Brookdale Senior Living (NYSE:BKD), but I suggest to get exposure to this sector through a European company (more favorable regulation).

You can invest in one of these 3 companies: Orpea (Market cap = 4 B€), Le Noble Age (Market cap = 250 M€) and Korian (Market cap = 2 B€). Clearly, if possible, it is better to invest in the French-listed entities, due to better liquidity and volumes. My favorite is Korian. Why?

Korian is a leading private operator of long-term and post-acute care facilities in Europe. The group operates circa 70,000 beds across approximately 620 facilities in 4 European countries. Korian generates 60% of revenue in France, 9% in Belgium, 19% in Germany and 12% in Italy.

The company trades at a P/E of 15.8x (based on 12M forward earnings) against 28.1x for Orpea and 22.1x for Le Noble Age. The EV/EBITDA shows a similar undervaluation with a multiple of 8.9x for Korian against 14.5x for Orpea and 10.7x for Le Noble Age. Based on a ratio of market cap/number of beds, Korian is also trading with a discount to peers. The EPS growth is expected to be around 15% for the 3 companies.

Korian shares have been recently penalized by the CEO stepping down a few weeks ago. Then, they got hit again warning on their profits for 2015 (2015 EBITDA margin will be 100 bps lower than 2014). I think it was a prudent move from a cautious new management that cleans the balance sheet before starting to run the business. The earnings release (03/23/2016) and the investor meetings will highlight probably the new strategy of the group and give more confidence to investors.

Conclusion

After the recent selloff, shares of Korian are more attractive than ever. They remain fundamentally undervalued and trade at a big discount to its peers. The growth potential is real and protected by regulations. There is a lot of things to like about the sector and the company. The share should offer decent upside over the next few years.

The main risks related to this investment are: Regulatory change, further pricing pressure, reputation risk, wages & rent inflation, and currency fluctuation for a US based investor.

Disclosure: I am/we are long KRMDF.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Editor's Note: This article discusses one or more securities that do not trade on a major U.S. exchange. Please be aware of the risks associated with these stocks.