Aged care operators’ share prices smashed

Estia Health Ltd (ASX: EHE), Japara Healthcare Ltd (ASX: JHC) and Regis Healthcare Ltd (ASX: REG) have all seen their share prices tumble today after Bank of America Merrill Lynch (BAML) downgraded all three aged care operators.

In early morning trading, Estia’s share price is down 5.6%, Japara 7.5% and Regis 4.4% to $5.32, $2.47 and $4.60 respectively.

According to the Australian Financial Review (AFR), BAML analysts reveal that all three companies face zero earnings growth. A portion of the aged care operators’ revenues comes from the government through grants called Aged Care Funding Instruments (ACFI), which helps to look after our aging population.

BAML say those ACFI payments may become harder to obtain.

“The impact of the Australian government’s revision to aged-care funding in the May budget, in our mind, the outcome is now clear. More detailed analysis supported by discussions with aged operators implies that the listed aged-care companies are facing zero earnings growth from fiscal 2017 through to fiscal 2019.

“We downgrade Japara and Estia to Underperform from Buy, and Regis to Underperform from Neutral.”

Treasurer Scott Morrison announced $1.2 billion of cuts over four years to aged care in the May budget, on top of $600 million pulled out in the mid-year update in December 2015.

Earlier this week, the AFR conducted a detailed analysis of Estia and its future growth potential noting that there were ‘concerns and questions’ about the $1.2 billion market cap company.

The AFR also noted that private equity companies Quadrant and Mercury Capital have been selling down their stakes in Estia Health. Mercury sold 7.7 million shares (4.3% of Estia) at $6.65 for proceeds of over $51 million – just before Estia’s disappointing first half result.

Quadrant sold 16 million shares in early May for $5.56, to reduce its stake from 17% to 7.9%, and sold its remaining 14.8 million shares the day after for the same price.

Questions have also been asked about the aggressive acquisition strategies in the aged-care sector by a number of participants including Regis – which has led to both Regis and Estia hold negative net tangible assets. There are also questions over aggressive accounting treatment of Refundable Accommodation Deposits (RADs) paid by customers when entering an aged care facility.

Foolish takeaway

Aged care accounting and funding are extremely complex areas many investors would struggle to understand. If we can’t understand the basis for an aged care operator’s revenues and expenses, then simple investing rules suggest we should give the company a miss. Combine that with the high risk of dependency on government funding for the majority of their income and aged care operators are much riskier than they might appear.

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Motley Fool writer/analyst Mike King doesn't own shares in any companies mentioned. You can follow Mike on Twitter @TMFKinga

The Motley Fool Australia has no position in any of the stocks mentioned. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. This article contains general investment advice only (under AFSL 400691). Authorised by Bruce Jackson.

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