Investors beware: This sector is next to face a royal commission meltdown

If the painful de-rating of our largest financial institution is anything to go by, investors should be wary of our listed aged care sector after the federal government announced on Sunday that it was launching a Royal Commission looking into bad practices in the sector.

This could be worse than the Banking Royal Commission. Age care is arguably a more emotive subject and there’s already plenty of circumstantial evidence pointing to the need for major regulatory reforms that are likely to squeeze the profit margins of our listed players.

The Banking Royal Commission is primarily responsible for the underperformance of the big banks like Commonwealth Bank of Australia (ASX: CBA) and Westpac Banking Corp (ASX: WBC), which have fallen by more than 10% since the start of the year, and AMP Limited (ASX: AMP) which has collapsed by nearly 40% over the same time.

In contrast, the S&P/ASX 200 (Index:^AXJO) (ASX:XJO) index is up 2% over the same period.

Stand back as the share prices of Regis Healthcare Ltd (ASX: REG), Japara Healthcare Ltd (ASX: JHC) and Estia Health Ltd (ASX: EHE) are likely to take a hit on this news.

The sliver-lining is that a de-rating has already started in the sector with many already trading at or around a 52-week low as the government has started looking at implementing new rules for the industry.

However, I suspect the recommendations from the Aged Care Royal Commission will recommend even harsher penalties and that it will find poor practices and mistreatment of the elderly to be more widespread than many believe.

I’ve longed believed that the for-profit industry players have lost their conscience. A Royal Commisson will help them find religion. That’s good news for the soul but bad news for the bottom line.

A change in staff ratios and wages to improve service has the potential to pressure profit margins, as will tighter regulations due to higher compliance costs.

While a big cleanout of the sector could put larger and more efficient operators in pole position to consolidate the fragmented industry, these commercial operators are facing competition from non-profits – unlike the banks.

The Royal Commission could just hand more power to the non-profits if they can prove that they are better at putting residents care above the bottom line.

The other fallout from the Royal Commission is litigation. Just as with the Royal Commission into the banks, lawyers are sharpening their pencils in anticipation of class actions from investors and other stakeholders.

Our largest energy companies like AGL Energy Ltd (ASX: AGL) and Origin Energy Ltd (ASX: ORG) are also biting their nails as a desperate Morrison government could be coming after them next to garner a few more votes ahead of next year’s election.

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Motley Fool contributor Brendon Lau owns shares of Westpac Banking. 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 Scott Phillips.

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