Analyst and report co-author Aaron Ibbotson said the companies have probably taken on too much debt. Photo: RNZ / Nate McKinnon
The financial performance of the retirement village sector is being held back by its heavy debt burden, according to a new report by investment firm Forsyth Barr.
It said three of the bigger firms in the sector listed on the stock exchange - Ryman Healthcare, Arvida and Oceania Healthcare - have tripled the amount of debt they are carrying over the past five years, more than any other sector.
But analyst and report co-author Aaron Ibbotson said the companies have probably taken on too much debt.
He said the debt growth for the sector had generated growth in units, net asset values and underlying earnings.
That approach made sense in times of low debt costs, rising property values and equity valuations, but times had changed.
"Today the world looks very different. All aged care operators are valued below tangible book value, house price inflation is negative, and the aged care companies are raising incremental debt above 6 percent.
"In this environment, we believe share price performance will be partly driven by an ability to generate free cash flow and reduce net debt."
In the meantime, it estimated debt servicing would consume about 20 percent of the companies' underlying profits compared with about 10 percent over the 2018 to 2022 financial years, while capitalised interest would eat up about 10 percent of new sales cashflow.
"Outside of company specific details, we expect levels of debt and house prices to dominate the overall performance of the aged care sector over the next 18 months," the report said.
"If interest rates and construction costs remain high, we estimate that the sector has an attractive 'out' by not starting any new build projects.
"This could result in the sector becoming largely debt-free."
Forsyth Barr said the three operators had each indicated they would scale back on development and take a more cautious approach.
"If these operators are able… to pay down debt alongside the development rundown… there would be a sizeable upside to the equity value over the next three to four years," it said.