university of auckland llapaca investments student ... · sum-of-the-parts dcf valuation. 21 ......

Llapaca Investments This report is published for educational purposes only by students competing in the CFA Institute Research Challenge.

Important disclosures appear at the back of this report

Ticker: ●RYM

Recommendation: ●BUY

Price: ●$2.46 Price Target: ●$2.99

Ryman Healthcare: pride and joy of the NZX A compelling New Zealand growth story with significant Australian opportunities

� Well-positioned in a growing industry: The retirement living and aged care industries will present considerable opportunities over the next 40 years. Demand in these sectors will increase significantly, underpinned by the rapidly ageing New Zealand population. RYM’s target population of 75+ is forecasted to almost triple by 2051 to 792,500. A strong brand which resonates with New Zealanders and secure financial capabilities places RYM in a strong position to capitalise on these huge opportunities.

� Strong management team and track record of results: RYM is run by a dedicated management team who collectively possess over 100 years of experience in the industry. Consistent strength in its management team has lead RYM to be a stellar performer, delivering a CAGR in underlying profit of over 15% for the past five years, consistently outperforming the NZX and climbing into the NZX Top 10 after only ten years of being listed. Since listing on the NZX in 1999, RYM has increased its portfolio of just under 1,000 beds/units in eight locations to over 4,700 beds/units in 24 villages across the country.

� Effective and proven business model: RYM has a unique integrated business model where it offers its residents both high and low levels of care in every retirement village. No other company in the industry provides a complete range of care in every retirement village. RYM’s operations are also vertically integrated with the design and development processes all carried out in-house. This allows RYM to standardise their village model and achieve scale and cost efficiencies that its competitors cannot replicate.

� Australian expansion with positive fundamentals and significant upside: Australia will experience an ageing of their population and a consequent increase in demand for aged care and retirement living. This offers very attractive prospects for RYM’s Australian expasion. We recognise that with any greenfield expansion, there are considerable risks, however, given RYM’s conservative step-by-step approach, we believe that downside risks will be minimised.

� BUY with a $2.99 target price: We value RYM at a target price of $2.99 based on our sum-of-the-parts DCF valuation.

21 September 2011

Exchange: NZE

Ticker: RYM

Current Price: $2.46

KEY STATISTICS

52 Week Price Range NZ$ 2.06 - 2.84

Avg. Daily Volume m 0.46

Shares Outstanding m 500

Market Cap m 1,230

% of NZX50 Index % 2.21

Beta 0.90

Inst. Holdings % 31

Insider Holdings % 15

Free Float % 63

Source: IRESS

Figure 1. RYM vs. NZX50

Source: IRESS

University of Auckland

Student Research This report is published for educational purposes only by students competing in the CFA Institute Research Challenge.

Recommendation: BUY

2.00

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RYM NZX50 rebased

Ryman Healthcare

Retirement living & aged care

CFA Institute Research Challenge 21 September 2011

University of Auckland | 2

Business Description RYM is one of the biggest retirement living providers in New Zealand. Founded in 1984, it currently has 24 operating villages nationwide with another two new villages still under construction. It was listed on the NZX in 1999 and entered the NZX Top 10 in 2009. RYM’s aim is to be the leading provider of retirement and healthcare facilities for the elderly and is working to achieve this with a current target build rate of 550 units/beds per annum. As at March 2011, RYM had over 5,000 residents in over 4,700 beds and units, and employed over 2,500 staff around the country. It provides a range of living options in each one of its retirement villages including independent living units, assisted living units and aged care facilities for its residents. Independent living and assisted living units can be purchased from RYM and the resident will be paid the purchase price less the management fee upon departure. Independent living units allow residents to live within the village while still maintaining complete independence. Assisted living units provide residents with daily services such as meals and housekeeping services in their one bedroom or studio apartment. Aged care facilities are divided into restthome beds, hospital beds and dementia level care. All villages contain a rest home and most villages contain hospital and dementia level care. Rest homes and hospitals provide residents with daily clinical care, and the dementia care unit provide residents with short term care, respite care and day care.

Figure 2: RYM’s share price movement

Historical two year movements in daily share price adjusted for dividends

Source: NZX, IRESS

RYM’s Competitive Advantage RYM is strongly placed to increase its market share and capitalise on the growth in the industry based on its ablity to differentiate itself from its competitors in terms of both internal operations and external reputation:

Strong Reputation RYM has been in operation since 1984 and has established itself as a New Zealand company with a strong reputation that resonates with its target 75+ population. It prides itself on its “Ryman Peace of Mind Guarantee” which offers a greater value proposition to its residents than its competitors and directly impacts on how prospective residents view the company. Surveys of the elderly have found that the top criterion in retirement village choice is reputation. RYM’s trusted reputation translates into high demand for its villages and a high rate of occupancy accross all of its retirement village units and aged care facilities.

Continuum of Care RYM has an integrated business model which offers a full continuum of care in each of its retirement villages. RYM reflects the preference of the elderly to “age in place” by allowing residents to reside in the same village from the moment they enter to the day they depart regardless of changes to their medical needs. Offering this ability to “age in place” is a differentiating factor for RYM’s villages and also allows RYM to channel independent living and assisted living residents into the care side of the business, resulting in economies of scope and higher occupancy rates in its aged care facilities.

0.00

0.50

1.00

1.50

2.00

2.50

3.00

Sep 09 Mar 10 Sep 10 Mar 11 Sep 11

02 Aug 11

Land

purchased in

Howick

24 June 11

Dividend of 3.8cps paid

17 Mar 11

Announced to

build 25th village

in Waikanae

10 Dec 10

Dividend of

3.4 cps paid

18 Nov 10

Record high interim profit of

$36m, announced interim

dividend of 3.4cps

29 Jul 10

Australian

expansion

plan

announced

22 Jun 10

Announced to

build 24th

village in

Tauranga

25 Jun 10

Dividend of

3.4cps paid

19 May 10

Record high full year

profit of

$72m, announced

final dividend of

3.8cps

19 May 10

Record high full year

profit of

$61m, announced

final dividend of

3.4cps

18 May 10

CEO Simon Challies

appointed as MD

26 Feb 10

Announced to

build 23rd

village in

Christchurch

23 Nov 09

Record high interim

profit of

$29m, announced

interim dividend of

2.7cps

11 Dec 10

Dividend of

2.7cps paid

18 Jul 11

Tainui Holdings sold

12.5% stake to

Craigs Investment

Partners



Source: Statistics New Zealand

Figure 3. Forecast 75+ population (000s)

Vertical Integration

All of RYM’s operations, including land selection, project management, procurement of materials, sales and marketing, are completed in-house. This vertical integration model is unique within the retirement living and aged care sectors and allows RYM to standardise all of its villages, ensuring the quality of its services and facilities. An in-house development team also gives RYM the ability to source its own land and choose the most optimal locations for its villages based on local demographics. Over 20 years of experience in the design, development, construction and marketing of villages has resulted in RYM becoming highly knowledgable and efficient in all aspects of its village construction.

Self-funding Model

Each of RYM’s villages is self-funding by the time that all the retirement village units are sold down for the first time. This means that RYM is able to maintain a low level of debt to equity (Mar 2011: 28%) and only borrow to fund the work in progress for a new village. Its strong balance sheet and relationship with its bank is a significant advantage going forward as RYM, unlike some of its competitiors, will not be limited by its ability to access capital. This places RYM in favourably position to capitalise on the upward trend in elderly population demographics.

Favourables Contracts

Affordability is another key consideration for the elderly in the selection of retirement homes. RYM, as well as offering its “Ryman Peace of Mind Guarantee”, caps its deferred management fee at 20%. Most other competitors cap their deferred management fee at 30% of the occupancy advance. RYM is able to offer a lower fee cap due to cost efficiencies from its scale and in-house vertical integration processes. These favourable terms contribute to the high demand and high occupancy rates of its retirement villages.

Industry Overview and Competitive Positioning

INDUSTRY OVERVIEW

Population Trend

Between 2006 and 2026, the 65+ population is expected to grow by 84% to 944,000. The overall population is only expected to grow at a rate of 20%, reaching 5 million in 2026. Demand for facilities

The aged care sector is a needs-based industry which means that as the 65+ population size increases, the demand for aged care facilities will also increase. Furthermore, the 65+ population are living for longer and are thus in worse health conditions in the last years of their lives. Recent research shows that men spend the last 6.8 years and women spend the last 9.1 years of their life with debilitating diseases of old age. As such, we believe that there will be an even greater increase in demand for aged care services such as rest home, hospital and dementia care in the coming years. The ARCSR report projects that between 44,000 and 52,000 aged care beds will be in demand in 2025 compared to 32,000 at present. Supply of facilities

According to the ARCSR report, the supply and renewal of aged care facilities has slowed down in recent years and needs to increase to cope with projected demand as half of existing aged care facilities are over already over 20 years old. However, on the investment side, the returns of replacing or building new facilities are often too low to justify investment in the industry, particularly for the smaller independent or not-for-profit players. Going forward, given the lack of incentive to invest, the industry may see a shortage of supply of aged care beds, which may call for an increase in government subsidies in this sector. Based on our analysis, RYM currently has the highest build rate in the industry, attributable to its self-funding model and ability to access capital, placing it in a strong position to supply the demand from the baby boomers going forward.

Government Policy

In recent years, in the interests of reducing government healthcare costs, the New Zealand government has introduced policies to encourage the elderly to age in their own home and only move into aged care facilities when absolutely necessary. The New Zealand Postive Ageing Strategy (2001) outlines 10 goals which all focus on helping older people “age in place” and feel secure in their own homes. The Health of Older People Strategy (2002) advocates an integrated approach to health and disability support services to reduce the need for external retirement care. As a consequence of this, we expect reduced demand for low-level care such as rest homes but an increase in demand for high-level care such as hospitals and dementia care. Whilst the demand for low-level care may decrease as a fraction of the elderly population, the absolute number of low-level beds demanded is still expected to increase due to the aging population. We believe that these policies won’t have a major impact on demand for RYM’s aged care beds. Its continuum of care model allows it channel its unit residents through to its care beds as opposed to having to fill its care beds directly from the community. Thus the government policies will have minimal effect on RYM’s occupancy rates

0

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400

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800

2011 2016 2021 2026 2031 2036 2041 2046 2051

CAGR = 2.7%



Figure 4. Competitive Positioning

Source: UoA estimates

Industry Consolidation

In recent years, many not-for-profit villages have been sold or taken over by commercial operations. The primary reason is financial in that not-for-profit villages are often unable to sustain losses year after year and corporate villages are run more cost-effectively and can achieve scale in corporate overheads. In the last decade, Macquarie Group has acquired many New Zealand retirement homes, turning them around into profitable operations. We see this consolidation trend continuing for two reasons. First, beds and facilities in the aged care sector achieve greatest cost-efficiency when there are over 80 beds in a village and currently half of all villages in the sector operate at 50 beds or less. Second, half of the existing beds and facilities are over 20 years old, calling for replacement as they near their useful life of 25 years. However, financial returns from replacing such facilities is too low to justify investment, particularly for smaller operators with low financial capacity. Therefore, in the coming years, we see larger operators acquiring smaller players and replacing existing facilities to take advantage of the cost-efficiencies available due to scale.

Property Prices

ORA prices are strongly correlated with property prices. Prospective residents typically need to sell their existing property to purchase ORAs, which means their ability to purchase an ORA is tied directly to residential house prices and property demand. A weak property market depresses RYM’s ORA prices and a strong property market boosts them. Given that RYM purchases land and builds new villages before the new ORAs are sold, lower ORA prices will directly impact its development margin. Furthermore, property prices also impact on resale prices and DMFs which are determined as a percentage of the ORA price. In the short to medium term, we believe that property prices across New Zealand will increase due to the recent Christchurch earthquake which has caused a shortage in the property market. Furthermore, if the Reserve Bank keeps the OCR at low rates, this will have an upward pressure on property demand and prices.

Government Regulation

The Retirement Villages Act 2003 protects the rights and interests of retirement village residents. Under this Act, it is compulsory for all retirement villages to implement a Code of Resident’s Rights and a Code of Practice, and be registered with the Companies Office. These requirements are mostly administrative and do not restrict day-to-day operations. Residents who require residential or hospital level care can apply for a Residential Care Subsidy from the Ministry of Health. Residents may be granted a subsidy for care from an approved provider if they are 65 years old or over, assessed as needing long-term residential care and pass the asset and income test. Most of this subsidy is paid directly to the hospital or rest home provider and the residents are paid a personal allowance of $41.64 per week. The number of dementia beds in rest homes are regulated by the DHBs who can choose which retirement village operators they want to contract with to provide dementia care. Daily subsidies paid to providers of dementia care ranges from $126 to $137 depending on the capital cost of building dementia care beds.

COMPETITIVE POSITIONING

The New Zealand retirement living and aged care industries are characterised by many small operators and a few large operators. There are 330 registered retirement villages in New Zealand and 179 operators. Around 21% of the operators are not-for-profit, 54% are corporate operators and the remaining 25% are for-profit independent operators. RYM and Metlifecare are the biggest operators, each with around 12% share of the market. The major players in the sector are RYM, Metlifecare, Oceania, Vision, Bupa, Primelife and Summerset. The figure on the left shows the position of each operator in terms of target age group and income class. RYM targets a slightly older demographic of 75+ who are mid-high class. We analysed these operators with respect to some key criteria that the elderly base their choice of retirement village on. These are reputation, affordability, location, facilities and services, and atmosphere. Out of all the major operators, RYM’s villages lead in reputation, additional services and facilities, atmosphere and location. Reputation

Reputation was judged by market presence, the extent of negative media exposure in recent years, growth prospects and leadership status in the industry. RYM scored the highest in this category due to its strong brand presence around the country and in the capital markets which has resulted in positive exposure particularly in the last few years. Affordability

Each operator was analysed on ORA pricing and weekly service fees. Whilst RYM’s ORA prices are higher than average, its weekly service fees are the lowest out of all the major operators. Location

Analysis of location was based on proximity to communities and services such as shopping and external healthcare. For this factor, Metlifecare was ranked the highest, followed closely by RYM and Primelife.

Older

Younger

High Low

Oceania

Summ.

Vision Primelife

MET

Bupa

RYM



0

100

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2010 2011 2012 2013 2014 2015

Profit EBITDA Rev FCF

Figure 6. Financial Projections (NZ$m)


Figure 7. Football Field

Figure 5. Major Competitors Comparison



Facilities/Services

This aspected was evaluated based on the availability of additional facilities such as gymnasiums, libraries and recreational areas, as well as additional services such as transport, fitness programs and scheduled leisure trips. Out of these criteria, RYM scored the highest as it offers an extensive range of services and facilities for its residents to enjoy. Atmosphere

Atmosphere of a retirement village is based on the number of outdoor recreational facilities, the number of social events and company philosophy. Overall, RYM was the highest scoring operator as RYM villages provide a positive and interactive environment for residents. Contracts

ORA contracts for each operator are analysed on their annual and capped DMFs, and any capital gains sharing. Of all the operators, RYM has the lowest annual and capped DMFs at 4% for five years with a cap of 20%. Other operators’ capped DMFs range from 25-30%. Continuum of Care

This criterion is based on the ability of operators to provide a full range of facilities ranging from retirement living to aged care, in every one of its villages. Overall, RYM has the highest continuum of care, providing both retirement living and aged care in every village. No other major operator provides a continuum of care to this level.

Financial Analysis

Earnings

Care fees, management fees and their associated expenses are forecasted to grow in line with the growth of new beds and units. Fair value movement of investment property is calculated based on market prices of ORAs sold. Calculated underlying profit exceeds Ryman’s 15% growth target over the next two years.

Cash Flow

Capital expenditure of both aged care beds and retirement village units are expected to grow at the rate of inflation as Ryman can be reasonably assumed to have already exploited most of its economies of scale and specialisation to its full extent. Dividends are expected to remain at 50% of underlying profits as this has been RYM’s policy for at least the five years. RYM is expected to begin paying taxes in 2016 as their accumulated tax losses run out.

Balance Sheet

RYM currently has a lot of debt capacity with a low debt to debt and equity value (based on market value) of approximately 11%. It has indicated that it plans to only increase debt for the purpose of funding future builds and has traditionally taken a conservative approach to debt financing, seeking to minimise it where possible. Therefore we forecast that Ryman will hold their D/D+E ratio constant at 11% into the future.

Investment Summary

Investment Summary Our BUY recommendation is based on a target price of $2.99 as per calculated from our DCF valuation. This represents an upside of approximately 22% to RYM’s current price of $2.46. Our DDM valuation arrives at a value of $3.01. This is similar to the value derived from out DCF and provides additional support for our recommendation. We have put no weighting on our comparable companies analysis because each of the comparable companies have a very different mix of operating segments, thereby decreasing the credibility of the analysis.

Valuation DISCOUNTED CASH FLOWS

Our DCF valuation of RYM is based on a 40 year forecast of free cash flows with no terminal value. Because of the lumpy nature of cash flows from the retirement village side, a forecast of at least 20 to 30 years is necessary to create an accurate profile of the distribution of cash flows across years. No terminal value has been included as any cash flow 40 years out from now would be so heavily discounted as to have little or no impact on valuation. Cash flows are forecasted separately for the aged care and retirement village unit segments. For each of the rest home, hospital and dementia segments of aged care, care fees, expenses and capital expenditure are calculated individually.

Ryman Metlifecare Summerset Oceania

Reputation 4 3 2 3

Affordability 2 3 3 4

Location 3 4 1 3

Facilities 4 2 2 1

Atmosphere 4 3 3 3

Contracts 4 1 3 1

Continuum 4 2 2 3

Overall 4 3 2 3

$2.00 $2.50 $3.00 $3.50 $4.00

DCF

DDM

EV/EBITDA

Pessimistic $2.27 DCF Base $2.99

Optimistic $3.40

Pessimistic $2.26 DDM Base $3.01

Optimistic $4.21

Pessimistic $2.50

EV/EBITDA Base $3.15

Optimistic $3.79

Target price = $2.99



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Number of years

Departure dist. Mortality dist.

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Departure dist. Mortality dist.

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2006 2011 2016 2021

Figure 8. ALU Departure Distribution

Source: Statistics New Zealand, UoA estimates

Figure 9. ILU Departure Distribution

Source: Statistics New Zealand, UoA estimates

Figure 10. Projected ORA Prices (NZ$000)

Source: Real Estate Institute of NZ, UoA estimates

Likewise, new sales, resales and capital expenditure are forecasted separately for independent and assisted living units. New sales are calculated based on new builds and resales are determined using a departure profile of residents based on mortality rates of the New Zealand population. In regards to Australia, using an assumption of one new village to be built in the next five years, we derive a value of 6cps. Due to the highly uncertain nature of the Australian expansion, we have not included this value in our final valuation. However, we view the Australian expansion as presenting further potential upside to the share price that is, at present, difficult to quantify accurately.

Retirement Village Segment

Statistics New Zealand has projected the 75+ population to grow at a CAGR of 2.7% over the next 40 years. RYM’s RVU build rates are dependent on this projected age group as they represent RYM’s target market. RYM’s new builds will compose one third ALUs and two-thirds ILUs. This split is based on the current composition of ALUs and ILUs in RYM’s retirement villages as well as additional forecast information provided by RYM.

Volume of new ORA sales are solely dependent on the projected build rates. After new ORAs are sold, these units are then modelled as sales of existing ALUs and ILUs. To model the sales of existing ALUs and ILUs, each segment requires a resident departure distribution. We construct departure distributions based on the mortality distribution, the average age of entrants, the gender split and the average length of stay within each of the two segments. For ALUs, average age of entrants is assumed to be 83, gender split is based on the gender split of the current population of 83 year olds and the average length of stay is four years. For ILUs, average age of entrants is assumed to be 78, gender split is based on the gender split of the current population of 78 year olds and average length of stay is seven years. In order to derive the departure distribution, we centered the mortality distribution to the average length of stay for each of the two segments respectively. The departure distribution is then used to forecast the volume of resales. ORA prices are assumed to be strongly correlated with residential property prices. The average ALU price is calculated to be 60% of median house prices and the average ILU price is 110% of median house prices based on historical RYM ORA pricing. For the next five years, property prices are forecasted by Infometrics to grow at 2.3% per annum on average and we have assumed that property prices will grow at the rate of inflation of 3% per annum from 2016 onwards. Capital expenditure per ALU or ILU is a function of new ORA prices and the development margin. This method uses projected ORA prices and back-solves to calculate capex per unit using the midpoint of RYM’s target development margin of 20-25%, which RYM has historically always achieved. Based on information that RYM has provided, we assume that the operating activities of the retirement living segment breaks even with all service fees offset by operating expenses.

Aged Care Segment

The build rates for aged care beds is based on the ARCSR projections of demand and these are forecasted out to 2026. After this point, we have extrapolated the trend out to 2051 for our DCF model. The growth rate of demand for aged care is broadly in line with the 75+ population growth rate.

Weekly care fees are divided into rest home, hospital and dementia segments and comprise of the base weekly fee plus an average premium of $80 per bed that RYM is entitled to charge under government specifications. We then net GST out from the weekly care fees. Fees are projected to grow at the rate of inflation. EBITDA per bed is based on the assumption that RYM’s per bed EBITDA sits at the top-quartile of industry EBITDA and the respective figures for each care segment are taken from the ARCSR report. These are projected to grow at 3%. The occupancy rate of beds in mature RYM villages is 98%, a figure provided by RYM. We assume that the occupany rate of beds in new villages will increase on a straight line basis, reaching 90% occupancy after 12 months. Fees for the new beds are assumed to grow as a proportion of beds occupied however we have taken the conservative assumption that operating expenses will be charged at 90% of full occupany level in the first 12 months. RYM states that capital expenditure per bed is $100,000 on average. This figure is lower than that for most other competitors in the market due to its vertically integrated development model. We assume that all efficiencies from vertical integration have been utilised given that RYM has been in operation for over 24 years, therefore we forecast capex to grow at the rate of inflation, reflecting increases in wage and material prices.



Figure 12. EV/EBITDA (Aus Comps)

Source: CapitalIQ, ASX, Company reports

Source: CapitalIQ, NZX, Company reports

Figure 11. P/NTA (NZ Property Trusts)

Effect of imputation credits on tax

We forecast that RYM will start paying taxes in 2016 as its accumulated tax losses run out. Whilst this may impact on the overall profit line, it will not change the DCF valuation as RYM’s imputation credits will always offset its corporate taxes, leaving shareholders unaffected.

Cost of capital

We have used a WACC of 9.81% which is derived from the inputs shown on the left. A more detailed description of these inputs is presented in the appendices.

DIVIDEND DISCOUNT MODEL

We forecast that RYM will pay 50% of its underlying profit as dividends in accordance with its current dividend policy. 46% of the full year dividend is paid as an interim in December and the remainder is paid in June of each year. This is based on the historical percentage split. We then add the value of imputation credits to the final dividend, which do not occur until 2016 when we forecast RYM to begin paying corporate tax. The value of the dividend plus imputation credit is then discounted by the required return on equity of 10.53% to arrive at our DDM valuation of $3.01 per share.

COMPARABLE COMPANIES

We consider that Metlifecare is the only comparable retirement village operator in New Zealand for which information is publicly available. However, given its stark contrast in performance to RYM, we consider other companies more relevant. We have looked at P/NTA comparisons against New Zealand property trusts given the similar nature to RYM’s retirement living side. According to this metric RYM is currently trading at double its NTA, implying that the market attributes considerable value to RYM’s management. We agree with this sentiment and, along with our much higher valuation, disregard this as a means of comparison. We have found four Australian property conglomerates who have retirement village operations. We have segmented this division for the companies to be able to compare them on EV /EBITDA. The low multiple for Becton reveals that the other divisions and the company overall are making losses and hence we exclude them from the comparison. Stockland has no aged care operations and FKP has only three aged care facilities in Australia, while Lend Lease operates 32 aged care facilities comprising 2,370 beds, making it more comparable. On this basis we allocate double weighting to Lend Lease and reach an implied share price of $2.86. However, considering that RYM is driven by cash flows, we take the multiples valuation as only a check of our DCF share price of $2.99 and reiterate it as our target price.

RISKS TO PRICE TARGET

Competitor listing

It is important to consider the possibility that, given only two listed retirement village operators in New Zealand, some investors may purchase shares in RYM in order to gain exposure to the New Zealand retirement village industry, rather than RYM itself. Floats of other retirement village operators, such as Summerset which has already begun discussing the possibility, could dampen demand for RYM shares. However, given that RYM is a much better managed and highly reputable asset, we believe that any effect on RYM’s share price from a competitor listing will not be significant.

Global economic turmoil

Economic distress in other countries may dampen global investor risk appetites and cause declines in share markets around the world. This would affect RYM’s share price for reasons unrelated to its fundamental performance.

Property market

Cashflows related to RYM’s retirement village segment are correlated with property prices. If property prices are weak, this will depress the cash flows from new sales of ORAs, capital gains from resales of ORA as well as DMFs related to ORA prices. This should only pose a short term threat to share price, as in the long term, prices for property should trend upwards. In our analysis, we expect property prices to pick up over the next few years and to grow at 3% per annum. The obvious risk to our target price is that the property market remains depressed.

Input Value

β 0.90

Rf 5.92%

MRP 5.17%

Rd 5.70%

D/V & E/V 11.2% & 88.8%

0.0x

5.0x

10.0x

15.0x

20.0x

25.0x

SGP RYM FKP LLC

Avg EV/EBITDA = 17.2x15.9x

0.0x

0.5x

1.0x

1.5x

2.0x

2.5x

RYM PFI VHP GMT KIP ANO ARG CDI NPT DNZ KPF

Avg P/NTA =1.0x

2.2x



Australian Expansion The population of 65+ in Australia is five times the size of that in New Zealand and is projected to grow by 89% to 5 million between 2006 and 2026. The overall population growth rate during this period is expected to be only 27%. Currently, only a third of the retirement villages in Australia operate on a continuum of care model. These villages with aged care facilities attract an older demographic who stay for fewer years than villages which do not. As such, villages operating on a continuum of care model achieve higher margins on average and also have higher occupancy rates. The Grant Thornton Retirement Living report for Australia identified that one of the main factors hindering the exponential growth of the penetration rate of retirement homes in Australia is the lack of full continuum care villages.

Retirement Village Sector

There are around 1,850 retirement villages in Australia catering to 140,000 people. The sector is fragmented with over 600 operators and 70% of them operating only one retirement village. Non-for-profit operators control over 65% of the retirement villages in Australia but only 45% of total units in this sector. Corporate or independent for-profit operators tend to run larger scale villages in order to maximise cost efficiencies from size. Large for-profit operators in the industry include FKP Property Group, Lend Lease Primelife, Aevum and Becton. In recent years, retirement village operators have been affected by financial difficulties and as a result, there have been high volumes of M&A and restructuring activity in the sector. We foresee further consolidation in the next few years, with financially-stronger companies acquiring a number of weaker operators and bundling them up to achieve economies of scale. Acquisition of retirement village operators will be especially pronounced for companies in the property sector who can can utilising their expertise in property development to maximise development margins. In Australia, over 5% of the 65+ population live in retirement villages – a similar penetration rate to that of New Zealand. The Jones Lang LaSalle Retirement Living report shows that the Australia penetration rate could increase to more than 8% in the next 10-15 years given the strong population demographics and increasing acceptance of retirement living. This implies that 80 to 96 new villages will need to built per year in order to cater to the demand from the ageing population. Village units in Australia are predominantly leased to residents on a “loan-lease” basis, a concept similar to that of ORAs. Australian operators also charge DMFs as a proportion of the entry “loan” amount or the resale price on exit, capped at around 35% of resale price. Approximately 64% of villages share capital gains with residents on resale, while the remainder of the operators keep 100% of the resale gains.

Aged Care Sector

The Australia aged care sector is also fragmented. The majority of the operators in this sector are not-for-profit operators as commerical operators are deterred by the stringent regulations and low margins. There are, however, some for-profit players such as Lend Lease Primelife, Bupa, Regis Group and Principal Aged Care. The Australian government controls the expansion of aged care facilities by restricting bed numbers in the sector. They allow for the provision of only 113 operational hospital and dementia beds per 1,000 people in the 70+ population. Aged care operators apply for bed licences in the annual Aged Care Approvals Round and new licences are only given in areas where there is significant unmet demand. Existing bed licences sell at prices up to AUD$30,000 per bed. Due to government limits on bed licences, average occupancy rates remain high at 97% across the board. There are also strict entry regulations with all new rest home operators needing to meet government standards for facilities and quality of care in order to qualify for government funding under the Aged Care Act 1997. However, new entrants may be able to enter the market by acquiring an existing rest home for which regulatory requirements are lower. Fees which may be charged to residents of aged care facilities are complex and subject to regulation by the government. There are a number of fees that can be charged including basic daily care fees with the maximum set by the government, income-tested additional daily care fees, accomodation bonds, accomodation charges and extra service fees. Strict government regulations coupled with high skilled-labour costs result in low margins in the aged care sector. Such conditions are not conducive towards investment in expansion or replacement of care facilities. Therefore we expect to see more consolidation in the future as the not-for-profit operators sell their facilities due to difficulties in financing upgrades to meet government standards. The Australian government also has policy measures in place to encourage elderly residents to “age in place”. The government promotes on community aged care, flexible care and home-based care which are less costly than aged care facilities. Such government measures will reduce growth in demand for low-level aged care such as rest homes, but will increase the proportion of aged care residents that receive high-level care such as dementia or hospital care.

Fragmented industry

Consolidation trend increasing the efficiency of operators in the industry

Low margins and opportunities for scale leads to consolidation

Tight government regulations controls supply



In June 2011, the Productivity Commission released a review of the aged care sector in Australia, proposing reforms to improve the range and quality of elderly services. Key proposals include removing restrictions on the number of bed licences and increasing subsidies for the aged care sector. Such proposals will open up the sector to competition, allow operators to earn higher margins and incentivise greater investment in beds to increase the capacity in the industry.

Investment Risks Government policies

Policies encouraging “ageing in place” for the elderly population may reduce the demand for low-level aged care facilities such as rest homes. Whilst this is a potential risk for RYM’s cashflows, RYM’s continuum of care model minimises its exposure to the effects of these policies as most of its aged care residents are channeled from its retirement village units rather than entering directly from the community.

Australian expansion

As with any expansion into a new market, there are always considerable risks. The retirement village sector in Australia is experiencing considerable consolidation at present, increasing competition within the industry. At the same time, the government heavily regulates the aged care industry, restricting bed numbers and squeezing operators’ margins. However, we believe that these downside risks are bounded due to RYM’s proposed conservative village-by-village expansion.

Rising costs of skilled labour

Nursing shortages pose a risk to companies in the retirement industry as nursing fees compromise a large portion of operating expenses. However, we believe that RYM is less exposed to this risk than their competitors. RYM welcomes nursing students to start working for them while they are still studying and offer them on-going education programs after they graduate. As a result, RYM is able to foster a positive relationship with nurses well before they start their career, giving RYM a head-start in recruitment and placing them in a better position to face this possible labour shortage.

Insufficient government funding

In 2011, RYM received government subisidies of $40.8m representing around 50% of RYM’s revenues from its aged care segment. If the government reduces its subsidies, or if subsidies become unable to cover rising costs, then RYM’s cash flows may be impacted. However, a decline is government subsidies seems unlikely and the government has, in fact, recently increased its spending on dementia care by 9.2%. Furthermore, the fact that RYM is able to charge a premium on its aged care beds dampens the effect any decrease in subsidy would have on RYM’s cash flows.

Management risk

As indicated by a high price to NTA ratio, the market places a high value on RYM’s intangible assets - one of which is their strong management team. Though it could be argued that this presents an investment risk to RYM if an important member of the management team were to leave, we prefer to take the view that the capabilities of RYM’s management team do no rest with any one individual. The strategy and operation of the firm should be largely unaffected by the replacement of one or two management team members and we expect that the market will be aware of this.

Other Considerations

Capital gains tax

A capital gains tax has no direct implications for RYM’s cash flows or share price. RYM only ever sell the right to occupy a unit, not a physical unit itself. Thus as long as all of RYM’s villages remain as going concerns, increases in property value will remain unrealised and untaxed. However, the introduction of a capital gains tax may cause fluctuations in property prices which will impact RYM’s cash flows.

Tainui sell-down

On 18 July of this year, Tainui Group Holdings, a New Zealand fund, sold off the 12.5% RYM stake that it owned. Whilst this may suggest that Tainui believe RYM is over-priced, Tainui’s CEO made a statement to the press announcing that the reason is largely due to the need to reduce the fund’s debt levels in the short run. He further noted that RYM is a well-managed asset and would have held onto its stake if not for aforementioned reasons.

Shareholder mix

Unlike with most other companies, the majority, 54%, of RYM’s shareholders are retail investors. This means that the relationship which usually exists between companies and asset management firms, who may hold onto their shareholding of a struggling company out of goodwill, would be much weaker in the case of RYM. Furthermore, retail shareholders are usually less rational than institutional investors and tend to act on general perceptions of company brand and reputation. The combination of these two factors means that RYM share price is more likely to be driven by market reactions and more volatile than other comparable companies.

Possible reforms to increase supply of beds and subsidies



Sensitivity Analysis After conducting the DCF analysis of RYM, we tested how volatile the share price would be to the fluctuations of a few key drivers. Our results are shown in the appendix section “Sensitivity”. We conclude that the key driver affecting our valuation is the WACC. This indicates that the value of RYM’s share price is driven considerably by its future cash flows. Our scenario analysis of the optimistic and pessimistic cases concludes that our DCF range lies between $2.27 and $3.40. Details of the scenario assumptions can be found in the appendices.



APPENDICES

Glossary

Retirement Village: Two or more residential units providing services or facilities for people predominantly of retirement age. Some provide care facilities, are attached to rest homes or hospitals or offer houses with basic services. Retirement villages must be registered. RVU: Retirement Village Unit. All living units within a retirement village, including independent living units and assisted living units. ILU: Independent Living Unit. A RVU that provides the minimal care to the resident where additional care services can be arranged on a user pay basis. ALU: Assisted Living Unit. A RVU where personal care and household management services are provided to the residents, for example meals preparation, housekeeping or shower assistance

Aged Care Facility: A facility which caters to the health needs of the elderly such as rest homes, hospitals and dementia care.

Continuum of Care: Range of aged care services that are available to the retirement village resident. A full continuum of care includes rest home level care, hospital level care and dementia care.

ORA: Occupancy Right Agreement. A written agreement that gives a person the right to occupy a retirement village unit. The relevant terms and conditions must be clear and unambiguous.

Development Margin: Net profit as a percentage of total development costs.

Penetration Rate: Proportion of retirement village residents as a percentage of the population by age group.

OCR: Official Cash Rate. An interest rate controlled by the Reserve Bank of New Zealand. The OCR defines the rates at which registered banks are able to lend their excess reserves at the Reserve Bank to each other. ARCSR: Aged Residential Care Service Review. A review conducted by Grant Thorton of the New Zealand aged care sector. This review contained the largest ever financial survey of aged residential care providers in New Zealand.

Provision Ratio: (Australia) An indication of the available aged care places available as a proportion of the population usually per 1,000 people aged 70 years and over. Single Person Base Pension: (Australia) The base pension rate an eligible, single retiree receives in Australia (currently $670.90 per fortnight). Pension rates are adjusted bi-annually in March and September. Aged Care Approvals Round: (Australia) The annual process where retirement village operators apply to be allocated a portion of the government aged care license quota.



Management Team

Simon Challies (Managing Director). Simon joined RYM in 1999 as the CFO/Company Secretary. He is a qualified Chartered Accountant and was appointed CEO in 2006 then Managing Director in 2010. Gordon MacLeod (Chief Financial Officer). Prior to joining RYM in 2006, Gordon was a Corporate Finance Partner at PricewaterhouseCoopers and has considerable expertise in financial management. He was also the Finance Director of a LSE-listed hi-tech engineering company.

Barbara Reynen (Operations Manager). Barbara joined RYM in 1992. She is a registered nurse and also holds a Masters in Health Sciences.

Debbie Versey (Group Sales Manager). Debbie joined RYM in 1990. She oversees the sales and re-sales of ORAs for all RYM villages.

Taylor Allison (Design Manager). Taylor has over 30 years of design experience. Since joining RYM in 2000, he has designed 14 RYM villages.

Tom Brownrigg (Construction Manager). Tom joined the company in 2006. He is now responsible for the construction division of RYM and is an expert in construction of residential and commercial properties.

Andrew Mitchell (Development Manager). Andrew has a strong background in property management and development. He is responsible for site identification, acquisition, design management and development feasibility.

Philip Mealings (Property Manager and Purchasing Manager). Philip has been with RYM since 2000. He is responsible for procurement and property management of all villages.

Neil Prior (Marketing Manager). Neil has over 20 years of advertising and marketing experience. He is currently responsible for national marketing of all 24 villages.

Board of Directors

Dr. David Kerr (Chairman). David joined the Board in 1994 and has been the Chairman for 12 years. He is a distinguished General Practitioner and also an advisor to the Canterbury District Health Board. Kevin Hickman (Director). Kevin co-founded RYM in 1982 with John Ryder. He has strong management experience in sectors such as retail, telecommunications and manufacturing.

Sidney Ashton (Director). Sidney joined the Board in 1994. He is a Fellow of the New Zealand Institute of Chartered Accountants and the founding partner of Ashton Wheelans and Hegan, a Christchurch accounting practice.

Jo Appleyard (Director). Jo joined the Board in 2009. She is an experienced advocate, litigator and partner at Chapman Tripp. Her areas of expertise include employment, resource management and commercial law.

Warren Bell (Director). Warren is currently the chairman of Hallenstein Glasson and St Georges Hospital. He was previously an audit partner at Deloitte. Warren has considerable insight into Australian market with HGL.

Andrew Clements (Director). Andrew is the director of a number of NZX-listed companies including the New Zealand Refining Company and Revera. He is also the chairman of Orion Health, New Zealand Assets Management and Amadeus Asset Administration.

Simon Challies (Managing Director). Simon joined RYM in 1999 as the CFO. He is a qualified Chartered Accountant and was appointed CEO in 2006 then Managing Director in 2010.



Investment Summary

2011A 2012E 2013E 2014E 2015E

Revenue NZ$m 180 205 235 264 294

Growth % 18 14 15 12 11

EBITDA NZ$m 86 101 119 133 147

Margin % 48 49 51 50 50

FCF NZ$m 20.0 26.4 40.6 47.5 55.2

Reported Profit NZ$m 100 102 128 140 153

Profit NZ$m 72 85 102 115 128

Growth % 18 18 19 12 11

Underlying EPS cps 14.4 17.1 20.4 22.9 25.5

PER x 17.0 14.3 12.0 10.7 9.6

P/NTA x 2.2 2.0 1.7 1.6 1.4

DPS cps 7.2 8.5 10.2 11.5 12.8

Div Yield % 2.9 3.5 4.2 4.7 5.2

ROA % 7.5 7.1 7.8 7.5 7.4

ROE % 14.1 14.3 15.4 15.4 15.4

Source: NZX, IRESS

Note: All figures above are based on underlying revenues and profit with the exception being Reported Profit

CFA Institute Research Challenge

Competitor Profiles

Operator Villages Units/Beds Retirement village

Ryman 24 ~4,700

Oceania 59 ~4,400

Bupa 16 ~3,500

Metlifecare 16 ~2,900

Summerset 12 ~1,400

Vision 6 ~1,200

Primelife 5 ~1,000

Analysis of Competitors

Reputation Affordability

Ryman 4 2

Summerset 2 3

Metlifecare 3 3

Vision 2 3

Oceania 3 4

Primelife 2 1

Bupa 3 4

Oceania

Bupa Metlifecare Summerset Vision Primelife

Oceania

Oceania is the largest aged care operator in New Zealand, and also offers a full continuum of care from independent living units to dementia care. Oceania is owned by Macquarie Group.

Bupa

Formerly Guardian Health Care, the company was acquired by the British Health Fund in late 2007.Bupa’s retirement villagesranging from 16 homes to 101 homes, and also provides hospital, dementia, respite and day care services.

Metlifecare

Metlifecare entered into the New Zealand market in 1986 and villages across Auckland, Bay of Plenty, Manawatu, Wairarapa, Kapiti Coast and Nelson. Metlifecare is listed on the NZX and$250 million.

Summerset

Summerset is the third largest retirement village operator and second largest developer in the industry. In the past two years, Summerset has built 253 new units across New Zealand. There have been recent rumours of an IPOSummerset next year.

Vision

Vision provides only independent living units in their Island and one in Christchurch . The company has been rumoured to undergoing an IPO next year to fund their developments and has been valued at around $180 million.

Primelife

Primelife is a subsidiary of the ASX-listed Lend Lease Group. The company focuses only on retirement villages and has three villages in Auckland, one in the Hibiscus Coast, and one in Tauranga.

Retirement village Aged care centre Target age

� � 75+

� � 80+

� � 80+

� � 70+

� � 70+

� 65+

� 65+

Affordability Location Facil./Services Atmosphere Contracts

3 4 4 4

1 2 3 3

4 2 3 1

2 2 2 1

3 1 3 1

3 3 3 1

3 1 2 2

Oceania

Metlifecare Summerset

Primelife

21 September 2011


Oceania is the largest aged care operator in New Zealand, and also offers a full continuum of care from independent living units to dementia care. Oceania is

Formerly Guardian Health Care, the company was acquired by the British Bupa’s retirement villages are relatively small –

ging from 16 homes to 101 homes, and also provides hospital, dementia,

ntered into the New Zealand market in 1986 and currently has 16 villages across Auckland, Bay of Plenty, Manawatu, Wairarapa, Kapiti Coast

is listed on the NZX and has a market capitalisation of

hird largest retirement village operator and second largest developer in the industry. In the past two years, Summerset has built 253 new units across New Zealand. There have been recent rumours of an IPO for

Vision provides only independent living units in their five villages in the North tchurch . The company has been rumoured to be

an IPO next year to fund their developments and has been valued at

listed Lend Lease Group. The company retirement villages and has three villages in Auckland, one in

the Hibiscus Coast, and one in Tauranga.

Target class Ownership

Mid-High Listed on NZX

Low Private

Mid-High Private

Mid-High Listed on NZX

Low Private

Low Private

High Listed on ASX

Continuum Overall

4 4

2 2

2 3

1 2

3 3

1 2

3 3



Figure A. Affordability

Source: Eldernet, SeniorLine

Figure B. Reputation

Source: Company websites, NZ Herald

Figure C. Location

Source: Company websites

Figure D. Additional facilities


Figure E. Atmosphere


Figure F. Continuum of Care

Source: Company websites, Eldernet

Figure G. Contracts

Source: Company websites, Eldernet

0

100

200

300

400

500

RYM Summerset MET Vision Oceania Primelife Bupa

Average RVU Price Average Weekly Service Fees

RYM

Summerset

Metlifecare

VisionOceania

Primelife

Bupa

0

3

6

9

12

15

18


RYM

Summerset

MET

VisionOceania

Primelife

Bupa

0

1

2

3

4

5

6


RYM

Summerset

MET

VisionOceania

Primelife

Bupa

0%

5%

10%

15%

20%

25%

30%


Annual DMF Rate Capped DMF Rate

CFA Institute Research Challenge

Cost of Capital

Sensitivity

Input Value Basis

β 0.90 RYM’s monthly prices for last five years regressed against NZX50 since Sep 2006

Rf 5.92% Average monthly yield based on 10

MRP 5.17% PwC’s 77 years historical equity MRP

Rd 5.70% Based on interest on RYM's secured bank loans in the 2011 Annual Report

D/V & E/V 11.2% & 88.8% Current levels. No significant changes expected

Share Price

Optimistic Scenario

Pessimistic Scenario

Basis

RYM’s monthly prices for last five years regressed against NZX50 since Sep 2006

Average monthly yield based on 10-year govt. bonds for the last 10 years

PwC’s 77 years historical equity MRP

Based on interest on RYM's secured bank loans in the 2011 Annual Report

Current levels. No significant changes expected

Share Price Assumptions

$3.40 Number of builds (units and beds) at 110% Capex per care bed at $90,000 EBITDA per bed at 110%

$2.27 Number of builds (units and beds) 90% Three years of property stagnation Care expenses increase by 5% over the next four years

21 September 2011


RYM’s monthly prices for last five years regressed against NZX50 since Sep 2006

year govt. bonds for the last 10 years

Based on interest on RYM's secured bank loans in the 2011 Annual Report

Care expenses increase by 5% over the next four years



Income Statement (NZ$m)

2010A 2011A 2012E 2013E 2014E 2015E

Revenue

Care fees 90.5 105.8 126.0 141.0 160.4 180.8

Management fees 18.6 23.3 27.7 35.8 40.0 43.9

Other revenues 0.6 0.6 0.5 0.5 0.5 0.6

Operating revenue 109.7 129.7 154.3 177.4 200.9 225.3

Revaluation of investment properties

Realised fair value movement 42.7 50.2 50.9 57.8 63.1 69.0

Unrealised fair value movement 23.6 30.6 26.3 36.6 37.7 39.6

Total income 176.0 210.4 231.5 271.8 301.8 333.9

Operating expense (79.67) (93.63) (104.16) (116.12) (131.26) (147.20)

EBITDA 96.4 116.8 127.4 155.7 170.5 186.7

Depreciation (5.23) (6.09) (6.62) (7.17) (7.75) (8.36)

EBIT 91.1 110.7 120.7 148.5 162.8 178.4

Interest expense (6.13) (7.96) (8.98) (9.89) (10.49) (11.05)

NPBT 85.0 102.8 111.8 138.6 152.3 167.3

Tax expense (5.40) (2.60) (9.53) (10.72) (12.43) (14.14)

NPAT 79.6 100.2 102.2 127.9 139.9 153.2

Plus deferred tax movement for the year 5.4 2.6 9.5 10.7 12.4 14.1

Less unrealised fair value movement (23.60) (30.63) (26.35) (36.64) (37.73) (39.61)

Underlying profit 61.4 72.1 85.4 102.0 114.6 127.7



Balance Sheet (NZ$m)

2010A 2011A 2012E 2013E 2014E 2015E

Cash and cash equivalents 1.0 0.7 1.0 1.1 1.3 1.4

Property, plant and equipment 247.2 322.9 350.7 380.1 410.9 443.3

Investment properties 1035.2 1206.3 1361.3 1563.7 1775.9 2001.4

Other assets 45.9 79.5 80.7 90.8 100.4 110.6

Total assets 1329.3 1609.3 1793.7 2035.7 2288.5 2556.8

Debt 142.0 157.5 173.5 184.0 193.9 202.7

Occupancy advances 654.8 788.8 905.2 1034.0 1167.6 1307.0

Other liabilities 76.0 97.2 89.7 115.5 142.2 172.9

Total liabilities 872.8 1043.5 1168.4 1333.5 1503.7 1682.6

Shareholder's equity 456.5 565.8 625.4 702.3 784.8 874.2

Net tangible assets 456.5 565.8 625.4 702.3 784.8 874.2

Cash Flow (NZ$m)

2010A 2011A 2012E 2013E 2014E 2015E

Operating cash flow 149.4 133.1 164.8 184.0 196.4 210.3

Investing cash flow (119.4) (113.1) (137.7) (143.3) (148.9) (155.1)

FCF 30.1 20.0 27.0 40.6 47.5 55.2

Dividends (27.8) (34.0) (42.7) (51.0) (57.3) (63.9)

Change in debt (1.0) 15.5 16.0 10.5 10.0 8.8

Other investing/financing cash flows (1.6) (1.8) 0.0 0.0 0.0 0.0

Net cash flow (0.3) (0.3) 0.3 0.1 0.2 0.2



Disclosures:

Ownership and material conflicts of interest:

The author(s), or a member of their household, of this report does not hold a financial interest in the securities of this company. The author(s), or a member of their household, of this report does not know of the existence of any conflicts of interest that might bias the content or publication of this report. Receipt of compensation:

Compensation of the author(s) of this report is not based on investment banking revenue. Position as a officer or director:

The author(s), or a member of their household, does serves as an officer, director or advisory board member of the subject company. Market making:

The author(s) does act as a market maker in the subject company’s securities. Ratings guide:

Banks rate companies as either a BUY, HOLD or SELL. A BUY rating is given when the security is expected to deliver absolute returns of 15% or greater over the next twelve month period, and recommends that investors take a position above the security’s weight in the NZX50, or any other relevant index. A SELL rating is given when the security is expected to deliver negative returns over the next twelve months, while a HOLD rating implies flat returns over the next twelve months. Disclaimer:

The information set forth herein has been obtained or derived from sources generally available to the public and believed by the author(s) to be reliable, but the author(s) does not make any representation or warranty, express or implied, as to its accuracy or completeness. The information is not intended to be used as the basis of any investment decisions by any person or entity. This information does not constitute investment advice, nor is it an offer or a solicitation of an offer to buy or sell any security. This report should not be considered to be a recommendation by any individual affiliated with The University of Auckland, CFA Institute or the CFA Institute Research Challenge with regard to this company’s stock.

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