THE FIELD SPLITS

SEPTEMBER 2016

ASX Listed Aged Care Company Performance.

INTRODUCTION

The past year’s volatile activity has provided a fascinating insight into the divergent pedigree and investment strategies of the listed aged care groups. This report provides an analysis of the activities of the listed aged care providers within an emerging consumer driven market.

THE FOLLOWING PROVIDES A SUMMARY AND HIGH LEVEL ANALYSIS OF THE YEAR END 30 JUNE 2016 RESULTS:

FINANCIAL RESULTS

Facilities FY16 (No.)

Facilities FY15 (No.)

Operational Beds FY16 (No.)

Operational Beds FY15 (No.)

Occupancy FY16 (%)

Occupancy FY15 (%)

Market Capitalisation ($ millions)

REGIS ESTIA JAPARA

54 69 43

47 48 39

5,880 5,842 3,717

5,049 4,010 3,207

95.2% 94.3% 94.4%

94.4% 93.6% 94.8%

1,334 593 538

PROFIT & LOSS

EBITDA Reported ($ millions)

EBITDA Normalised Margin FY16 (%)

EBITDA Normalised Margin FY15 (%)

Profit Before Tax FY16 ($ millions)

Basic EPS FY16 (cents)

93.0 66.6 56.1

19% 21% 17%

20% 22% 18%

69.4 46.6 41.8

15.3 15.1 11.5

BALANCE SHEET

Net Current Assets1 ($ millions)

Net Assets ($ millions)

Cash at Bank ($ millions)

-111.8 -116.1 -47.5

174.4 591.7 532.3

25.3 29.8 24.6

External Debt ($ millions)

RAD Liability ($ millions)

210.0 253.5 59.5

808.0 652.6 383.5

EBITDA Normalised ($ millions) 105.1 92.7 56.1

Bed Places (intangible assets)

Goodwill

205.2 214.9 204.8

190.0 715.3 260.8

1 Excludes RAD Liability

Source: Annual Financial Reports and Investor Presentations

Earnings before Interest, Tax, Depreciation and Amortisation (EBITDA) indicate that the listed company performance is still behind the national top quartile performance based on the Aged Care Financing Authority (ACFA) data. Regis’ average EBTIDA per bed has improved and Japara’s results remain steady. Estia’s performance has declined, which reflects their active acquisition year and possible inefficiencies resulting during the transition of the acquired facilities.

2.

EBITDA PER BED PER ANNUM

25,000

20,000

15,000

10,000

5,000

-REGIS ESTIA JAPARA ACFA TOP

QUARTILE**

EBITDA per bed FY15* EBITDA per bed FY16*

* Based on Normalised EBITDA results and weighted annual bed numbers

** ACFA “Fourth Report on the Funding and Financing of the Aged Care Industry” reflecting National 2015 Results

Full year revenues are presented below (excluding other income items). Government funding, which primarily represents revenue from the Aged Care Funding Instrument (ACFI), and resident fees remain relatively comparable between entities. In the past year, the listed companies have introduced an asset replacement or capital refurbishment fee, as well as “club fees” for additional services and amenities.

There are other providers who have introduced or are proposing to introduce similar fees, however the Department recently released a statement advising providers of their concerns regarding some additional service charges, particularly capital refurbishment fees. The listed company share prices have dropped subsequent to this announcement.

FY2016 REVENUE BREAKDOWN

OPERATIONAL PERFORMANCE

Resident Fees

Government Funding

REGIS ESTIA JAPARA

30% 26% 28%

70% 74% 72%

3.

There has been a significant shift in resident payment preferences over the past year. The payment preferences of the listed companies still vary from national averages, however, there has been a substantial downward movement in incoming residents electing to pay a RAD, with only 51% of Regis’ incoming residents electing to pay a RAD compared to 69% in FY2015; 76% of Estia’s incoming residents elected to pay a RAD compared to 86% in FY2015; and 59% of Japara’s incoming residents electing to pay a RAD, compared to 65% in FY2015.

As a core source of development funding, changing resident preferences towards the payment of refundable deposits will need to be carefully monitored. The cash flow implications will be material as the benefits of “high care” RADs are fully realised under Living Longer, Living Better legislative reforms.

INCOMING RESIDENT PAYMENT PREFERENCE AT 30 JUNE 2016

RAD DAP Combination

REGIS39%

10%

51% JAPARA

59%22%

19%

ESTIA

76%

11%

13%

ACFA 40%

35%

25%

Whilst positive financial results have been achieved by the listed companies, share prices have declined over the period, and Estia’s share price plummeted further since the release of their FY2016 results. Estia’s share price has been in the decline for some months in response to budget cuts to aged care funding and major shareholder sell-outs.

The Government announced changes to residential care funding arrangements in the 2015 Mid-Year Economic and Fiscal Outlook (MYEFO) and in the 2016-17 Budget. The announced ACFI measures were estimated to reduce budgeted expenditure on residential care by a combined $2 billion (including DVA cuts) over the forward estimates.

Ansell Strategic performed a more detailed analysis of the implication funding cuts would have on older Australians in care and the organisations who care for them. The report was undertaken with support from UnitingCare, Catholic Health Australia and Aged & Community Services Australia.

Over 500 homes were surveyed, representing nearly 40,000 places – approximately 20% of aged care places in Australia. Further details of the report can be found here.

While Estia was quick to reassure investors about the impacts of the cuts, their share price was impacted when principal investor, Quadrant Capital, divested its interest, shortly after the Budget 2016 announcements. Estia Founder, Peter Arvanitis, also divested his interest in the company just days after the organisation released their FY16 results.

INVESTOR SENTIMENT

4.

1

2

3

4

1

2

03/05/16 - Budget 2016/17 released

07/05/16 – Quadrant divests interest

3

4

29/08/16 – Estia FY16 Results released

31/08/16 – Founder, Peter Arvanitis divests interest

SHARE PRICE TREND

Estia has grown at a record pace in a bid to achieve its goal of operating 10,000 beds by 2020. Much of the Group’s value is underpinned by these aggressive targets and attaining Estia’s objective will become more challenging as the focus moves from rapid acquisitions to organic growth through brownfield and greenfield developments.

While Regis and Japara have grown their portfolio through a mix of acquisitions and organic growth, Estia was created through the amalgamation of mid-sized and smaller providers and has continued to grow through acquisitions since listing in 2014.

In Estia’s presentation on its 2016 results, the Group indicated that the opportunities for future acquisitions will be limited and its focus would now shift to greenfield and brownfield developments to achieve growth targets.

However, Estia may be hamstrung in its efforts to catch up as the race changes direction. The following provides our insights in to the challenges associated with this new strategy.

GREENFIELD DEVELOPMENTAs outlined in our previous report, the roll out of the Federal Government’s reform agenda is having a major impact on the aged care market. The recent budget funding cuts represent part of an overall shift of responsibility for care costs away from the taxpayer to the consumer. Combined with the deregulation of pricing and supply constraints, the market is becoming more consumer driven with expectations of high quality accommodation.

Estia’s planned shift towards investment in new sites is appropriate given these changes. However, its capacity to deliver on this objective is constrained by the small number of Commonwealth approvals granted for new places and a very shallow development pipeline.

ESTIA’S CHALLENGE

2015 ACAR Place Allocated

Development pipeline (net new beds)

1200

1000

800

600

400

200

0REGIS JAPARA ESTIA

DEVELOPMENT PIPELINE

5.

In contrast, Regis and Japara have well-established capital development strategies, with building development approvals and licences held for the majority of planned developments.

REFURBISHMENT OF EXISTING HOMESThe change in consumer expectations also creates an impetus for Estia to rejuvenate its portfolio. Within the Group’s acquired portfolios are a number of modern homes, however, many are dated. Some of these older homes can be refurbished while others will need to be sustanially redeveloped.

The positive news for Estia is that many of the services are in good locations around major population centres. The bad news is that they have paid very high prices for these assets, often more than it costs to build new homes. Because their redevelopment or replacement means that beds would need to be taken off line, resident deposits (RADs) will need to be refunded before investment in new beds would commence, reducing revenue streams from occupied beds.

With growing completion and limited revenue streams, this becomes a very expensive exercise. It will be compounded by the fact that Estia is heavily dependent upon resident deposits and bank borrowings to fund its growth strategies.

FINANCING GROWTHAt the beginning of the 2015/16 financial year, Estia entered into bank financing agreements which made available $300 million to fund acquisition and developments (an additional working capital facility was also established). Although reported bank borrowings on 30 June 2016 was $252.5 million, a deferred acquisition instalment for the Kennedy Group was paid on 1 July 2016, bringing total bank debt to around $289 million.

This balance exhausts the majority of the capital facilities available to Estia at 30 June 2016 and there is another $48 million in “deferred consideration” still to be paid to the Kennedy Group.

On top of this, Estia has also resolved to pay a final dividends of $24 million in November 2016, as well as making provision of around $90 million for the redevelopment of the older Kennedy Group homes.

The Group’s acquisition strategy has resulted in a heavy accumulation of intangible assets (mainly business goodwill and operating bed licences on acquisition). At 30 June 2016, this sum had amassed to $934 million and the company had a negative Net Tangible Asset position of around $342 million.

Under these circumstances, it seems unlikely that Estia will be in a position to expand at historic rates through acquisitions or organic growth.

6.

We believe there will be acquisition opportunities arising in the current financial year and we are currently assisting operators with their divestment strategies. However, we do expect that fewer opportunities are likely to present in the coming years and the focus for the listed providers will be on capital development and redevelopments.

Our future publications will monitor the development progress against these growth targets.

MOVING FORWARD

The next “In a Nutshell” publication will focus on additional charges, including the type of charges and the validity of these charges in the context of the Aged Care Act.

NEXT EDITION

About “In a Nutshell”To help busy executives in a rapidly changing

aged care world, Ansell Strategic provides summaries and high level commentary on

new developments in the industry. Detailed reports are provided on our website at

www.ansellstrategic.com.au

FOR FURTHER INFORMATION, PLEASE CONTACT:

CAM ANSELL Managing Director+61 8 9468 7520cam@ansellstrategic.com.au

AMBER CARTWRIGHT Senior Finance Consultant+61 8 9468 7527amber@ansellstrategic.com.au

ANSELLSTRATEGIC.COM.AU