Ryman Healthcare
a fundamental analysis
Symbol: RYM (New Zealand Stock Exchange)
Share Price: NZ$13,45
Market Cap: NZ$6,73 Billion
Price to Underlying Earnings: 27x
By Manuel Maurício
June 6, 2020
Short Thesis
I believe Ryman Healthcare to be one of those unique businesses that you find only so often in your lifetime. I am constantly looking for that beautiful compounder I can build a big stake on and own for a very long time as long as the story stays intact. I’ve found it before with China Maple Leaf, but unfortunately, I’m suspicious of it. I’m convinced that Ryman Healthcare is an even better business.
Ryman Healthcare builds and operates retirement villages in New Zealand and it’s rapidly expanding into Australia where people are queuing up for the opportunity to live in one of its villages. Ryman is growing at 13% year over year, it’s the undisputed leader in a fast growing industry that is about to grow even faster in the coming years, it has a World-Class management team, and most importantly of all, a culture of care that filters down to every single detail.
Due to a very peculiar business model and to its scale advantages, Ryman is able to charge less than its smaller competitors, get better locations, grow faster with very little equity, have a longer waiting list and benefit from the widespread public perception of being the best of the best in elderly care.
Although I still need more time to fully understand the quirkiness of its financials and the risks involved, I suspect I will soon be building a large stake on Ryman Healthcare. If you’re interested in knowing more, keep reading.
How I've heard about Ryman
Rob Vinal runs a highly concentrated fund of high-quality companies. One of those companies is Ryman Healthcare. I’ve heard him talk about it several times in the past but I never really got myself into studying it. Last week I was eating a delicious spider-crab with my friend Laurent Constanty, we were talking about several different companies and he mentioned one that got me interested. It’s called Summerset Retirement Villages and it’s the second largest retirement villages builder and operator in New Zealand. Ryman is the first. Every single thing I’ve read about the two companies leads me to believe that Ryman is the best one. I’ve figured that if I were to study a company on the other side of the world, I might as well start with the industry leader and then go down the quality ladder. Although I have yet to extensively research Summerset, it’s my understanding that both business models are identical.
Company
Ryman’s business is quite a clever one. The company builds retirement villages out in New Zealand (and Australia) for older citizens (+75 yo). You’ve got the single-family houses with the front lawn and the garage just like in any American suburb. At the centre of the village there are usually medium rise buildings that house not only serviced apartments but also amenities such as the cafeteria, hair salon, etc as well as the hospital and care center.
Ryman’s villages offer different types of accommodation: Independent Units > Serviced Apartments > Rest-Home Care > Hospital Care > Dementia Care. In the industry’s jargon, this is called the continuum of care. When you’re 75 years old and still independent, you will likely get a house or an apartment to live with your spouse. You will be able to live independently while enjoying the benefits of having a care center near your home and neighbors who are also retired so you can play bowls, New Zealand’s national sport for the elderly. The older you get, the more care you’ll need. Within the same Ryman village, you’ll be able to switch to a serviced apartment. If you need to go to a hospital, you’ve got one inside the village. When you become senil, there will be rooms for you with the proper care. It’s a win-win-win game. The old people get taken care of, their families can rest assure that their elderly are in good hands and the shareholders make money.
Here’s how it works. The company buys a plot of land (preferably within a urbanized area), develops and builds the villages – all of this with its own in-house teams – and then sells the houses or apartments to the retirees who will benefit from all the amenities for the rest of their lives. Actually, what the residents are paying for is not the house/apartment itself, but the right to live in the unit (to simplify things, I’ll be calling it a unit from now on). This is called an Occupancy Right Agreement or ORA (Remember this name. It’s the central-piece for the business model and I’ll be talking about it a lot). When the residents vacate their units (mostly because they go up the ladder on the continuum of care, or because they die), the company gets to resell those rights to a new resident, usually at a higher price (real estate tends to go up in value) and it is only when Ryman gets to “re-sell” the ORA that the previous resident (or her family) gets the money back. This is genius. Let’s pause here to appreciate the beauty of this business model.
The company is financed – interest free – by its residents. That initial sum of money paid by the residents is essentially Float. Float is money that the company holds, but that it doesn’t own. Float from the insurance companies is also how Warren Buffett became one of the wealthiest persons on the planet. He used the money that wasn’t his to buy other businesses. And just as in an insurance business, it’s virtually impossible for all the residents to vacate their units at the same time so the company doesn’t need to have all that Float available at all times. It can use it to grow. The more villages the company builds, the more float it has, the more villages it can build, and this goes on and on. It creates a flywheel effect that will lead to exponential gains.
The initial sale of the ORA is enough to pay for the whole development and construction of the villages (residences + communal areas + care facilities) plus a +20% margin called the development margin.
The average period of tenure is a little over 5 years. The average period of stay in the care facilities is 2,5 years. From the initial ORA amount (variable depending on the type of unit), the company will retain 4% annually for Management Fees capped at 20% (equal to 5 years). If you live there for 10 years, the company will only retain 20%. After you vacate the unit, you will get back the initial ORA amount less the Deferred Management Fee (DMF). Let’s say that the ORA has cost you $500K. At the end of the stay, and only after Ryman sells that unit again, you will get back $400K (500-20%=400). Ryman prides itself of the fact that the longest period of time it took to sell a unit was 6 months. This is one of the advantages or Ryman over its competitors. Someone looking for a retirement village, even if they end up dying there, will want to get their money back quickly.
When Ryman gets to sell that unit again after 5 years, it will usually sell it for a higher price, effectively gaining a Resale Margin which has historically been in the low 20’s. Not only that, but it will be able to charge a higher Management Fee in nominal terms ant it will have more float to grow. This loop will go on forever – stated that the housing prices don’t drop dramatically and stay there for long. The company is able to sell its real estate over and over again in perpetuity. It’s brilliant.
On top of this fee, there is also a Care-fee that is used to pay for the care services. This is a regulated market, the prices are set by the NZ Government and the more care you need, the more you pay. Although the care prices are capped, Ryman gets to earn more than the set price given that it has better facilities and more services than the standard requirements.
So to recapitulate, the company makes money in the following ways:
– Care-Fees
– Management Fee (caped at 20% of the ORA)
– Development Margin (20%-30%)
– Resale Margin (20%)
– Unrealised gains/ losses on property (not really a cash income). I’ll be talking about it later.
* The residents also pay a fixed weekly fee to cover for utility bills, communal activities, maintenance and other stuff, but I’m still not sure how this weekly-fee is accounted for on the Income Statement. I suspect it’s mixed with the Care-fees, but I am waiting to talk to Michelle from the Investors Relations department on the 15th of June to better understand it.
A fellow investor compared Ryman’s business model to a combo of 3 different business models. This is a real estate company that buys and develops property, a time-sharing company that manages and sells time slots on housing and an health-care company.
Because Ryman sells its units – or should I say the rights to its units – at a discount to the market price of the surrounding homes, it’s a very attractive proposition for the residents and their children.
And this is another beautiful aspect of this business model. When the residents decide to move to one of Ryman’s retirement villages, they sell their houses, freeing up capital. If their house was worth $1 Million and they move to a $800K unit, they will be left with $200K. The CEO mentioned that he had several new residents coming up to him on one of the village’s parties asking what they could do with the money. Most of them had paid for those houses with a mortgage over the span of their lifetimes. It was the first time in their lives that they had that amount of money available.
This discount to market prices, allows the company to weather some real estate price variations. If the housing price declines, Ryman can maintain their prices due to that buffer. Ryman has both the pricing power and the lowest cost, two great competitive advantages right there.
There is a lack of care-beds in New Zealand and these companies can’t actually charge more for them because the prices are set and paid by the Government, BUT, if you live in an Independent Unit within a Ryman village, you will get priority to its care-units. Although the company can’t raise prices for the care beds, it can raise the price of the ORA.
The company currently has 10.731 operating units in its villages and it has guided for 900 new ones in Fiscal 2020 (ended March 31, 2020). The plan is to get to an annual build rate of 1600 units. (More on this later)
Supply and Demand
The world population above 80 years old is now 143 Million. In 2050, it will triple to 426 Million. Because of the Baby Boomers, these numbers will be even higher for New Zealand and Australia as we can see from the image below. (VIC stands for the state of Victoria in Australia)
I believe Simon Challies, the former CEO, explains this demand dynamics better than I could.
“You could say that we have spent the past 18 years since we listed warming up for the main event – and it is about to begin. I’d like to explain why.
The clear majority of our residents were born in the 1920s and 1930s, in a period when the birth rate was declining post World War I and into the depression. We are entering a period where the birth rate starts to gradually climb before almost tripling at the height of the baby boom.
That’s why we’re starting to see an increase in demand for independent units, and we expect to see that demand starting to flow through to our serviced units and our care centres over the next two to three years. Our established care centres are already running at 97% occupancy, and we are going to need all the resources we can muster to cope with the demand ahead. “ Simon Challies, 2017 Annual Report
Management and Directors
Every quality investor dreams of finding a great management team to whom he could entrust his mother. Interestingly enough, Ryman’s motto is “it’s got to be good enough for mum“.
Ryman was created by Kevin Hickman (a police officer) and John Rider (an accountant) back in 1984 after Kevin was investigating a fire in an elderly rest-home. Kevin was so impacted by the bad conditions that he created Ryman.
After the long tenure as a CEO, Simon Challies stepped down in 2017 due to Parkinson’s disease, giving way for the then CFO, Gordon MacLeod, to become the new CEO. On his last speech as CEO, Simon said something I enjoyed hearing. The company tries to build its managers from within the ranks. This way the culture lives on.
Watching the latest webcast, you can sense there is a feeling of camaraderie among these guys. You’ve got David, the young cheeky CFO on the left, “Gordy”, the competent leader and CEO (on the centre) and David, the serious Chairman (on the right) playing his role with some distance, but very warm nonetheless. The mood is light and even the way they treat the analysts that are questioning them has a warmth to it. If you ever consider investing in Ryman, I strongly suggest you to watch the video. You can find it HERE.
I believe these guys are completely committed to delivering the best quality services they can. On the 2019 webcast there was an analyst who asked about the levers they could pull if the property market tightens so they could attract more people. Gordy’s response was all that an investor would like to hear. He didn’t mention sales techniques such as discounts or promotions (like his competitors are doing). He talked about excellence of service. Rob Vinal had already mentioned this in one of his letters, but after spending some hours watching these guys, I have no doubt it’s people like these that I want running my companies.
“We are the long term owners of our villages”, Dr. David Kerr, Chairman
myRyman Life
I wish to talk about the myRyman Life just as an example of the initiatives that put Ryman at the top of the industry. myRyman Life is an electronic care app that helps the caregivers with their tasks. They can now record the specific needs of each individual they’re taking care of so when they go into a room to give medication to an old lady or a bath to a senior gentleman, they don’t need to “go downstairs” and pick up his or her file to know what to do. They just need to pick up their phones and they’ll have all the information they need right away. You don’t see this kind of innovation in your traditional retirement home.
The myRyman Life has only been used internally so far, but the management doesn’t exclude the possibility to license it to its competitors. This could be huge. They could effectively grow a Software-as-a-Service business as well.
Landbank
The more villages and units the company has, the more cash it generates. That’s why the development team is constantly buying and developing new villages. The company now operates 36 villages and has 22 villages in the LandBank.
As I’ve mentioned earlier, the company currently had 10.731 units at the end of September 2019. Gordy has said that by year end (March, 31) they would have 900 new units. But the plan is to raise that build rate to 1600 units per year, about half in each country. For that, they reckon that they must have a Land Bank of around 4 years, or 6400 units. As we can see from the image above, for the past 4 years or so they’ve been agressively building their landbank and they expect it to flow through to earnings in the coming years.
Australia
The company has recently entered the Australian market through Melbourne, which will soon become the largest Australian city and they’ve had huge success. Australians are not used to these villages. The management says that they’ve sold the units in Australia faster than they’ve ever sold them in NZ. If the opportunity in New Zealand is big, in Australia it’s even bigger, not only due to a larger population but also to the much inferior quality of the competitors.
They currently have 2 working villages “Nellie Melba” and “Weary Dunlop” in Australia, 1 in construction and 8 more planned. These guys are going all in.
“They like our apartments, they like our terms, they like the reassurance of having the care on the same site, and that’s rare in Australia, and quite a few residents told me on that night that they had looked all around the area and they could not find anything like Nellie Melba. For them it was very special.” Ryman’s CEO, “Gordy” MacLeoud
Financials
It’s not easy to understand Ryman’s financials. I must warn the readers who are less interested in the numbers that you may want to skip this part. For the geeks among you, this is pretty interesting.
Several accounting methods make it difficult for investors to gauge the company’s real profitability or even the value of its assets. For instance, the ORA isn’t accounted for as Revenue on the Income Statement. It’s recognized as an amount that the company owes to its residents, so it goes into the balance sheet as a liability.
On top of that, every time the company revalues a village (every 6 months), it has to recognize that change of value on the Income Statement, even if no cash was lost or earned. These and other quirks make the Income Statement of limited use – at least from the traditional perspective.
The industry chose the Underlying Profit as the best metric to understand how the business is doing. The Underlying Profit excludes the Unrealised Gains (or losses) on investment properties.
Since the profits are generated by the assets (unlike, for instance, a software or a consulting company), the profits tend to track the assets on the balance sheet, so the growth in assets is one of the key drivers of growth for Ryman.
The usual way a company carries real estate on its balance sheet is by stating it at cost and then it depreciates its value on a straight line basis throughout its useful life. Sometimes this creates what is called in investing jargon Hidden Assets. These are assets that the company has owned for so long that the accounting methods aren’t able to properly harness their current market value. This doesn’t happen with Ryman. Every 6 months, an independent appraiser (CBRE) values the company’s assets taking into consideration the future cash flows than can be generated by those properties and an estimated future inflation rate for the housing prices.
This way of accounting lends even more complexity to the financials. I’ve seen several investors complaining about looking at these companies on a Price-to-Book basis because having assets on the balance sheet that are valued based on estimations of future value rather than on historical cost can be tricky. If you estimate an inflation rate 1% higher, you will get a materially different value for the same asset. I believe that might be a reasonable concern. On the other hand, the traditional accounting methods aren’t perfect either. Anyways, this is just food for thought for the geek investors amongst you and it’s not an impediment to fully appreciate the business model. It might be, perhaps, a source of risk and I’ll be looking into this in greater detail going forward.
The debt on the balance sheet is there just to get a new village up and running and it will be paid by the resident’s ORA even before the construction ends so it’s not actually needed on the regular business. It’s only needed to build more villages.
On a typical retirement-home there is usually a large amount of debt used to pay for the construction of the building. The same happens here. The difference is that on the typical retirement-home you will need the cash flows from the care services to pay for the interest every year and to eventually repay the principal on the debt. That takes time, limits the growth capacity and adds risk to the business.
Here, after just a couple of years, the residents hand Ryman the money to pay down the debt, substituting themselves to the lenders. But the company will never pay interest on this new “debt” nor will it to pay down the principal. The new residents will be responsible for that when they pay their new ORA’s which are typically more expensive than the old ones, creating the possibility for Ryman to earn money every time it refinances this “debt”. This way, the risk of refinancing is minimal given that the company will only repay the ORA AFTER it resells the unit. Yes, if the housing prices come down, the company might face some issues.
The financial debt has been increasing, not only on an absolute basis but also on a relative basis to the equity. Usually this is something I don’t like to see, but at 66% of the total equity, we’re still very far from the debt levels of a typical real-estate company or even a regular western retirement-home developer whose weaker business model forces it to maintain debt-to-equity ratios well over 100% to sustain the business. That doesn’t happen with Ryman. Nonetheless, I am keen on comparing this to the competition.
All of these accounting rules make this business very tax efficient. The company pays virtually no tax.
Another intriguing thing that I have yet to understand is the fact that there is no cash on the balance sheet. I’m sure that the company has cash on the bank, but this is accounted for in a different way. Another good question to ask the IR department.
Dividends
If there is one thing I don’t like in this company is its dividend policy of returning 50% of the underlying profit to the shareholders in the form of dividends. This is quite common in NZ and Australia, even for growth companies. I guess I will have to get used to it.
Price Ratios
As we’ve seen previously, the Earnings in the Price-to-Earnings ratio should be the Underlying Earnings, not the Net Income. At a PE of 27x, we can’t say that this company is cheap by any standard value metrics.
On a Price-to-Book, the same could be said (even more so when this is messed up by the constant revaluations).
So, investors looking to put money into Ryman, shouldn’t expect to benefit from the multiple expansion, but only from growth of assets or underlying profit alone. The underlying profit has grown at 16%, 14% and 13% annually for the past 10, 5 and 3 years respectively. The management is aiming for a 15% annual growth rate for the foreseeable future. Let’s say that for the next 10 years the company is able to grow at this rate and reach NZ$1 billion in underlying profit in 2030. Even if the PE ratio comes down to the long-term market average of 16x (unlikely for such a defensive business growing at 15%), we would be talking about a 9% annual return.
Is a 15% annual growth rate achievable? It’s highly likely. I confess I have yet to think hard about the needs for capital and debt to achieve such growth rates and figure out what the balance sheet would look like by then, so the math stated on the table above should be taken with a grain of salt for the time being.
BUT, the reinvestment returns created by this business model are so good and the opportunity to redeploy those returns is so large that as long as the management executes, the most likely path going forward is up.
Conclusion
Every investor I talk to says that Ryman is the best retirement village operator in New Zealand and much of this status comes from its culture. Unfortunately I haven’t yet reached the stage where I can just catch the next flight to New Zealand to see it for myself. I will someday. For now, in what regards to those intangible advantages, I can only rely on other people’s opinions.
I’m not sure if it was Warren Buffet or Charlie Munger who said that “what you want is a business that can produce high returns on invested capital while being able to keep reinvesting those returns at attractive rates“. That’s a very difficult business to find. I believe Ryman is such a business. In fact, the only thing I’m not liking in this business so far is the dividend.
So the question you might be asking right now is “You’ve started this analysis by saying that you had probably found a great compounder to own for the long-term, you’ve presented a good case, but you’re not buying it. Why?“. There is no doubt in my mind that I have found something unique. Picture a cartoon where a blind man bumps into a friendly dinosaur. He touches it, feels it, smells it, he spreads his arms wide open and figures he is standing next to something big. He takes two steps to the right, figures the thing is still there, 4 steps to the left, still something there. He knows the thing is big. But if you ask him how big it is, he’s still not able to tell you. He needs more walking and more touching before he can answer with certainty.
I feel I have bumped into a dinosaur. I’ve gathered all the financial data on Ryman, I’ve watched their webcasts, read the reports, I’ve reached out to fellow investors who have researched it extensively, I have gathered data on the competition, newspaper articles, even negative views about the model, but I have yet to grasp all of it before I can explain everything clearly. Even more importantly, I have to fully understand the risks involved.
I will continue to study Ryman and the industry for at least the next week. The Full Year results will come out on Friday the 12th and I will be talking to Michelle from the IR department on Monday the 15th.
In the meantime, here’s a video of the launch of the new Ryman uniforms designed by Annah Stretton which I believe illustrates the type of culture I’m talking about.
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