Although the sharemarket has been doing it tough of late, there's one sector that's managed to buck the trend, and in a big way: ASX-listed operators of aged care facilities and retirement villages have seen their shares climb ever higher over the past year, on expectations that an ageing population and meaningful consolidation opportunities will provide a significant, and long lasting, earnings windfall for the sector.
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The three biggest ASX-listed operators - Regis Healthcare (ASX: REG), Japara Healthcare (ASX: JHC) and Estia Health (ASX: EHE) - are all relatively new to the market, and have been thoroughly embraced by investors with shares rising between 20 to 40 per cent over the past 12 months.
For context, the benchmark All Ordinaries index has lost about 2 per cent over the same period.
Golden years boom
Investor enthusiasm is certainly understandable.
Declining fertility rates, increasing longevity and the demographic hump of the baby boomers mean that there will be a lot more of us in our golden years over the next few decades.
Over the past 20 years, the proportion of Australians aged 65 years and older has grown from 11.8 per cent to 14.7 per cent.
By 2040, that's expected to double to roughly 25 per cent.
That's a strong tailwind for the sector.
Further, the industry is quite fragmented which allows corporations to prosecute the ever-popular 'roll-up' strategy. Growth via aggregation unlocks some scale advantages -- better buying power for things like maintenance work and consumables, as well as the benefits of centralised back-office operations.
In general, it also means that, at least for a time, there is a type of arbitrage between what corporate dealmakers pay for earnings, versus what the market is prepared to value them at. For example, companies can buy an independent aged care centre for, say, 4 times pre-tax earnings. But because listed companies, especially fast growing ones, tend to trade at much greater earnings multiples, the acquisition can have a disproportionately positive impact on shareholder returns.
The downside
There are nonetheless good reasons for investors to be cautious. Unfortunately, acquisition strategies don't always work out as well as people usually expect. Integrating many separate businesses into a greater whole represents a significant challenge and there is real potential for a loss of focus on the front line.
Another problem is that expansion requires plenty of cash, which usually comes from debt or the pocket of shareholders. That's not automatically a problem, and for the current breed of aggregators that still have plenty of capital from their recent floats it's not yet an issue. But longer term it is something to watch.
Next, the earnings arbitrage can quickly disappear once acquisition opportunities start to fade. Without the potential to buy growth, and with little organic growth potential available, the market can quickly adjust the premium it is prepared to pay. The market giveth, and the market taketh away!
Finally, even though the potential for growth and aggregation is significant and valid, competition among the various players may well act to keep acquisition prices high. Again, when organic growth is limited, the price paid for acquisitions is vitally important. Pay too much, and the acquisition strategy can quickly unravel.
Foolish takeaway
The grey boom represents an exciting opportunity for those in the aged care and retirement accommodation sector. Strong tailwinds and meaningful market opportunity offer great potential to savvy operators like Japara, Regis and Estia.
The trouble is, there can be great risks investing in companies -- even good ones -- that are priced for perfection. Ironically, when most investors are convinced that an investment is attractive, it's often the worst time to buy in.
Of course, investors shouldn't shun an investment purely because it has had a good run of late. But it is vital to ensure that the price paid represents good value relative to future return potential. With regard to the key listed players, that's fast becoming increasingly less certain
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Andrew Page is a Motley Fool investment advisor. You can follow The Motley Fool on Twitter @TheMotleyFoolAu. The Motley Fool's purpose is to educate, amuse and enrich investors. This article contains general investment advice only (under AFSL 400691). Authorised by Bruce Jackson.
