For our Livewire Christmas Cracker, we discuss why we have shorted a number of Aged Care stocks. Firstly, because of the upcoming Royal Commission. and secondly, the risk to incoming bed pricing and the associated RAD flows due to the slowdown in the housing market.
The potential impacts from the upcoming royal commission
Royal Commissions are never good news for any industry. When announcing the Royal Commission, the Prime Minister warned that Australians should brace themselves for some “difficult stories”.
There is no way to know whether any of the listed Aged Care providers will be involved in these “difficult stories”. Nevertheless, the newsflow and the ultimate findings of the Commission will be a negative for the sector.
From the various media reports we have seen so far, it is fairly clear that increases in staff levels will go a long way to improving the outcomes for residents in Aged Care. Critically, this will need to occur in terms of both the number and qualifications of Aged Care workers.
We believe that the Royal Commission is likely to recommend minimum staffing levels and required minimum qualifications for the sector, in a very similar way to the Childcare sector. In Childcare centres there are minimum staff requirements based on the age of the children in the centre, and qualified teachers are required as part of the staffing mix.
A similar approach makes sense in the Aged Care sector. We believe that Government will be attracted to this, as currently there is an incentive for Aged Care facilities to rank incoming residents as needing the highest care in order to maximise Government payments, however, there is no requirement to match staffing levels to this. Therefore, a system where there is a direct link between staffing levels and the required levels of qualifications based on patient needs will clearly benefit residents and better target Government funding.
With staff being by far and away the largest expense in these businesses, any change will negatively impact margins. Then there is the issue of exactly where these extra staff will come from. Nurses in Aged Care earn around one third less that nurses in the Hospital system, and it is difficult and demanding work. Therefore, attracting nurses will likely require increases in base salaries across the industry, further impacting margins.
We also believe that the accreditation system will be a focus. As it stands now, the vast majority of facilities achieve a 100% score in large part because the reviews are scheduled and facilities have ample time to “get their house in order”. As such, there is no information content arising from the accreditation system for families deciding whether an Aged Care facility is right for them.
Once again, the Childcare sector has a sensible approach in the National Quality Framework which ranks centres across seven criteria as either exceeding, meeting, or working towards. This provides families with an easy method to compare one Childcare centre against another.
However, for the Aged Care providers it would foster increased transparency, which would likely see poorer facilities occupancy decline and a general increase in capex/opex across the industry to improve the ranking of facilities.
There is also likely to be some softening in occupancy levels during the Royal Commission hearings, as the telling of the “difficult stories” at the margin sees some families rethink their arrangements, or delay the decision to move a family member into Aged Care.
Effects of the slowdown in housing market
The second reason we have shorted the Aged Care stocks is the negative implications to RAD flows (Refundable Accommodation Deposit) arising from the slowdown in the housing market.
At the end of the day incoming bed prices are a function of the housing market, and with falls in house prices and critically the time it takes to sell, this will pressure incoming bed pricing. This, in turn, feeds into RAD inflows that are a critical funding source for the Aged Care providers.
What to expect
We acknowledge that the listed players have strong development pipelines, and valuation multiples of the Aged Care stocks have come down since the announcement of the Royal Commission from a PE of around 18-20x to 12-14x and at face value the sector may look attractive.
That said we are yet to see the earnings impacts that will be associated with the Royal Commission, let alone the negative newsflow that will be associated with the Commission’s hearings, and we are therefore maintaining our short position.
The industry shake-up is likely to be material, which over the longer-term provides opportunities for the listed players. However, a lot of pain will be felt between now and then.
More about Monash
Monash Investors Limited Monash Investors aims to achieve their objectives by investing in a small number of compelling stocks that offer considerable upside, and by shorting expensive stocks that are at risk of falling. Find out more here
Fair enough, the issues you raise as the base case for a short position are solid..but concentrate only on the ‘liabilities’ side of the Balance Sheet. The article should be balanced by recognising a few industry plusses. Firstly, short the government coffers as well...for they have a massive financial responsibility here...and their very own RC will be scathing of recent policy, funding restrictions and a Canberra centric bureaucracy which would struggle to understand the commercialities of running a school sausage sizzle fund raiser. The government will be forced to meet a goodly portion of the cost explosions. Secondly, higher and more costly standards will really favour the large operators. A fragmented industry will be consolidated and small marginal players will be exited. Thirdly, don’t overlook technology in reducing costs. Ryman Healthcare has made huge strides here. The Google AI suite of products will come to the fore over the next 5 years.