Development on time, on budget; de-risking FY18
We toured Aveo Group's (AOG) major retirement development projects in SEQ which are all key to earnings and ROA upside in coming years. All project stages are clearly on time, on budget and pre-sales are flowing through in line with expectations. The fact that the build-out of these development projects is significantly progressed de-risks our FY18 development earnings forecast. With confidence in the product and timing of delivery, AOG's execution now becomes key as the company ramps up its delivery of development units from 336 in FY17 to 500 in FY18.
Freedom to kick in from FY18 and more materially thereafter
The conversion of Serviced Apartments in AOG's existing portfolio to the Freedom contract/model provides a material earnings opportunity in coming years and the company is seeing success in the early rollout stage. AOG is currently converting Serviced Apartments across 10 villages (c500 units). This will have a two-fold earnings benefit (one-off profit on a higher average sales price + an enduring earnings uplift once these contracts start rolling, e.g. higher percentage Deferred Management Fee on a higher average sales price). The turnover of Serviced Apartments is higher given the average length of stay of 4 years (vs Independent Living Units at c10 years). Over and above this initial conversion phase, AOG has a further 1,800 Serviced Apartments in its existing portfolio which can be converted to this model in time. This would provide a significant earnings/valuation tailwind over the medium-long term should the returns continue to stack up (likely in our view) and residents continue to embrace the contract.
NTA/EPS growth trajectory will continue – risk to the upside
We continue to see meaningful upside to AOG's NTA in coming years, not from tweaking inputs, but rather from the following:
- increased penetration of the Aveo Way contract through Independent Living Units (35% Deferred Management Fee; 100% capital gain);
- conversion of Serviced Apartments to the Freedom contract (as explained above); and
- increasing development earnings (to 500 deliveries in FY18).
There is also additional upside on offer should AOG choose to lower the discount rates associated with the RVG and Freedom cash flows (13.75% and 14.5%, respectively vs AOG's average rate of 12.5%) as vacancy rates improve; and as RVG product is converted from freehold to leasehold. AOG's current EPS guidance is 7.6% for FY17 and 7.5% for FY18. We believe earnings risk remains firmly to the upside.
Our clear preference in the sector
We have maintained our forecast for FY17 and increased our forecasts by 2.3% in FY18 and by 14% in FY19. FY19 sees more material upgrades relating to more confidence in the earnings kicker from the Freedom conversions. The key downside risks are a fall in residential property prices and failure to meet development sales targets.
Aveo Group is, in our view, the place to be in the retirement/aged care sector. We maintain our Add recommendation.
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Disclaimer(s): Morgans Corporate Limited was a Joint Lead Manager to the Aveo Group share placement and received fees in this regard.
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