Singapore Healthcare REITs: Defensive assets warrant value premium

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REITs

By Peggy Mak • 22 Sep 2024

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We find out if healthcare REITs are worth revisiting following IHH's recent purchase of Island Hospital.

singapore healthcare reits parkway life vs first reit

In this article

Summary

IHH is acquiring a 296-bed Island Hospital in Penang for RM3.92bn. The hospital is a leading medical tourism focused private hospital in Malaysia, with a 33% share of foreign patients. The hospital has room to expand to 600 beds. The transaction values Island Hospital at 5.9x P/B, 39.7x annualised PE and 24.6x EV/EBITDA for FY24.
Healthcare stocks deserve to trade at premium earnings multiples. Unlike other asset class, hospitals are critical infrastructure to provide an essential social goods. It takes high capital investments to draw skilful doctors and medical specialists, and several years to achieve operating leverage and a strong franchise. Well-run hospitals thus command a scarcity value, underscored by an ageing population and increased life expectancy.
ParkwayLife REIT has always traded at premium to book value. The current valuation at 1.7x price to book and 3.7% FY24 annualised distribution yield is pricing in: 1) a 24% rent uplift in FY26 when the AEI work at Mount Elizabeth Hospital is completed; 2) 100% or revenue is derived from developed markets with Singapore contributing 70% of total; 3) strong capital ratios with low cost of debt at 1.4%; 4) potential growth in portfolio with right of first refusal to acquire Mount Elizabeth Novena Hospital; and 5) management is committed to maintain DPU.
On the other hand, First REIT trades at 8% discount to book value of S$0.283, which represents the underlying potential cash flow that the assets could generate. Distributions have steadily improved and grew by 15.4% CAGR over the last three years. At 8.7% FY24 annualised distribution yield, the yield spread of 2.7% is wider than that of Parkwaylife REIT at 1.2%. Looming Federal Reserve interest rate cuts will allow Indonesia to follow suit. Decline in interest rates will lead to positive sentiment towards the REITs sector.

Hospitals are scarce assets deserving premium value

Unlike other asset class, hospitals are critical infrastructure to provide an essential social goods. It takes high capital investments to draw skilful doctors and medical specialists, and several years to ramp up to achieve operating leverage.

Well-run hospitals command a scarcity value, underscored by an ageing population and increased life expectancy.

Healthcare stocks thus deserve to trade at premium earnings multiples, for both asset operators and owners.

For healthcare REITs, whose asset values are measured on the underlying cash flows, this intangible premium factor has largely been excluded.

On this argument, ParkwayLife REIT (PLIFE) has always traded at premium to book.

PLIFE and FIRST trade at wide disparity in terms of P/B and yield. While PLIFE is priced at 1.73x P/B, FIRST has only recently narrowed the discount to 8.1% of book.

Diverse valuation — *Source: Company, Beansprout*

Wide yield differential — *Source: Company, Beansprout*

ParkwayLife REIT's premium valuation

ParkwayLife REIT's premium valuation is backed by the following factors:

#1 Rent will see a significant 24.5% uplift in FY26 with the completion of AEI at Mount Elizabeth Hospital. Management estimated pro-forma DPU of 18.26 cents/unit, which translates to yield of 4.49% at current price.

Rent revision till FY26 for the Singapore assets — *Source: Company*

#2 Singapore assets which cater to an affluent middle and upper class, contribute to 70% of revenue. 100% of revenue is derived from lower-risk developed markets.

Operate in developed markets — *Source: Company*

#3 Strong capital ratios, with interest coverage ratio of 10.6x and low effective borrowing costs of 1.4%. About 72% of its borrowings are in lower-cost Yen, with the remainder in S$. Current gearing of 35.3% might see marginal increase from ongoing improvement work at Mount Elizabeth Hospital for S$150m which is debt-funded.

#4 Potential growth in portfolio with right of first refusal from sponsor to acquire Mount Elizabeth Novena Hospital Property.

#5 Management is committed to maintain DPU. Distributions have increased at 4-year CAGR of 1.03%, derived from rent growth and acquisitions. The assets generate stable NPI yield in excess of 6%.

Total distributions grew at 1.03% 4-year CAGR — *Source: Company*

NPI yield of above 6% — *Source: Company, Beansprout*

First REIT’s total distributions have improved

#1 Total distributions have steadily climbed back up from the dip in FY20 after the renewal of master lease on the Indonesian hospitals. The improvement would be stronger if not for the strong S$ against Rupiah. The addition of Japan nursing homes in FY22 also contributed to the increase. Over the last 3 years, distributions have grown by CAGR of 15.4%.

Distributions grew at 15.4% CAGR over last 3 years with Japan acquisitions — *Source: Company*

The distributions are supported by a strong overall NPI yield of 9.1%.

NPI yield in excess of 9% — *Company, Beansprout*

#2 Rupiah has strengthened by 2.8% against S$ since its lowest point on 1 Aug. With 83% of revenue derived from Indonesia, a stronger Rupiah would lift distribution.

President-elect Prabowo Subianto has stressed economic growth and would take on more debt to fund its programme. This has led to sell-off in Rupiah, which is still 1.5% below the level at end-Dec 23.

A moderate increase in government debt is unlikely to significantly affect Indonesia’s credit ratings, in our view. But investors should expect currency volatility.

Indonesia account for more than 80% of revenue — *Source: Company*

#3 Indonesia economic expansion should continue. Indonesia GDP grew 5.05% in 2Q24. The country has taken the lion’s share of ASEAN foreign direct investments. Geopolitical tensions and accelerated moves by corporates to diversify supply sources will continue to favour Indonesia.

Indonesia interest rates should be lower from 4Q as the probable Federal Reserve rate cuts will allow Indonesia to follow suit. We expect the Bank of Indonesia to lower its interest rate in Oct from the current peak of 6.25%. High domestic interest rates have brought down inflation to the 2-3% range. This should lift consumption.

Indonesia garners the biggest share of foreign direct investments — *Source: CEIC*

#4 FIRST’s capital ratios remain healthy. Gearing ratio as at Jun 24 was 39.5%, with interest coverage of 3.7x and all-in cost of debt at 5.0%. Only concern is an outstanding receivable of S$6m from PT Metropolis Propertindo Utama, one of its master leasee.

What would Beansprout do?

IHH’s recent purchase of Island Hospital highlights the premium valuation that hospital assets should command.

First REIT is trading at a 8% discount to its book value of S$0.283, compared with PLIFE REIT’s 73% premium to the book.

At current distribution yield of 3.7% and 8.7% for PLIFE and First REIT, PLIFE’s yield spread is narrower at about 1.24% point, compared to First REIT's 2.73% point.

Looming Federal Reserve interest rate cuts will allow Indonesia to follow suit. Decline in interest rates will lead to positive sentiment towards the REITs sector.

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