A step closer to the end game

In light of yesterday’s sharemarket rout of listed residential aged care players, triggered by the release of a BAML research report forecasting a potential 13% decrease in ACFI funding rates, I want to discuss briefly (1) ACFI claiming practices in the industry; and (2) balance sheet implications.

Aggressive ACFI claiming Practices

The listed sector have thrived of late on constant increases in ACFI claims achieved per resident – at a rate of 10.7%, 8.0% and 8.7% per annum for Estia, Japara and Regis respectively.

This is twice the growth rate that the government is comfortable with (as per below from its ACFI Monitoring Report):

In fact, Estia brags about its ability to claw higher ACFI payment per resident out of the government under its ownership, charging the Australian Government 15% more per resident within 6 months after acquiring a new facility.

How? Apparently through “improved documentation and compliance standards“:

Probably not the most prudent assertion for Estia to have made in the public domain in an environment where the government states explicitly in its most recent Mid Year Economic and Fiscal Outlook that:

Expenditure on residential aged care subsidies under the ACFI for 2014-15 has exceeded budget estimates by approximately $150 million. This level of growth is not sustainable for Government. It is clear that the growth is being driven by claims in the complex health care domain which are higher than can be explained by the increase in the frailty of residents.

While the overwhelming majority of ACFI claims from aged care providers audited by the Department of Health are correct, one-in-eight of 20,000 checked last year (2014-15) were deemed to be incorrect or false. This figure is already tracking even higher at one-in-seven in 2015-16.

Balance Sheet Fragility

Given that more than 70% of industry revenue is derived from the government, industry economics is obviously hugely sensitive to changes in government policy. The apparent sector-wide “EPS reductions of -19% to -27% by FY2019E” (taken from BALM research report at face value) from a seemingly small revision in the May Federal budget is demonstrative of this.

As we’ve established in my previous article, goodwill from acquisitions make up a substantial portion of balance sheet assets for Estia, Regis and Japara. Remove goodwill, Net Assets are actually negative or close to negative.

Now, goodwill valuations are typically justified via cashflow projections – refer below for Estia’s impairment testing guidelines:

It is then not too difficult to see a scenario where, given any deterioration in industry conditions, a material amount of balance sheet goodwill is deemed impaired especially in context of huge acquisition multiples having been paid for those assets in question.

Note that a significant portion of those goodwill assets have been paid for using liabilities in the form of Refundable Accommodation Deposits (lent to the providers by its residents).

This could very well wreck havoc on already thinly capitalised Balance Sheets.

Here’s my original detailed article on Leverage in the Australian Residential Aged Care Sector.

Note: The above blog post constitutes the author’s personal views only and is not to be construed as investment advice. Being obviously passionate about the art of investing, the author may from time to time hold positions in the aforementioned stocks consistent with the views and opinions expressed in this blog post.