Aveo Group recently hosted an investor day in Queensland and Ord Minnett came away more positive on its prospects, leading us to lift our earnings forecasts due to higher assumed development completions – we now have greater confidence in project deliveries – and increased margins due to the material development profit from Freedom product refurbishments.
We now assume 10.7% EPS growth in FY17 and 8.4% in FY18, ahead of management guidance of circa 7.5% in each year, leading us to raise our recommendation on Aveo to Accumulate from Hold and our target price to $3.70 from $3.40.
Aveo has underperformed the S&P/ASX 300 Index by 20 percentage points in the past 12 months, but the company has positive EPS and NTA momentum.
The following factors will drive earnings and NTA growth: firstly, converting old contracts to the more lucrative Aveo way contracts – 35% deferred management fee and 100% capital gain; secondly, refurbishing its serviced apartments in combination with offering Freedom care at 10 new villages and 550 apartments - Aveo expects a material uplift in the refurbished unit values; thirdly, a ramp-up in development activity with a target of 500 units to be delivered in FY18 and growth of circa 50 units per annum beyond this; and lastly, higher sale prices from the strength in residential markets and reduction in discount rates on the RVG and Freedom acquisitions via lower vacancies.
In terms of strategy, the company needs to consider two key questions, in our view. Firstly, can it sell the development product? Aveo is in ramp-up mode on its delivery program, and it needs to prove it can not only deliver the units but also sell them in a timely fashion and at expected prices.
Secondly, what are its long-term intentions for aged care? From a full-service offering perspective, the aged-care assets are a good fit alongside the retirement villages, but the earnings and asset recognition are materially different to retirement villages. Aveo needs to ensure it is appropriately valued for this part of the business. It may look to move the aged-care business off balance sheet as it builds scale.