*Update: After a comment from a reader, I added an update to my original article regarding the risk within the company’s occupancy advances.
In January, I will be attending RV Capital’s Annual Gathering in Switzerland. RV Capital is a hedge fund managed by Rob Vinall, an investor I admire that has accumulated a very good track record over more than a decade. Investors in his fund can attend the meeting, along with emerging managers. CEO’s of companies that RV Capital has invested in have attended in the past as well. This year, management of Ryman Healthcare will be at the meeting and will take questions. I’ve never met with management of a public company before, so I thought it would be interesting to take a look at Ryman before attending the meeting. I wasn’t planning on taking things any further, but after studying the company I was very impressed with what I saw. Now I am an owner of the business.
Ryman Healthcare caught my attention for another reason that didn’t turn out to be very helpful. I used to live in Nashville, Tennessee, which is known for country music and a large healthcare industry. The Ryman Auditorium is a historic concert venue in Nashville that hosts the Grand Ole Opry. I thought the combination of the two words in its name was a sure sign of a Nashville connection. I was completely wrong. Ryman Healthcare has nothing to do with country music or Nashville, and is headquartered on the opposite side of the world in New Zealand. The company was founded by John Ryder and Kevin Hickman, which explains the name. It was too late though. The more I read about the company, the more I enjoyed studying it no matter how little of Nashville was involved.
Ryman has an excellent track record of compounding shareholder capital since it went public in 1999. As of the end of its fiscal 2018 year, Ryman had doubled its ‘underlying profits’ every 5 years since its IPO. The company’s reported net income figures include unrealized gains on its real estate portfolio, while its underlying profitability removes these short term fluctuations. A double every 5 years translates to about 15% growth. While this consistent 15% growth is impressive in its own right, the company achieved this while only retaining roughly half of its income. Ryman paid out dividends to shareholders with the other half of its income. This is unique, as a typical business has little free cash flow during its growth phase, but spits out free cash flow once it is no longer growing. Capital is typically required to finance growth.
The reason why Ryman can both finance growth and return cash back to its owners at the same time is because it generates float from customers. This is an industry dynamic that Ryman and its competitors benefit from. Float is very beneficial to companies that are growing. The company raised $25 million in its 1999 IPO, and was valued at $135 million at the time. Ryman hasn’t needed to raise anymore capital from shareholders ever since, and instead has paid out over $1.1 billion in dividends. The valuation has increased to $3.3 billion today. This is closer to $2.1 billion in US Dollars. Existing shareholders haven’t been diluted over this time frame either, as the firm’s 500 million shares outstanding have remained constant over time. Instead of issuing stock options, employees are offered interest-free loans to purchase shares. I am a fan of this compensation strategy. It is a different mentality for employees who actually purchase stock in the open market, as opposed to those who receive “free” shares. Nothing is ever really free, and it is existing shareholders that pay the price for stock based compensation programs.
Throughout its history, Ryman has sold for a premium valuation. There were times when the valuation approached almost 5 times book value. However, that has changed as it has faced a difficult few years. The company operates retirement communities, and Covid challenged Ryman’s residents more than any other demographic. Dealing with Covid increased operating costs at Ryman, while sales and marketing efforts were slowed by this environment at the same time. The stock price is down almost 50% year-to-date, and the company now has a valuation that is below net tangible assets. These tangible assets are almost entirely made up of real estate properties, not some sort of outdated equipment or unsaleable inventory. The book value of Ryman has compounded at a rate above 18% annually over the last 15 years. Surprisingly, the stock price of Ryman is more than 20% below the Covid lows of March 2020. This is an interesting time to be studying Ryman Healthcare.
When I was reading about Ryman’s ability to generate float, I realized that I had read an interesting article in the past about a competitor named Summerset (SUM.NZ). In the article from March 2018, the author points out that although Ryman is a higher quality operator, Summerset had a cheaper valuation at the time. The stock price of Summerset has increased 85% in the last 5 years while Ryman has seen its stock drop 35% over that time frame. This appears to be a good call at the time by the author, but the situation does provide for an interesting opportunity for us today. After a decline in the valuation of Ryman, we can now own the highest quality operator in the industry at a bargain price.
Background
Ryman was founded in 1984 in New Zealand, one year after Kevin Hickman walked into a retirement home that was of lower quality than he would have liked. Four people shared a room, and the shared bathrooms were down the hall. Today, the company has 13,200 residents in what appear to be very high quality living arrangements. The company expanded to Australia over time as well. The residents of Ryman range from people who live in independent villages all the way to those requiring hospital level care. Ryman has been recognized often for the quality of their villages, as well as in the trustworthiness of their brand. When I retire from investing at the age of 103, I could see living in a Ryman property. Most importantly, the residents of Ryman appear to be satisfied customers who are treated well.
Ryman is vertically integrated, as its villages are “designed, built, sold and operated by Rymanians”. The company does take on some debt, along with internal capital, to buy land and start developing properties. However, much of the operations are funded by customers through occupancy advances from that point on. The occupancy advances are what creates the float that I was referring to earlier. This is basically an interest-free loan for Ryman, and it funds further growth in the construction of retirement villages. Occupancy advances made up 39% of Ryman’s assets in fiscal 2022. Equity capital accounted for an additional 31% of assets, while debt made up 23.5% of assets.
Residents purchase an Occupancy Right Agreement in order to live in Ryman’s properties. This allows residents to live there for life or until they decide to leave. The occupancy advance is kind of like a deposit, as the resident is repaid the advance, net of management fees, after vacating the property. This situation makes sense for the residents, as neither rent or full ownership would quite make sense at a retirement community. If you are a 50 or 60 year old, you might not want to inherit a property in a retirement home from your 80 or 90 year old parents. It would be an asset with a very limited group of prospective buyers. On the flip side, a resident might not want to worry financially about how long they can afford a monthly rent check. It’s not exactly clear how many years you have to budget for at the tail end of your life. I didn’t enjoy moving homes in my 20’s, and I doubt I would like it any better at the age of 80. Many residents can sell their previous home, purchase an occupancy right agreement, and have a guaranteed place to stay in a safe and fun environment with some funds leftover.
Ryman generates earnings from many different sources. The company earns a development margin, management fees, a resale margin, care fees, and benefits from any appreciation in its underlying real estate portfolio.
The development margin is earned as Ryman sells the occupancy right agreement to a resident above the cost to construct the unit. Residents pay management fees for the right to use the village facilities and amenities. The management fee was 4% of the occupancy advance per year, but is now changing to be 5%. The management fee is capped at 20% though. This means that if a resident stays longer than 4 years, no further management fee will be charged to that customer. When a resident vacates the property, Ryman pays that resident back the original cost of the occupancy advance minus the accumulated management fee. Ryman then sells the occupancy right agreement to a new resident at the current market value. The market value of the occupancy right agreement to a new resident is typically higher than what the previous resident paid for the occupancy right agreement. This means that Ryman earns a profit margin on the resale of its residential units. Ryman earns care fees, which are fees charged for residents who need higher level care, such as in a hospital setting. The local governments set the rate at which Ryman can charge for care fees. Finally, Ryman owns the underlying real estate, so the company benefits from any increase in property values over time. Part of this appreciation in real estate is recognized in the resale margin of the residential units, but Ryman also owns the community facilities and surrounding land, as well as some undeveloped land for future growth.
To understand the return on shareholder equity that Ryman can achieve, a few adjustments must be made to the reported financials. Its balance sheet is made up of real estate that has appreciated quite a bit over time. Measuring its real estate at cost gives investors a better idea of just how profitable this company has been. Ryman doesn’t really flip properties, so some of its real estate has been owned for many years. Additionally, Ryman discloses its ‘underlying profit’, which strips out unrealized gains on its properties. This is a better measure to use than reported net income when judging Ryman’s profitability in a single year. The underlying profit is typically lower than reported net income due to unrealized gains being reported on its real estate as opposed to unrealized losses.
Since 2007, Ryman has reported $3.5 billion in the fair value movement of properties on its income statement. The company has $3.4 billion of total shareholders’ equity on the balance sheet. This tells me that, at cost, very little shareholder capital is tied up in this business. Ryman has a large portfolio of real estate that it can borrow from banks against, and the company gets a major amount of financing from the float from customers. This leads to Ryman having the ability to earn high returns on shareholders’ capital.
Risks
The main risk that shareholders of Ryman face is regarding the supply of retirement communities in New Zealand and Australia. Ryman’s competition includes multiple publicly traded companies. This industry enjoys the benefits of float from customers, and this float is most valuable to a growing company. Businesses in this field have enjoyed attractive compounded returns, and it is logical for companies to keep retaining earnings and building more communities. Ryman’s management points to the favorable demographic trends related to growth of the elderly population that will continue increasing demand for its services. However, the important piece is whether or not supply can remain rational as multiple publicly traded companies fight for growth.
The issue of supply could be catastrophic for Ryman, as high vacancy rates would mean bankruptcy for the company. Ryman takes on liquidity risk from its leverage from float, as well as from the additional debt it has. When a resident vacates a property, Ryman has to pay back the former resident in cash, net of any management fees. At a minimum, Ryman will owe the former resident 80% of the original cost of the occupancy advance. Ryman hasn’t had any trouble in the past finding a new resident to take the place of an old one, and the company has been able to increase the price of the occupancy right agreement as well. This means that turnover in the residential units has been a cash generative process for Ryman. Just because things have worked out well in the past doesn’t mean things will always go so smoothly in the future though. Due to the deduction of management fees, as well as a 7 year average length of stay for residents, Ryman doesn’t realistically face much risk in terms of short term pricing fluctuations in the real estate market. For Ryman to get itself into serious trouble financially, it would have to have plenty of empty rooms. This turns into a negative cash flow situation in a hurry if Ryman ends up having large vacancy rates.
Currently only 1.7% of their units are available for resale, which means they are just about full. Historically, they have had excellent occupancy levels. Residents of a retirement community are more needs-based than the average person. Ryman isn’t dealing with 20 year olds who might relocate to take advantage of a cheap deal on rent or due to changing employment opportunities. As long as Ryman continues to provide a quality experience for its residents, and the industry avoids overbuilding too many new properties, then it should be able to find residents who wish to live in their communities. The company is not dealing with any issues of vacancy right now, but it is still a risk to keep in mind for those who wish to be a very long term owner of the business.
Interestingly, Ryman’s existing properties might contain more risk over time than the properties under development, despite being proven a success in the past. This is unique for a real estate developer. A residential unit turns over about every 7 years for Ryman, and this turnover is a continuous cycle. A property might have been excellent in 1999, but the surrounding area and community could make a turn for the worse in 2030. Additionally, supply from competitors could flood the market in a given city, making it more difficult for Ryman to find new residents to fill an existing unit. Since Ryman relies on the funds from a new resident to payback the previous resident, it is crucial for its old properties to continue into the future.
This means that there are scale advantages in this industry in terms of risk management. In the insurance industry, it is crucial to avoid the accumulation of correlated risk. Ryman does have correlated risk in terms of the demographic it serves, which is noteworthy for a situation like Covid. However, the more villages that Ryman builds, the more diversified its risk profile is. Each new town, city, or country that Ryman enters into, the less correlated its risk is in terms of the funding from occupancy advances. Ryman is the largest operator in its industry, so it currently has a scale advantage over its competition. This could help Ryman take market share in a difficult period for its industry, but it also provides an investor at least slightly more safety. At the end of fiscal 2022, Ryman served 13,200 residents and had 61 retirement villages completed or under construction. Summerset and Oceania are two competitors with comparable operations. Summerset served 7,100 residents and had 37 villages completed or under construction. Oceania served 4,000 residents and had 45 villages completed or under construction. Additionally, the scale of Ryman is one reason why the company is able to charge lower fees to residents despite a reputation for offering the highest quality service. Ryman caps its management fee at 20% of the occupancy advance, while its competitors are more in the 25% to 30% range.
The housing market and the changing interest rate environment has caused some concern for investors recently, and could be a reason for the decrease in Ryman’s stock price. The company reported that it has $512.5 million worth of contracts that aren’t settled yet. This situation is common for Ryman, but the value of the unsettled contracts did increase nearly 25% in the last 6 months. A certain amount of settlement time is natural for this business, as many residents sign a contract and then put their former house on the market for sale. The 25% increase in unsettled contracts is partially due to a slowing housing market, making it more difficult for residents to sell their old homes. As I mentioned before, many residents of a retirement community are needs-based. If the housing market causes an extreme decrease in the value of homes, prices of Ryman’s units might have to come down too, but I don’t think the demand will completely fall off based on housing prices. A certain percentage of the population needs the services that Ryman provides. A poor housing market alone may affect pricing, but it will not alone cause vacancies at Ryman.
Besides the float from customers, Ryman has additional leverage from traditional debt. The company has $3 billion in debt, most of which is due 4 to 5 years out in fiscal 2027 and 2028. The balance sheet is made up of $11 billion of real estate, as well as a small amount of receivables. Banks are typically willing to lend against assets like this. Additionally, Ryman has produced steady cash flows throughout its history. Care fees, in particular, have increased every single year since 2007 and should withstand difficult economic periods. Ryman’s debt level is not concerning in isolation, but the liquidity situation will always be deserving of attention given the added leverage from customers from the occupancy advances.
On the positive side, it doesn’t look like Ryman’s residents have much leverage at all. Management has stated that most residents pay with a cash lump sum. I presume this cash comes from the sale of a home the resident used to live in. The balance sheet of Ryman points to a lack of customer leverage as well. The gross occupancy advances from residents were $4.9 billion at the end of fiscal 2022. The company subtracts management fees and resident loans from that figure to come up with the net occupancy advances. Combined, the management fees and resident loans were 12% of the gross occupancy advances. Ryman charged management fees of 4% per year in the past, so if residents were 3 years into their stay on average then that would account for the full 12% value. This would mean resident loans were zero. I assume resident loans aren’t actually zero, but this information shows that they must be a pretty minor value compared to the gross occupancy advances.
Conclusion
Ryman has a long history of compounding shareholder capital, and operates in an industry with favorable economics. The assumptions needed to justify the current stock price aren’t very demanding. Investors in Ryman are taking on some amount of catastrophe risk given its leverage, but this risk has the potential to slowly decrease over time if it can expand geographies and become less correlated.
*Disclaimer:
This newsletter has been prepared for informational and educational purposes only, and solely represents our views with respect to certain securities, markets, and other financial matters. It should not be used as the sole basis of any investment or financial decision, and should be construed to render any legal, tax, or other professional advice. The statements made herein are solely based on our research, and any forward-looking statements should not be construed to guarantee any particular outcome. All investment strategies involve risk, including our strategy of seeking out a concentration of undervalued companies in the pursuit of potential long-term appreciation. Past performance of an investment is no indication of its future returns, we make no guarantees whatsoever about any future investment returns.
Investment advisory services offered by McDonough Investments, LLC, an investment adviser principally registered in the State of Michigan and registered or exempt from registration in other jurisdictions as applicable.