The Estia Health Ltd (ASX: EHE) share price fell 37% throughout 2018, but is now a good time to buy into the company while the price is low?

Let’s take a look at the company, why it has fallen and its valuation.

Estia Health Ltd and the Industry

Estia Health is one of the largest care providers in Australia and is included in what the industry terms “the big six for-profit providers of residential aged care.” Estia has 68 facilities and 5,910 operating places across the eastern states of Australia and South Australia. According to Estia’s annual 2018 report, the company has a bed occupancy rate of 94%.

In other promising news, a report by IBISWorld states industry revenue will grow by 5.4% over the next five years. This comes as no surprise with Australians over 65 set to make up 20% of the total population by 2030. Estia is in a strong position to capitalise on this as the majority of their facilities are located in growing metropolitan areas.

Sounds Promising, right? The Elephant in the Room

The announcement that there will be a Royal Commission into aged care quality and safety saw Estia drop 23% in share price. The significant reaction and selloff was likely due to the drama surrounding the banking Royal Commission in 2018.

The aged care Royal Commission, however, will be entirely different from the banking one as it will focus on the system as a whole rather than trying to pick out a few culprits misbehaving badly.

The findings and recommendations from this Royal Commission could have an impact on operating expenses for the company. For example a fixed ratio of staff to residents may be implemented causing an increase in staffing costs. This sector is also heavily reliant on government funding and with an election looming this year any legislation changes could impact Estia’s business model.

Valuation

Based on its current share price of $2.25 Estia Health has a price-to-earnings (PE) ratio of 13x which is lower than the sector average of 16x. The current market capitalisation is $556 million.

In 2018, earnings per share (EPS) decreased by 5.70% which management states is a result of the dilution of 2017 capital raising. InvestSmart predicts EPS to drop by another 2.20% in 2019 but then increase by 4.30% in 2020.

Earnings before interest, tax, depreciation and amortisation (EBITDA) increased by 4.1% in FY18 to $90.1 million, with an improved operating revenue of 4.3%. Additionally, an opening of a further 186 beds in 2018 should increase inflows of revenue and refundable accommodation deposits (RAD) in 2019 as the new beds reach full capacity.  

Management

One significant piece of news for Estia in 2018 was Norah Barlow stepping down as CEO and Ian Thorley will take up the vacant position. Ian has worked with Norah as the company’s COO and deputy CEO for the past four years and Norah will stay on the board as a Non-Executive Director.

It will be interesting to see the effect this has on the company as Norah took over as CEO in a transitional period for the company and has been slowly steering Estia towards improved operational performance. Ian has a big job ahead of him considering the current environment under which the sector is operating.

Summary

In summary, Estia has a lower PE compared to other companies in the industry and the market. However, it does have an attractive dividend yield of 7.12% and is in a steady cash flow position to benefit from the ageing population over the next ten to twenty years.

Despite this, I will not be buying shares at its current price due to the uncertainty surrounding the industry and the recent change of CEO. That said, I will be keeping an eye on the company and news surrounding this sector as there may be an opportunity in 2019 to take advantage of any further reaction the market may have to the Royal Commission.

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Disclaimer: Any information contained in this article is limited to general financial/investment advice only. The information has not taken into account your specific needs, goals or objectives, so please consider consulting a licenced and trusted adviser before acting on the information. Please read The Rask Group’s Financial Services Guide (FSG) for more information. This article is authorised by Owen Raszkiewicz of The Rask Group, which is a corporate authorised representative No. 1264179 of Strawman Pty Ltd (ACN: 610 908 211) (AFSL: 501 223).

Disclosure: At the time of publishing, Jack Magann does do not own any shares in Estia Health Ltd.