MET - Metlifecare - one for the fundies?

[Joshuatree]

Performance wise over the last two years RYM has been dismal only up re 3% after todays 11c gain.
MET from re $4.00 to $4.80 re 20% gain
SUM up re 29%

[Beagle]

Lets dig into this debate about MET because I for one find it fascinating that the SP seems so closely correlated with the asset backing and this is by no means a recent thing.

I held a while back when asset backing was circa $4.20 and at the time development margins were tracking okay, IIRC about 15% and I thought they might be headed higher but with the result last year they came out and said their target development margin was 15%. Keep in mind SUM just achieved 20% and RYM are north of that again.

So how did they do against this very modest target ? Development margin in an extremely robust time for the Auckland housing market was an incredibly modest 12%. For me this redefines the term underwhelming.

They acknowledged they need to do better but have been saying the same for a while now so what gives BP ? They've had the expertise of Infratil on board for quite some time now and development margin's appear to have gone backwards in an absolutely booming property market...how could this possibly have happened ?

Yes embedded value of just over $700m is good and supportive of future underlying profit generation and yes the PE is cheap but is the upper North Island property market, and Auckland in particular starting to come off the boil ?

When will MET start to generate half way reasonable development margins ?

The forecast this year is for underlying profit of (at the mid point) $63m. EPS underlying is approx. 29 cps so forward PE of about 16.8 which is slightly cheap for this sector In the medium term yes I think this level of underlying EPS is repeatable going forward because of the large embedded value of $700m which should generate close to $100m per annum in future underlying profits given the average occupancy time of the units. Why is it underperforming in terms of average earnings based on the level of embedded value ?

Seeing as the vast majority of the company profit is made from historical embedded value and seeing as the property market may be starting to come off the boil ?, perhaps not after Mr Wheelers kind assistance last week ? and seeing how their development team appear woefully inferior to either SUM or especially RYM until such time as they prove up their ability as developers its hard to make the case that the SP won't be inextricably tied to the NTA isn't it ? If one is to try and make the argument that they're worth more than NTA this would appear to fly in the face of the market SP for the last 2-3 years and what is one basing that assumption on ? They make very little from the actual operation of the villages, ostensibly a cost recovery exercise and their development margins and modest volumes of same are woefully inferior to either RYM or SUM so how to make a case its worth more than NTA ?

Seeing as the dividend yield is so incredibly low and playing devil's advocate here, isn't one simply better to own Auckland property outright and enjoy the same fortunes of the property market one way or the other ? Certainly one can leverage their own rental property far easier and more inexpensively than leveraging shares and the rental yield, while admittedly low now is certainly better than MET's dividend yield. Further, most of us can swing a paintbrush and a hammer so adding value often isn't difficult as has been well espoused in property T.V. renovation programmes.

If MET could prove up their development capabilities then its possible their SP could attain escape velocity from the NTA but until they can prove otherwise I see little prospect of that happening, cheap PE notwithstanding.

So..from my perspective the key question becomes when do you see their development team making genuine progress and getting real traction BP ?

[Snow Leopard]

...The forecast this half is for underlying profit of (at the mid point) $63m which translates to an annual underlying of $126m...

HY presentation Slide 7 - Full year underlying expected to be $62M to $64M; Half year was $33M5

Best Wishes
Paper Tiger

[Beagle]

Thanks PT, oops my bad. From underwhelming to even worse.

So let me pose this question. Seeing as they have embedded value of $700m and the average occupancy from that presentation is circa 8 years depending on unit type, why aren't they achieving at least one eighth of $700m each year i.e. $87.5m ? Where is the leakage in profit ? If all they can do is $63m underlying for the full year in a market that's best described as booming what hope for the future ? Remembering that a booming market not only helps resale profits but also development profits. What underlying profit do they make when the market isn't booming ?
Maybe they should stop all development and ensure each centre is run on the basis that it at least covers costs that way they'd make an underlying profit on average of $87.5m each year ?

My view is that there are very sound and logical reasons why this trades at close to NTA and has done for quite some time. In my view it probably will continue to do so for the foreseeable future until such time as they may be able to finally get some genuine traction from their property development team. IFRS, (International Financial Reporting Standards that include full revaluation of all properties each year as normal EPS) IMO can be a dangerous and volatile way to measure earnings and can give misleading indications of relative valuations in this sector, especially so for mature companies.

[BlackPeter]

Hi Roger & PT, sorry for my tardy response ... I plainly missed your posts - too many other things going on in my life.

Absolutely agree - the MET development margin does not look flash (though - they started at least to develop again ... and the margin appears to improve (from a low base).

I can only speculate on the reasons - but here is my view: SUM and RYM are basically cranking out small standard houses (wooden boxes) as every builder in NZ is able to deliver even when sleepy and intoxicated - and spread them across nice places with more and more limited availability (and often close to nowhere). MET seems to develop mainly larger apartment blocks in areas where space comes at a premium (close to public transport, shopping malls, etc).

NZ building industry has little experience with these larger structures and has a long history of appalling mistakes in building them (rotten balconies, lacking noise insulation, leaky buildings, lack of seismic strengthening). MET is now trying to build them in good quality with limited local expertise, which is obviously more expensive and fault prone = lower development margins. Hopefully, though they are learning.

Obviously they need to repeat all the mistakes which have been made already in the last 10 decades or so somewhere overseas ... this is New Zealand, and we can't just learn from other people's experience;

OK - sorry to get carried away, sometimes I am not yet full in the Kiwi spirit ... but what I wanted to say is ... I don't think that it is at this stage fair to compare MET's and e.g. SUM's developments margins and draw from them the conclusion that the MET team is less capable. They just try something much harder ... which, if successful, might well pay dividends (literally).

I guess the question is - where is the future for new housing in NZ if every square meter around Auckland is occupied by a hardly accessible (other than by car) wooden box (standalone house) in a wooden box (fence line)?

Maybe that's the time when people wake up and discover that apartment blocks with good access are the way to go (hint - most parts of the world discovered that already) and than I do think that companies able to provide them in good quality will be king.

O.K. - but back to the share price: MET's PE looks currently outstanding (consistently below 10) - and yes, I do add property revaluations to the earnings - since that is what they are: A regular addition to the income stream. Will they continue? Who knows, but as long as most New Zealanders prefer to live in their own stand alone box and the population is growing do I not see how the housing bubble we clearly have can seriously deflate any time soon.

I know that the Graham formula has its limitations - and not sure, whether I believe the $28 per share it delivers if I enter the current earnings and growth rate ... but I still think that the share is more worth than it currently is traded for.

BTW: anybody noticed that the MET SP just passed the golden cross ?

[Beagle]

Some background. The long held view regarding recognition of profit going back over thousands of years is that it isn't real until its realised. This is known as underlying earnings and forms the core basis by which I endeavour to compare these companies.

The doctrine of conservatism has been well entrenched in accountants thinking going back since the profession was first established hundreds of years ago and realised means sold and money in the bank or sure beyond reasonable doubt it's coming into the bank pretty shortly. (There's lots of grey lines in regard to construction of projects and the convention based upon percentage of completion is reasonable well entrenched).

But then fancy new doctrines emerged and it became accepted practice that property companies who's main purpose was to invest in property could and should under the International Financial Reporting Standards (IFRS) report the current years revaluation as normal profit.

The problem with IFRS profits is that valuation changes from one year to another can vary widely and even in some years be negative so that makes the use of such in models like Benjamin Graham's valuation formula which relies on reasonably certain growth completely inappropriate. I do have some sympathy with this point of view as there's ample evidence that the cost of construction generally goes up each year at least as fast as inflation so some level of core revaluation on a long term basis is probably baked into each years result.

The problem with underlying profits is it gives too much of a lagging indicator in terms of the real change in value that's occurred during the year because only approximately one seventh of the units change hands each year and its generally older units that people have been in for a while.

So I came up with a hybrid model. This very recent theory of mine looks to explore the future direction of underlying earnings, (these are the real earnings...everything else is theoretical until its realised and is nothing but paper until proven otherwise).

This hybrid model looks to predict future underlying earnings based on development margin plus a theoretical one seventh of current embedded value, (the difference between what people paid for their occupation licence and what's its currently worth).

The benefit of this theoretical approach is it looks to remove the wild swings in IFRS revaluation profits that can come from dramatically changing property values from one year to another and smooth them out, (normalise them) BUT I struck a major problem when looking at MET. They have embedded value in their units of just over $700m. Based on average occupancy of approx. 7 years and assuming they did nothing else and each centre runs itself as a cost recovery centre this should theoretically generate $100m in underlying earnings every year for the next 7 years and yet in a booming market all MET is forecasting is an underlying profit of $63m ?.

So my question is, where is the leakage ? What is sucking up the $37m per annum in profit that would appear to accrue if the company did nothing at all but manage its existing facilities and fired all its apparently excessively expensive corporate team ?

It seems clear to me that some other aspects of MET's operation are anything but value adding to shareholders and until they can prove their development team can add value, regardless of how they build I'm a sceptic. Yes they had a good bounce on Friday but are still very close to their NTA.

It will please you to hear BP that I spoke with the GM of one of the major Australian owned real estate franchisees yesterday. He told me the Chinese are back in a big way in the Auckland market and immigration keeps rocking on at record level's so they all have to live somewhere. I therefore expect MET to keep going up at a rate not dissimilar to Auckland's house prices.

[macduffy]

.... and RYM are basically cranking out small standard houses (wooden boxes) as every builder in NZ is able to deliver even when sleepy and intoxicated - and spread them across nice places with more and more limited availability (and often close to nowhere).

Hi B-P. Have you seen the Bob Scott village in Petone that RYM are currently developing? No small wooden boxes there, mainly 3, 4 and 5 level buildings. Two other RYM villages that I have seen recently, the Rita Angus in Kilbirnie and Malvina Major in Johnsonville also lack any standalone apartments although the latter does still incorporate the single level motel complex from which it sprung. Wellington's topography, for one, doesn't allow the luxury of too many single level dwellings!

[BlackPeter]

Hi Roger,

Thank your for taking the time to detailing your rationale. This is a very useful and educational post - and certainly will help people to understand why there might be always more than one version of the truth, particularly when looking forward.

Happy to acknowledge as well your superior knowledge in the accounting domain ... I am engineer by trade ... and while I learned in the meantime how to read a balance sheet (and write a business case), my professional contact with accountants was mainly confined to submitting my travel expenses .

One thing I learned as engineer is that there are no right or wrong models, just models which are better or less suitable, depending on the chosen context (e.g. they say that custard is in some context an excellent model for the human brain) .

So - why not simply "test" your three different models? Question: if you apply them (underlying earnings, IFRS, hybrid) to the past earnings of the three retirement village operators - say over the last 10 years or so ... which of them would have described most accurate the realised earnings of somebody buying the shares in 2006 (or whenever they started) and selling them in 2016?

Why not simply using this model?

[BlackPeter]

Hi B-P. Have you seen the Bob Scott village in Petone that RYM are currently developing? No small wooden boxes there, mainly 3, 4 and 5 level buildings. Two other RYM villages that I have seen recently, the Rita Angus in Kilbirnie and Malvina Major in Johnsonville also lack any standalone apartments although the latter does still incorporate the single level motel complex from which it sprung. Wellington's topography, for one, doesn't allow the luxury of too many single level dwellings!

I intended to say "mainly"... and admittedly didn't follow Ryman too much anyway over the last couple of years (sold out when they started plateauing). However - pleased to hear that they seem to move into a more sustainable direction ...

[percy]

I intended to say "mainly"... and admittedly didn't follow Ryman too much anyway over the last couple of years (sold out when they started plateauing). However - pleased to hear that they seem to move into a more sustainable direction ...

Google Frances Hodgins retirement village.RYM built it years ago.