Extendicare upgraded to buy at Leede Jones Gable

Douglas Loe of Leede Jones Gable is eager to spread the word about Extendicare (Extendicare Stock Quote, Charts, News, Analysts, Financials TSX:EXE), upgrading the stock from a “Hold” to a “Buy” while raising his target price from $8/share to $8.25/share for a total return of 21.6 per cent in an update to clients on Thursday.

Founded in 1968 and headquartered in Markham, Ont., Extendicare offers long term care services, retirement living services and home health care services such as nursing care, occupational, physical and speech therapy, assistance with daily activities and contract and consulting services to third parties.

Loe’s latest update comes as Extendicare is poised to formally divest its retirement residence operations in Ontario and Saskatchewan to SiennaSabra LP, a partnership formed between Sienna Senior Living Inc. and SABRA Healthcare REIT.

“We endorse the transaction and the cash that it generates because in our view, Extendicare achieved a point in the build-out of its retirement residence operations where it either needed to commit to growing the portfolio more aggressively than in prior years, or divest it to another healthcare-focused REIT with pre-existing scale, as Sienna-SABRA does, and it clearly chose the latter option,” Loe said.

The agreement is valued at $307.5 million, subject to typical closing adjustments, including receipt of regulatory approvals from the Ontario Retirement Homes Regulatory Authority and Saskatchewan Health Authority and pursuant to Canada’s Competition Act.

The deal includes Extendicare’s entire retirement living operations, which is made up of 1,048 retirement living suites across 11 retirement communities. Extendicare’s initial foray into retirement residences came in the fourth quarter of 2015, when it acquired, or began construction of, nine distinct facilities totalling 810 suites in rural Ontario and urban Saskatchewan for cumulative purchase price and development cost of $220 million.

According to the company’s February 3 press release announcing the acquisition, the deal is structured on a debt-free basis, with existing debt associated with the portfolio of approximately $172.4 million, as well as estimated debt prepayment costs of approximately $6.3 million, being repaid at closing from Transaction proceeds.

“With today’s announcement, we are repositioning Extendicare to focus on growth in our long-term care and home health care segments where we can leverage our deep expertise and scale to drive improved performance and high-quality care for seniors across Canada. Proceeds from the sale will provide the flexibility to allocate capital strategically, including priority investments in our people, technology and our long-term care redevelopment program,” said Dr. Michael Guerriere, President and CEO of Extendicare in the release. “We are pleased with the value we will realize on our retirement living investment.”

Despite the divesting, Loe believes Extendicare will continue to generate ten-figure revenue totals, with the year-end projection of $1.25 billion for 2021 producing implied year-over-year growth of 8.2 per cent. From there, Loe projects minor losses in both 2022 ($1.23 billion, 2.4 per cent year-over-year loss) and 2023 ($1.17 billion, 4.1 per cent year-over-year loss), primarily on account of the loss of revenue from assisted living, along with a $41 million drop in SNF revenue in 2023.

Meanwhile, Loe projects the company’s EBITDA bounceback to continue, forecasting EBITDA of $70.7 million for a 5.6 per cent margin, and is a 69.5 per cent increase over the $41.7 million in EBITDA reported in 2020. Loe forecasts the EBITDA to step up to $90.3 million for a 7.4 per cent margin, then increasing to a projected $92.9 million in 2023 for a 7.9 per cent margin, effectively bringing the margin back to pre-pandemic levels.

From a valuation perspective, Loe projects the company’s Price/AFFO multiple to drop from 12.9x in 2021 to 11.1x in 2022, then to a projected 10.5x in 2023. The EV/EBITDA multiple follows a similar path, with Loe projecting the multiple to drop from 10.9x in 2021 to 8.5x in 2022, then to a forecasted 8.3x in 2023.

“Though we have long believed that retirement residences were prudent and profitable operations to bolt onto the firm’s core nursing care/home care operations – on a relative basis, it was by far the most profitable division within Extendicare’s ecosystem,” Loe said. “If we couple that observation with our view that retirement residences operated more as a bolt-on than as an integrative component of Extendicare’s overall eldercare services offering, it thus became apparent to us long ago that the asset could be seamlessly packaged and divested to another REIT operator without any impact on Extendicare’s continuing eldercare operations.”

Extendicare generated a 21.1 per cent return over the last 12 months, with the momentum continuing early into 2022 at a 2.2 per cent return. Extendicare has made progress from its 52-week low of $6.26/share from a year ago, eventually hitting a 52-week high of $8.67/share on July 12.