Should You Invest In Vital Healthcare Property Trust (NZSE:VHP)?

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Vital Healthcare Property Trust is a NZ$1.1b small-cap, real estate investment trust (REIT) based in Auckland, New Zealand. REITs are basically a portfolio of income-producing real estate investments, which are owned and operated by management of that trust company. They have to meet certain requirements in order to become a REIT, meaning they should be analyzed a different way. In this commentary, I’ll take you through some of the things I look at when assessing VHP.

View our latest analysis for Vital Healthcare Property Trust

REIT investors should be familiar with the term Fund from Operations (FFO) – a REIT’s main source of cash flow from its day-to-day business activities. FFO is a higher quality measure of earnings because it takes out the impact of non-recurring sales and non-cash items such as depreciation. These items can distort the bottom line and not necessarily reflective of VHP’s daily operations. For VHP, its FFO of NZ$46m makes up 50% of its gross profit, which means over a third of its earnings are high-quality and recurring.

NZSE:VHP Historical Debt, June 12th 2019
NZSE:VHP Historical Debt, June 12th 2019

In order to understand whether VHP has a healthy balance sheet, we have to look at a metric called FFO-to-total debt. This tells us how long it will take VHP to pay off its debt using its income from its main business activities, and gives us an insight into VHP’s ability to service its borrowings. With a ratio of 6.7%, the credit rating agency Standard & Poor would consider this as aggressive risk. This would take VHP 14.95 years to pay off using just operating income, which is a long time, and risk increases with time. But realistically, companies have many levers to pull in order to pay back their debt, beyond operating income alone.

I also look at VHP’s interest coverage ratio, which demonstrates how many times its earnings can cover its yearly interest expense. This is similar to the concept above, but looks at the upcoming obligations. The ratio is typically calculated using EBIT, but for a REIT stock, it’s better to use FFO divided by net interest. With an interest coverage ratio of 1.75x, VHP is not generating an appropriate amount of cash from its borrowings. Typically, a ratio of greater than 3x is seen as safe.

I also use FFO to look at VHP’s valuation relative to other REITs in New Zealand by using the price-to-FFO metric. This is conceptually the same as the price-to-earnings (PE) ratio, but as previously mentioned, FFO is more suitable. In VHP’s case its P/FFO is 23.15x, compared to the long-term industry average of 16.5x, meaning that it is overvalued.

Next Steps:

As a REIT, Vital Healthcare Property Trust offers some unique characteristics which could help diversify your portfolio. However, before you decide on whether or not to invest in VHP, I highly recommend taking a look at other aspects of the stock to consider:

  1. Future Outlook: What are well-informed industry analysts predicting for VHP’s future growth? Take a look at our free research report of analyst consensus for VHP’s outlook.
  2. Valuation: What is VHP worth today? Is the stock undervalued, even when its growth outlook is factored into its intrinsic value? The intrinsic value infographic in our free research report helps visualize whether VHP is currently mispriced by the market.
  3. Other High-Performing Stocks: Are there other stocks that provide better prospects with proven track records? Explore our free list of these great stocks here.

We aim to bring you long-term focused research analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material.

If you spot an error that warrants correction, please contact the editor at editorial-team@simplywallst.com. This article by Simply Wall St is general in nature. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. Simply Wall St has no position in the stocks mentioned. Thank you for reading.