Primary Health Properties is a landlord that, under long-term leases, rents out 113 modernised premises to GPs (78% of sales), pharmacists (9%), dentists, and the government. In 2007 it converted into a real estate investment trust (Reit) and now pays out most of its £19.6m rental income in the form of a juicy 6.9% yield. According to most analysts, Primary Health Properties can do this because it operates a low-risk business model with 90% of revenues underpinned by NHS funding, coupled with high occupancy rates.
Primary Health Properties (LSE:PHP), rated a BUY by Numis
But don't be lulled into a false sense of security. Secure cash flow is the life-blood of Reits, but Ithink Primary Health Properties is at risk of running dry. At the last count, its gearing had ballooned to 250%, equating to debt of £203m against net assets of just £79m. After factoring in new facilities coming on stream, it only has £25m of headroom under its £265m in banking facilities. This limited capacity will crimp future growth, especially as the government wants another 150 centres to be built in the next two years.
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Property values could drop further, triggering a breach in Primary Health Properties' covenants. For example, one of its terms stipulates that its loans must not exceed 75% of the market value of its sites (tightening further to 70% in March 2010). If this was to occur, the company would need a hefty slug of painful medicine. The dividend would probably be cancelled and an emergency rights issue launched, hammering the shares. To make matters worse, I suspect its much-vaunted 'near guaranteed' rental income could also disappoint. As mainstream commercial property prices soften, it may be impossible for Primary Health Properties to continue its 'upward-only price reviews' without losing tenants a problem that has already hit retail landlords hard.
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This niche sector is also becoming surprisingly cut-throat. Already, Boots, Sainsbury's, Tesco and Virgin have piled in and currently operate GP and pharmacy practices within their stores. If these chains ever decided to treat the services as loss-leaders to attract more punters, that could send Primary Health Properties' profit margins into a tailspin.
There is also an outside chance that the NHS could reverse part of its much-criticised decision in 2005 to hike payments to GP surgeries hitting the wallets of Primary Health Properties's core end-users. So while the share price has fallen 55% over the past two years, if property values keep falling and/or interest rates climb again, the firm could be soon heading towards the sick-bay.
Recommendation: SELL at 240p
Paul Hill also writes a weekly share-tipping newsletter, Precision Guided Investments
