How should a company’s performance be measured? It’s a question that’s more complicated than it sounds. Many executives of public companies look first to their share price. If their company’s share price went up 50% in a year then they must be doing an excellent job right? The short answer is no. It’s possible that the stock price went up while the business fundamentals of the company deteriorated during the year. That the executive made the wrong decisions. That they blundered badly. Just not as badly as investors expected.
That’s the first lesson an investor or board should consider when evaluating the performance of their executive team. Expectations, not fundamentals, drive short term movements in stock prices. It’s a Keynesian beauty contest, expressed most elegantly by Warren Buffett in his 1993 shareholder letter as:
In the short-run, the market is a voting machine – reflecting a voter-registration test that requires only money, not intelligence or emotional stability – but in the long-run, the market is a weighing machine.
Evaluating executive performance on total stock performance for a year is folly because it’s largely out of the hands of the executive. My aversion to using short term arbitrary periods like a calendar year extends beyond share price performance. Not only can the share price performance in any one year be driven by industry tailwinds, lower supply costs due to a fall in commodity prices or a change in investor sentiment but a company’s financial performance can be as well. A company’s profit may be up 50% this year, not because the executive team did anything special but because there was a delay in a large customer order from the prior period to the current one. Executives want to assume that it was their effort that led to the improved profit but that’s not always the case. The second lesson an investor or board should consider when evaluating executive performance is to beware of misattribution. Using a more specific target and longer time-frame for the targets makes it easier to separate the impact of skill from the impact of luck. Almost any CEO could meet the goal of increasing earnings per share for their company for a year given the right environment. Meeting a target of increasing earnings per share every year for five consecutive years is a tougher test and one that would better differentiate between luck and skill.
That leads us to our highlighted shareholder letter for this week. When looking for companies that have delivered winning strategies to profile on this blog, we wanted to take a step back from short-termism and look for two things:
Ryman Healthcare Ltd. is one of these companies. Since its IPO in 1999, Ryman’s shares are up 48 times and if you had reinvested the company’s dividends in buying more shares you would have made 81 times your initial investment. Meanwhile a similar investment in Amazon shares would only be up 30 times and Berkshire Hathaway stock would only be up 4.5 times (yes, I’m aware that the timing of the tech bubble skews this comparison but still…). Ryman has also grown its underlying earnings per share in 19 years out of the 20 years it’s been public, including right through the global financial crisis, when most other companies were losing money and operating scared for the future.
Ryman’s business is not as sexy as Amazon or as high profile as Berkshire Hathaway. Ryman develops high-end retirement villages in New Zealand and Australia. The company was founded in 1983 by Kevin Hickman when he visited a fire-damaged retirement home and saw the low quality of the living conditions.
There were four people to a room with shared toilets down the corridor. The people running the resthome were nice and did a good job in as much as they were expected to. But to me, it was crazy. The standards were so poor. But that’s how resthomes were in those days.” It started Kevin thinking about what the standard should be. “I thought, what would I want for Mum? I’d want a single room with an ensuite, for a start.
Over the last thirty years, Kevin has transitioned from being the founder to a board member to a significant, but uninvolved shareholder, but his mission continues through Ryman’s operations. The company’s villages have a mix of apartments, where the resident lives independently but benefits from access to Ryman’s services and community support, assisted living or “serviced apartments”, where the resident receives ongoing care and support but maintains a degree of independence, and aged-care centres that provide 24-hour intensive care. In words of the company, “We look after older people” and provide care that must be “good enough for Mum”.
Ryman’s annual report is different than the other two companies we have profiled to date. It’s well written to be sure, conveying a keen sense of purpose focused on resident care and the quality of Ryman’s villages, yet it provides almost no useful information on the actual economics of the retirement village business. That juxtaposition always catches my interest. Ryman has generated excellent returns for shareholders over the last 20 years, is running a business with a vision that inspires employees yet it seems to be obfuscating the information that I would want to know as a business owner. But why?
Ryman’s business starts with the development side. First, the company looks for sites where there are both a shortage of high-quality existing aged care or retirement home options and the demographics are favorable. In other words, Ryman wants to see areas with no competition and lots of older people … potential customers or soon to be customers (demographics are destiny after all and most people tend to favor getting old to the alternative). If there is a suitable site in one of these areas, the development team acquires it and adds it to the company’s land bank. This kickstarts the planning and community engagement phase, where the team reaches out to residents in the surrounding area to determine the optimal design of the retirement village for the site and start the regulatory approval process. Once the company has the required permits in hand, they start marketing the new village to attract residents and initiate early construction work. As the construction team is building units, the sales and marketing team is busy finding people to fill them. This is where Ryman’s reputation comes into play. Ryman has won the top award in the aged care and retirement village category of the New Zealand Reader’s Digest Most Trusted Brands fives times in the last six years and has received the gold standard certification for clinical care from the Ministry of Health in 81% of their homes vs. less than 45% for competitors. There is a 97% occupancy rate for units at the company’s villages and many have a waiting list. Ryman’s retirement villages are nice, looking much more like a new condo development than the sad rundown retirement home that is featured prominently in North American media. This means that Ryman can sell out new development projects quickly. As the company finishes construction and sells the first phase of units, Ryman hires nursing and operations staff to run the facility. Residents move in and gradually the village becomes fully occupied.
One of the areas where Ryman differentiates itself from the competition is that its reputation allows it to fill retirement villages quickly and the scale of its development operations has made the company a well-polished machine at securing land, getting local consents and opening new villages. Ryman has been typically able to move from land acquisition to construction completion in two to three years while the competition often takes five years or longer. The short development period means that the company’s capital is recycled faster, generating a higher return for investors at the same time as providing a better experience for buyers who move in early. Imagine moving into a half-empty retirement village. It would feel like a ghost town. Resident satisfaction would fall, which in turn might harm Ryman’s reputation and make it harder to fill the next village.
We’re a company with a purpose – to look after older people. We know that if we get our care and resident experience right, and have happy staff, the financial results take care of themselves.
Up to this point, Ryman’s operations sound no different than those of the average developer of a suburb, condo or master-planned community. However, the ongoing involvement of the company after development is completed and residents move in separates this business model from that of other real estate developers. For residents in independent living in the village, Ryman provides exercise programs, activities programs (Ryman Engage) and other amenities like hair salons, cinemas and spas. 20% of residents in a Ryman Retirement Village live in a serviced apartment with flexible but more intensive levels of care. Residents in serviced apartments have certain meals prepared for them, receive assistance with their medications and other chores but live in an apartment that is otherwise identical to other residents in the independent living area of the village. Another 30% of residents live in Aged-Care Centres or more traditional retirement homes in the village where they receive 24-hour care. Aged-Care Centres are in short supply and Ryman gives residents in its independent living apartments priority access to suites in its aged care facilities if their needs change. This is one of the attractions for residents to move into an independent living apartment before needing round the clock care.
Ryman generates cash flow from three primary sources:
Unlike a condo or home, the title to an apartment in a retirement village is not sold to the resident. Instead, residents purchase an occupancy right which gives that resident the right to use that apartment for life and to use the community facilities. The underlying title/ownership is retained by Ryman. This payment dynamic explains much of Ryman’s exceptional performance over the last twenty years. Similar to our discussion of float in the Trupanion post, Ryman receives cash for occupancy from residents upfront and then can use this cash to finance the development of other villages. Ryman has received more than $2.8 billion of occupancy advances, net of the repayment of the capital sum. Ryman pays no interest on occupancy advances, so this provides the company with a low cost financing alternative to bank debt. It’s the principal reason that Ryman has been able to fund $3.7 billion of real estate development investment since its IPO without raising additional equity. Think of it as similar to deferred revenue from the software-as-a-service business model.
Another benefit of Ryman’s business model is that the 20% deferred management fee doesn’t depend on the duration that a resident stays in a village. It’s just a fixed 20%. Ryman’s customers are older people so their life expectancy can be on the shorter side. Ryman will make more money if its residents live for a shorter period after they move in. Ryman still benefits from providing high-quality care, as they need to convince people to move into a village in the first place, but the company makes more money in a year where more people die as the company can accrue all of the remaining unrecognized management fee revenue on the person’s contract when they do. That’s a bit morbid and it’s one of the reasons I jokingly refer to Ryman as a “merchant of death”.
The last interesting thing to take away from the practice of selling occupancy rights is that the resident doesn’t benefit from any appreciation in real estate prices. Ryman guarantees that it will repay the resident or the resident’s estate their 80% share of the capital sum at the end of the residency. It doesn’t matter if the underlying real estate has appreciated a lot. Ryman effectively has a call option on the real estate. At the end of a residency, Ryman will resell the occupancy right to another resident. The price that the new resident will be willing to pay for the occupancy right will depend on substitute products, a.k.a how expensive other housing in the area is. If house prices have gone up a lot since the last time the apartment has been sold, then Ryman will be able to resell the occupancy right for a significant margin over the cost of reimbursing the last resident his/her capital sum. These resale contracts are the most lucrative part of Ryman’s business. The capital cost of building the unit was entirely/mostly covered by the first resident, so any increase in the capital sum paid by the second resident will be pure profit margin for Ryman. New Zealand real estate prices have gone up a lot over the last 20 years, more than 5x in select cities (9% per year), so Ryman has made a lot of money from its call option held through retaining the title to the apartments and units in its villages. This is likely the largest single driver of Ryman’s exceptional performance over the last 20 years. And it’s one that is unlikely to repeat going forward for the next 20 years.
While the practice of selling occupancy rights and charging a deferred management fee can seem a little off-putting, I should note that the practice is common and that Ryman’s fees are on the low end of its peers. Ryman has also gone out of its way to be transparent on fees, provides residents with downside protection in the event real estates were to fall and fixes their weekly fees for the duration of the occupancy. This is more than can be said for many of their competitors. In my view there is nothing immoral in Ryman’s practices. The company is not evil. They just make more money when people pass away.
In periods where resale contracts are low, Ryman’s financial results lag expectations and forecasts as real estate market dynamics have made this the most profitable part of Ryman’s business. Ryman’s Chairman highlighted this in the annual report.
We fell short of this 15 percent increase this year, for two reasons. Firstly, we made some longer-term strategic decisions to reinvest in the business, which we believe will help performance in the coming years. Secondly, resale volumes were flat. It’s hard to predict the number of resales we get in the short term, but we would expect volumes to grow in the medium term in line with portfolio growth.
Said more bluntly, fewer residents died than Ryman was expecting so underlying profit grew less than expected. But investors shouldn’t be worried because the more Ryman grows its retirement village portfolio and the more residents they have, the more likely it is that more people will die in any given year. Death is the great inevitability after all. That and taxes. That’s another reason why Ryman is a merchant of death.
Ryman’s long-term profitability is a direct result of resident happiness. The happier residents are, the more likely they will be to recommend to their friends that they should live in a Ryman community. The more people that want to live in a Ryman village, the more the company can collect in occupancy advances and the higher the price the company can charge on resale units. That’s why, despite being a merchant of death and all that, Ryman does a really good job is maintaining high-quality care and living conditions for all residents. They make money when you die but they’ll treat you as well as possible while you’re there. If you could just hurry up on your way out, they’d like that even better.
We also invested in developing our people, by establishing the Ryman Academy. With several excellent education providers, including the Melbourne Business School, we will provide world-class development courses and support for our senior leaders.
Ryman has invested a lot more in care than its competition. Historically, retirement village operators tended to outsource care and focus on developing apartments with amenities. This led to poor quality care at many villages, such as the resthome that Kevin first looked at before founding Ryman in 1983, as operators were incentivized to keep outsourced care costs low. Since its IPO, Ryman has focused on providing a direct continuum of care model where care is provided by dedicated company staff and there are a range of care options available to suit all needs. Ryman goes out of its way to pay its staff well and expresses in the annual report that it wants to prioritize promoting from within when possible. Ryman wants employees to work there for their whole career, a novelty in this day of us millennials hopping between jobs every 24 months. To this end, the company has introduced Ryman Academy to provide development courses to its employees. The quality of care provided by Ryman is a big reason why the company has been so successful. The better the care and accommodations in Ryman’s villages, the faster it can sell down units in its villages and the better the return on capital will be for investors.
Our land bank is the strongest it’s ever been. By the end of 2020, we plan to have five villages open in Victoria. Our goal is to keep the land banks in both countries at a supply of not less than 4 years. From that point, we want to open four villages a year: two in Victoria, one in Auckland, and one somewhere else in New Zealand.
The more villages that Ryman has, the higher its underlying profit from management fees, care fees and the more money it can make if real estate prices continue to increase. Compared to other retirement village operators, Ryman’s development and construction groups are well-oiled machines that create value through the faster development timeline, fewer regulatory issues and higher build quality. It’s no surprise then that the company is focused on maximizing its build rate.
The key driver of Ryman’s returns since its IPO is local real estate conditions. The key driver of Ryman’s underlying profit in any one year is the number of resale opportunities. Management can’t predict either one. So how much credit should executives get for Ryman’s financial performance in any given year? They certainly deserve some of the credit. They’ve made high-quality housing for seniors, delivered great care to their residents, picked good development sites and kept build quality high and costs low. But the industry environment matters a lot too. Initiatives and performance should always be considered in the context of the environment to avoid misattribution. Exceptional results in a recession are likely to be lower than mediocre results in an economic expansion.
We’ve highlighted Ryman as a company that has delivered exceptional returns for investors, motivated by both profits and the purpose of helping older people enjoy their well-deserved retirement. But Ryman doesn’t make most of its money on a resident enjoying their retirement, it makes most of its money when a resident’s retirement ends. That’s the third and final lesson we’ve taken from Ryman’s annual report for evaluating the performance of an executive team. You better know how the company makes money. Ryman’s board and management team certainly do. They just aren’t that eager to tell their shareholders.
|North Star Performance||$2.8 Billion in Cumulative Net Occupancy Advances|
|Resident Focused Activities||Open Four New Villages Per Year |
Achieve “Gold Standard Certification” at Care Centers
Improve Resident’s Quality of Life Right side text
|Resident Focused Activities||Roll Out myRyman (Healthcare App for Residents)|
Expand Ryman Delight program
|Development / Financial Focused Activities||Expand the Land Bank for Future Development|
Receive Permits and Consents for 12 Sites
Keep resale stock low
|HR Activities||Introduce Ryman Academy|
Expand Lead, Energise and Perform (LEAP) leadership programme