Retirement village developer and operator Summerset Group Holdings reported its financial result for the six months ended 30 June last week. Highlights included underlying earnings growth of 45%, an expansion of development margins to a record 28% and a material uplift in net tangible assets. Compared to most of our local listed companies, the headline financial performance of Summerset is impressive. However, its performance is heavily tied to the residential property market.

Like the other listed operators in the sector, Ryman Healthcare and Metlifecare, Summerset primarily generates earnings growth via:

  1. Constructing a new village and generating a profit on the sale of its units to incoming residents;
  2. Collecting a management fee throughout each resident’s stay in a unit; and
  3. Capturing a capital gain when a unit is resold.

Other activities undertaken at the village, such as providing care services to the residents, are far less material to earnings growth.

The rapid growth that Summerset has experienced is due to the company aggressively developing new villages and our previously buoyant residential property market allowing for a material expansion in sales prices of both new and old units. However, recent residential property market data has been making investors nervous that the company’s growth may slow. Summerset’s share price has fluctuated with this sentiment over the past year.

Recent Real Estate Institute of New Zealand (REINZ) data to 31 July reported a 25% decline in national sales volumes with prices down for the third consecutive month and annual price growth easing to just 1.2%, which is the softest since mid-2011.

In contrast to the data, Summerset is continuing its aggressive development path. CEO Julian Cook remains upbeat about the company’s ability to continue to generate significant earnings growth despite recent evidence of a slowing property market. Summerset intends to build 450 new units this year and will likely seek to increase this in years to come. It also continues to increase its banking facilities, recently raising $100m via a retail bond offer.

The key feature that Cook believes will sustain Summerset’s profit growth through a slowing housing market is the embedded value within the business. This measure reflects the cash that will be generated when existing units currently occupied by residents are resold at current market prices (via capital gains and crystallising the management fee payment). For Summerset, this measure at present represents $419m of earnings that will flow in years to come.

Summerset could continue to report impressive underlying earnings growth and expand aggressively for several years to come due to its embedded value. However, in the long term, the residential property market will heavily influence the performance of the company. How investors reflect this through the company’s share price will be interesting to observe.