G8 Education Ltd (GEM) – BUY
|Date of Report||ASX||Price||Price Target||Analyst Recommendation|
|Date of Report|
|Sector : Consumer Discretionary||52-Week Range: A$2.01 – 4.71|
|Industry: Commercial Services||Market Cap: A$950.0m|
We rate GEM as a Buy for the following reasons:
- Post recent share price drop we see value re-emerge in GEM’s valuation.
- Long-term outlook for childcare demand remains positive with growing population (organic and net immigration).
- New management team (CEO and CFO), with a greater focus on organic growth as well as acquired growth.
- Increasing exposure to offshore markets (Asia).
- Strategic investor in China First Capital Group (12.45% stake in GEM) could see a partnered expansion into the Chinese market.
- National footprint allows the Company to scale better than competitors and mum and dad operators.
- Potential takeover target by a global operator.
We see the following key risks to our investment thesis:
- Execution risk with achieving its FY19 earnings per share (EPS) target.
- Increased competition leading to pricing pressure.
- Increased supply in places leading to reduced occupancy rates.
- Value destructive acquisition(s).
- Offshore expansion execution risk.
- Adverse regulatory changes or funding cuts to childcare.
- Recession in Australia.
- Dividend cut
GEM’s first half calendar 2018 (1H18) highlighted that the current oversupply in the industry is not abating and will likely keep downward pressure over the next 12 months on occupancy levels with management expecting some sort of balance to the supple/demand equation in late 2019.
What further disappointed the market and us was the jump in operation costs (wages and support staff). With occupancy levels down 250bps, underlying operating earnings (EBIT) down -21.3%, dividend cut (implementing new dividend policy sooner) and underling NPAT down -24%, all contributed to a significant de-rating of the share price (down -16.5% yesterday).
On a positive note, the Company has undertaken refinancing and restructuring of its debt on more favourable terms and existing self-help initiatives should provide some support going forward.
Having said that, there is no doubt near-term earnings and trading conditions remain tough. Our confidence has been shaken but not completely broken (yet). In our view, the challenges remain are of a cyclical nature and not structural.
What keeps us interested:
1. Government funding should provide some support;
2. Call centre pilot is showing encouraging signs with improved occupancy and conversion rates;
3. The supply / demand equation can only be pushed so far before it becomes untenable (in this scenario large operators with scale have some advantage weathering the storm), however we are seeing signs of pipeline of firm/commenced development applications (DAs) moderating. Maintain Buy.
- Regulatory changes impact wages. Management noted wage growth saw a $7.2m uplift in costs due to regulatory changes. Management noted the time it took for GEM’s wage efficiency initiatives to help offset this impact took longer than expected. However, current wage trends point to improved group performance in this front in the second half of the year.
- Market dynamics – supply/demand pushed out. The overall market has been characterized by oversupply in recent years, with second quarter of CY18 seeing +4.0% supply growth led by ACT (+4%), SA (+7.2%) and VIC (+8.0%). However, management noted supply has started to moderate with encouraging signs it may be more balanced by mid to late 2019. The pipeline of firm/commenced development applications (DAs) are forecast to moderate. Having said that, market conditions are expected to remain challenging over the coming 12 months.
- New pilot indicates positive early signs. The Company is currently running a pilot call centre, which during the first half of the year delivered positive results in line with expectations. The pilot which is currently being tested across 17 centres experienced approximately +1.5% increase in occupancy vs. rest of the group, with conversion rates doubled from 20% to 40%. The Company will look to roll out this strategy to the rest of the group in the early part of 2019.
- New subsidy causing some disruption. Management noted that, as expected, the new rules coming into effect 1 July 2018 (providing additional $3.5bn to the early learning sector) has caused disruption. With those not meeting the requirements dropping off but management also seeing a healthy pick up offsetting these, pointing out “…probably did have some parents reducing their days and also some leaving our centres. They were actually more than offset by new parents and parents increasing their days, as we had good levels of occupancy growth in July and August.”
1H18 RESULTS SUMMARY…
Figure 1: GEM 1H18 results summary
Operating earnings. Underlying EBIT of $48.1m was -21.2% below pcp, with the decline predominantly driven by:
1. a $10.6m increase in wage expense (regulatory changes to staff ratios);
2. Icreased costs in support costs and higher depreciation costs; and (3) occupancy decline.
Figure 2: GEM underlying EBIT drivers
Regulatory changes impact wages. Management noted wage growth saw a $7.2m uplift in costs due to regulatory changes. Management noted the time it took for GEM’s wage efficiency initiatives to help offset this impact took longer than expected. However, current wage trends point to improved group performance in this front in the second half of the year.
Occupancy levels drop. GEM’s occupancy levels dropped 250bps to 70.1% during 1H18, with a decline felt in across all States (ACT was most impacted down 410bps). We have previously noted that +/- 1% occupancy levels result in a +/- $10m impact at the EBIT line (all else being equal). On a positive note, this has seen a steady improvement in occupancy levels since February 2018.
New pilot indicates positive early signs. The Company is currently running a pilot call centre, which during the first half of the year delivered positive results in line with expectations. The pilot which is currently being tested across 17 centres experienced approximately +1.5% increase in occupancy vs. rest of the group, with conversion rates doubled from 20% to 40%. The Company will look to roll out this strategy to the rest of the group in the early part of 2019.
Cash flow & Balance sheet. Cash flow conversion was solid at 99% of EBITDA. The Company made good progress on refinancing upcoming maturities, with a $400m credit approved and progressing towards securing an additional $100m debt facility.
Dividends. During the half, the group applied its new dividend policy (was meant to start in 2019), with a target payout ratio of 70-80% of NPAT. The Company declared an interim dividend of 4.5cps (85% of underlying NPAT).
Market dynamics – supply/demand pushed out. The top 5 players in the sector hold approximately 20% of market share, with the remaining 70% shared among smaller operators. The overall market has been characterized by oversupply in recent years, with second quarter of CY18 seeing +4.0% supply growth led by ACT (+4%), SA (+7.2%) and VIC (+8.0%). However, management noted supply has started to moderate with encouraging signs it may be more balanced by mid to late 2019. The charts below highlight the acceleration in supply over the past 2 years, however pipeline of firm/commenced development applications (DAs) are forecast to moderate. Having said that, market conditions are expected to remain challenging over the coming 12 months.
Figure 3: National Long Day Care Supply (% Chg YoY)
Source: Company, ACECQA / Cordells
Source: Company, ACECQA / Cordells
Figure 5: GEM Financial Summary
Source: BTIG, Company, Bloomberg
G8 Education Limited (GEM) owns and operates care and education services in Australia and Singapore through a range of brands. The Company initially listed on the ASX in December 2007 under the name of Early Learning Services, but later merged with Payce Child Care to become G8 Education.
Recommendation Rating Guide
|Recommendation Rating Guide||Total Return Expectations on a 12-mth view|
|Speculative Buy||Greater than +30%|
|Buy||Greater than +10%|
|Neutral||Greater than 0%|
|Sell||Less than -10%|
Reach Markets Disclaimer
Reach Markets Pty Ltd (ABN 36 145 312 232) is a Corporate Authorised Representative of Reach Financial Group Pty Ltd (ABN 17 090 611 680) who holds Australian Financial Services Licence (AFSL) 333297. Please refer to our Financial Services Guide or you can request for a copy to be sent to you, by emailing email@example.com.
Read our full disclaimer here >
This publication contains general securities advice. In preparing the advice, Reach Markets Australia has not taken into account the investment objectives, financial situation and particular needs of any particular person. Before making an investment decision on the basis of this advice, you need to consider, with or without the assistance of a securities adviser, whether the advice in this publication is appropriate in light of your particular investment needs, objectives and financial situation. Reach Markets Australia and its associates within the meaning of the Corporations Act may hold securities in the companies referred to in this publication. Reach Markets Australia does, and seeks to do, business with companies that are the subject of its research reports. Reach Markets Australia believes that the advice and information herein is accurate and reliable, but no warranties of accuracy, reliability or completeness are given (except insofar as liability under any statute cannot be excluded). No responsibility for any errors or omissions or any negligence is accepted by Reach Markets Australia or any of its directors, employees or agents. This publication must not be distributed to retail investors outside of Australia.
It is recommended that you seek independent advice and read the relevant Product Disclosure Statement before making a decision in relation to any investment. Any advice contained in this communication is general and has not taken into account the investment objectives, financial situation and particular needs of any particular person.
Banyan Tree Disclaimer
This document is provided by Banyan Tree Investment Group (ACN 611 390 615; AFSL 486279) (“Banyan Tree”).
The material in this document may contain general advice or recommendations which, while believed to be accurate at the time of publication, are not appropriate for all persons or accounts. This document does not purport to contain all the information that a prospective investor may require. The material contained in this document does not take into consideration an investor’s objectives, financial situation or needs. Before acting on the advice, investors should consider the appropriateness of the advice, having regard to the investor’s objectives, financial situation and needs. The material contained in this document is for sales purposes. The material contained in this document is for information purposes only and is not an offer, solicitation or recommendation with respect to the subscription for, purchase or sale of securities or financial products and neither or anything in it shall form the basis of any contract or commitment. This document should not be regarded by recipients as a substitute for the exercise of their own judgment and recipients should seek independent advice.
The material in this document has been obtained from sources believed to be true but neither Banyan Tree nor its associates make any recommendation or warranty concerning the accuracy, or reliability or completeness of the information or the performance of the companies referred to in this document. Past performance is not indicative of future performance. Any opinions and or recommendations expressed in this material are subject to change without notice and Banyan Tree is not under any obligation to update or keep current the information contained herein. References made to third parties are based on information believed to be reliable but are not guaranteed as being accurate.
Banyan Tree and its respective officers may have an interest in the securities or derivatives of any entities referred to in this material. Banyan Tree does, and seeks to do, business with companies that are the subject of its research reports. The analyst(s) hereby certify that all the views expressed in this report accurately reflect their personal views about the subject investment theme and/or company securities.
Although every attempt has been made to verify the accuracy of the information contained in the document, liability for any errors or omissions (except any statutory liability which cannot be excluded) is specifically excluded by Banyan Tree, its associates, officers, directors, employees and agents. Except for any liability which cannot be excluded, Banyan Tree, its directors, employees and agents accept no liability or responsibility for any loss or damage of any kind, direct or indirect, arising out of the use of all or any part of this material. Recipients of this document agree in advance that Banyan Tree is not liable to recipients in any matters whatsoever otherwise recipients should disregard, destroy or delete this document. All information is correct at the time of publication. Banyan Tree does not guarantee reliability and accuracy of the material contained in this document and is not liable for any unintentional errors in the document.
The securities of any company(ies) mentioned in this document may not be eligible for sale in all jurisdictions or to all categories of investors. This document is provided to the recipient only and is not to be distributed to third parties without the prior consent of Banyan Tree.
This document has been commissioned by Reach Markets Australia Pty Ltd and provided by Banyan Tree Investment Group (ACN 611 390 615; AFSL 486279) (“Banyan Tree”).