New Investor Augurs Well For G8 Education

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Child care provider G8 Education has improved its balance sheet metrics, teaming up with a Chinese investor to provide capital to pursue acquisitions.

-Commentary around dividend augurs well for improved capital allocation
-Need to witness delivery on performance indicators such as occupancy
-Increased detail on longer-term strategy welcomed
 

By Eva Brocklehurst

Child care operator G8 Education ((GEM)) has teamed up with a Chinese investor, which has provided the capital to enable the company to restore its balance sheet and pursue acquisitions.

The $213m placement to fund committed growth opportunities and de-gear the balance sheet was a positive surprise for Deutsche Bank. The broker also welcomes increased disclosures around occupancy in the 2016 results and the commentary surrounding the dividend, which augurs well for improved capital allocation.

The company settled on 21 new childcare centres in 2016. Its Australian portfolio has increased to 490 with 38,713 daily licensed places. An additional 28 centres are expected to settle in 2017 at a cost of $80m. The placement, to China First Capital at $3.88 per share, will be used to pay down a corporate bond and working capital facilities. The company now has a 12.5% stake in G8 Education.

Following debt re-payment the company's net debt/earnings ratio will reduce to 1.7 from 2.2. Management intends to maintain gearing at this level. The equity raising alleviates Deutsche Bank's main concerns while reducing the downside risks for shareholders.

Moelis notes around $200m has been committed for future acquisitions, mainly new developments, over the next 2.5 years and assumes a contribution of around $45m to earnings by the end of 2019. The broker, not one of the eight monitored daily on the FNArena database, has a Buy rating and $4.22 target.

Occupancy Concerns

Deteriorating occupancy remains a concern for UBS, stemming from increased supply, and this in turn raises the question of whether the company can continue to raise prices at around 6% annually over the medium to long-term.

The re-capitalisation of the balance sheet underpins the company's acquisition profile and while trading multiples are not demanding Macquarie, too, would like to witness delivery on key performance indicators, particularly around occupancy, as well as obtain further details on the nature of acquisitions which are development weighted.

Operating revenue was around 2% below Macquarie's expectations and this reflected a decline in occupancy in operating centres where there are pockets of weakness such as inner Sydney and the northern beaches as well as generally in both Western Australia and north Queensland.

Occupancy weakness, caused by increased supply, is also Canaccord Genuity's main short-term concern regarding the stock. The broker notes the company will spend the next three months evaluating whether there is an opportunity to collaborate with China First Capital in the early education sector in China.

While the detail is absent at present, the broker believes the opportunity is significant, although suspects, should this materialise, the board would take a cautious approach. Canaccord Genuity, not one of the eight monitored daily on the database, has a Buy rating and $4.30 target.

Ambitious 2019 target

In consultation with major shareholders, the company will determine the appropriate dividend policy moving forward. The broker suspects that with a balance sheet positioned for growth, it is likely that the pay-out ratio, considered too high, can reduce as earnings per share increases.

Canaccord Genuity estimates the pay-out ratio will reduce to below 70% by 2019, assuming the dividend is maintained at 6c per quarter.

Management is targeting earnings per share of 40c in FY19 but the broker believes this goal is likely to be a stretch, although it does point to expectations for strong earnings growth over the forecast years. Moelis also expects a lower pay-out ratio in future and assumes 65-70% from 2018.

While early days, Canaccord Genuity welcomes the approach by the new management team to market communication. The broker observes greater detail on the long-term strategy. Investors usually respond well to further clarity, which could have a positive influence on sentiment over time, the broker suggests.

Results were in line with guidance and, importantly, Ord Minnett notes a stabilisation of operating costs. The broker believes the investment by China First Capital provides the financial flexibility to pursue growth opportunities and removes a primary negative attribute, in that the company was relatively highly geared versus its peers.

Ord Minnett upgrades forecasts but remains well below management's FY19 target of 40c for earnings per share. Nevertheless, the broker believes this is the time to upgrade to Buy from Accumulate.

There are three Buy ratings and one Hold on the database. The consensus target is $4.05, suggesting 6.6% upside to the last share price. Targets range from $3.87 (Macquarie) to $4.20 (Deutsche Bank). The dividend yield on FY17 and FY18 forecasts is 5.8% and 5.9% respectively.
 

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