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Think Upside

Small Caps | Nov 13 2018

An impressive update from child care centre operator Think Education has brokers lining up their Buy ratings after a tough year for the industry.

-Occupancy rates improving
-Guidance retained despite headwinds
-Signs of industry turnaround

By Greg Peel

The share prices of child care centre operators have been in a downward trend all year as growing supply outstrips occupancy growth despite new government child care subsidies. But more recent signs suggest the industry could now be turning the corner.

After hitting a low late last month, listed industry leader G8 Education ((GEM)) has since enjoyed a rebound, albeit buoyed by improvement in macro sentiment (until today) and the fact the stock was over 9% shorted as of last week.

Smaller rival Think Education ((TNK)) similarly bounced off a low of $1.13 having peaked at $2.29 in January, closing at $1.45 yesterday. Yesterday the company provided a September quarter update which left brokers rather impressed.

Think had suffered a drop in occupancy levels of -6.2% year on year in the period February to June but this number improved to -2% in August and is now at -0.5% according to yesterday’s update. The company has guided to earnings of $10.6m in 2018 compared to a prior $10-11m range.

While this might represent the barest of upgrades, brokers find guidance very encouraging considering the earnings headwinds the company has faced to this point. Given Think posted earnings of only $2.7m in the first half, guidance is for $7.9m in the second half. This comes despite delays in the settlement of a previous acquisition costing -$200,000, greenfields sites underperforming by -$500,000 and an additional -$300,000 spent on marketing.

Bottom-Of-The-Cycle Opportunity?

Stockbroker Wilsons suggests the company’s improving occupancy trend reflects the early success management is having turning around 14 of its underperforming centres, the impact from a successful marketing campaign directed at better performing centres, and more favourable centre locations.

Greenfield underperformance remains a concern but timing was unfavourable as the company missed the key second half enrolment period.

Moelis Australia estimates Think’s centres currently operate at around a 67% occupancy level compared to G8’s 74% and Goodstart’s (not for profit) 80%. The broker expects Think’s occupancy to continue to increase in line with significant reinvestments being undertaken across all areas of asset and service quality.

Think operates under a unique model which provides the opportunity to compound capital at high rates of return. The company can achieve around a 20% return on capital deployed, Moelis notes, thanks to its “incubator” program.

This program sees Think managing centres from commencement to 75% plus occupancy before actually acquiring them. The company has more than 100 centres within its incubator pipeline and yesterday announced the acquisition of five new centres.

Canaccord Genuity assumes eight more centres will be acquired in 2019.

Canaccord recently conducted its third child care industry survey for the year, which showed some improvement in several operating metrics including occupancy and the impact of supply. Of those centres surveyed which have begun enrolments for 2019, 63% reported enrolments at either equivalent of higher levels than a year ago.

The broker believes occupancy is improving, initial child care subsidy teething problems have largely been resolved and supply issues may start to ease in 2019.

Moelis sees a “bottom of the cycle” opportunity on an improving sector outlook, as the new subsidy supports demand and as supply moderates.

Canaccord believes management has done an exceptional job in positioning the company to both weather the challenges and take advantage of improving industry conditions.

All three brokers see value in the stock after a year-long decline in share price.

Wilsons maintains Buy and $1.69 price target, Moelis retains Buy with a $2.00 price target, and Canaccord upgrades to Buy from Hold, lifting its target to $1.78.

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