Treasure Chest | Jul 16 2019
FNArena's Treasure Chest reports on money making ideas from stockbrokers and other experts. Brokers suspect G8 Education faces difficulties as its acquisitions underperform.
-Excess supply of new childcare centres negatively affecting the company's existing portfolio
-Consensus estimates may be downgraded at the first half result
-Acquisitions made in 2019 face minimal competition to date
By Eva Brocklehurst
Childcare centre operator G8 Education ((GEM)) is facing an uphill battle, amid surging growth in new childcare centres. Brokers had been expecting occupancy growth would continue to improve in 2019 as the supply of new centres abated.
However, Moelis notes growth in new childcare centres nationally was 3.9% as of June 30 and there were 71 net new centres added in the second quarter, versus 47 in the previous corresponding quarter.
This reverses the trend of declining supply rates observed since the September quarter of 2018. In adjusting estimates to reflect this increase in new supply, the broker reduces G8 Education's earnings forecasts by around -3% for 2019, to $149m. Like-for-like occupancy growth forecasts have been reduced to 1.6% from 2.0%.
Wilsons believes the company's cohort of 2019 acquisitions have also underperformed expectations. Admittedly, acquisitions can take up to two years to trade at sustainable levels but the broker suspects medium-term earnings momentum will be challenged. Combine this with excess supply of new centres negatively affecting the existing portfolio, as well as ambitious consensus estimates, and forecasts are expected to be downgraded at the first half results on August 26.
Wilsons has looked at the most competitive suburbs for child care operators nationally and the level of direct competition faced by the company. G8 Education has significant operations in five of the 10 most competitive suburbs by number. The broker calculates, in the last four years, childcare centre developers have, on a consolidated basis, built and opened 1.6x the required annual demand.
Acquisitions have also underperformed historically, as the company acquired 74 centres between 2016 and 2018, which should now be achieving annual earnings of $46.5m, and in 2018 they delivered just $17.5m. Furthermore, the analysis shows that, despite micro issues, these 74 centres are competing with a total of 757 within their suburbs of operation.
The company expects earnings from prior acquisitions to be $27.0m in 2019, which implies earnings underperformance of the majority of the acquisitions. This is attributed to the significant competition each faces. The broker is not that surprised by the likely underperformance. The 2017 cohort of 37 centres took almost two years to trade to sustainable levels and, while the 2019 occupancy levels for this cohort started more positively, Wilsons assesses the 2017 cohort faces the most competition.
Of the 2019 cohort only three out of the 19 centres were operating in July. The remainder are likely to be opened late in the second half and could strategically shield the company from additional headwinds to earnings over the rest of the calendar year. This cohort is better situated and faces minimal competition to date, Wilsons points out, although it is still being rolled out. Still, the 2019 cohort is not expected to make a large difference to earnings in the near term.
Wilsons forecasts earnings (EBIT) of $145.9m in 2019 and $150.1m in 2020, below consensus and makes no changes to forecasts. The broker attributes stronger consensus forecasts to expectations for more bullish price increases, at 3.5% versus 2.5% (Wilsons).
However, the main risk to numbers, given broad sector feedback, is cost inflation, particularly staffing costs, which the broker assesses could be running as high as 5.5%. G8 Education has not provided quantitative guidance but had advised at its AGM that the second half is likely to be stronger than the first. Wilsons, not one of the seven brokers monitored daily on the FNArena database, has a Sell rating and $2.46 target.
Moelis, also not one of the seven, downgrades to Hold from Buy and lowers the target to $3.38. Regardless of the downgrade, the broker continues to expect "decent" earnings growth for the company in the medium term and concludes that the combination of internal quality investment in the new subsidy, favouring the company's low-middle income parent cohort, will continue to drive incremental demand.
Nevertheless, Moelis would like to observe either occupancy growth exceeding estimates at the half-year result or evidence of supply moderating, in order to upgrade the outlook.
Regular brokers on FNArena's database have not updated recently, and there are four Buy ratings and one Hold (Morgans). The consensus target is $3.56, signalling 31.4% upside to the last share price. The dividend yield on 2019 and 2020 forecasts is 5.2% and 6.2% respectively.
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