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History has taught us that federal budgets sometimes prove to be catalysts for the share price of selected stocks.  In the Federal Budget of 2014 projected cuts to healthcare spending sent some stocks reeling. 

So are there any clear-cut winners and losers coming out of the 2015 Budget? 

First let’s look at some stocks that may have been affected by early budget previews and speculation. Investors burned by the reaction to last year’s budget may have been concerned about the potential changes to the Pharmaceutical Benefits Scheme (PBS).  Specifically, it appeared a variety of over-the-counter drugs were to be eliminated, causing the Pharmaceutical Sector to “prepare for war,” according to a headline in The Australian.   Given the cost of federal healthcare spending and the current government’s pledge to fix the budget, the XHJ Healthcare Index may have suffered as well because of concerns over reimbursement funding for certain medical procedures.  Here is a one month chart comparing the XHJ and the two biggest pharmaceutical stocks on the ASX, Australian Pharmaceutical Industries (API) and Sigma Pharmaceutical (SIP).  

You can see the drop which roughly coincided with the appearance of financial articles speculating on the budget.  Year over year the XHJ is up 25%; SIP is up 20%; and API is up 200%.  You can also see the share price of the two Pharma Sector stocks began to go back up as the budget was released.  Details are sketchy but the new budget calls for $1.6 billion devoted to new inclusions in the PBS, including cancer treatment drugs.  Despite the pre-budget concerns, analysts at JP Morgan claim the budget is a “net positive” for the healthcare sector. 

Another sector that caught investor attention prior to the release of the budget was childcare.   The government previewed spending proposals for the sector, causing a rush of investors gobbling up shares of the likely winners.  Analysts at Canaccord Genuity said the proposed $3.5 billion in extra government funding and incentives would drive demand for childcare; helping to achieve the government’s goal of increasing participation in the work force.  Three stocks were mentioned by Canaccord Genuity – G8 Education (GEM); Affinity Education Group (AFJ); and Folkestone Education Trust (FET).

When the actual budget was released, the childcare sector proposals came with details, including income thresholds and subsidy percentages.  Families earning less than $65,000 per year will have 85% or their childcare costs paid for by the government.  The subsidy is calculated on a means-tested sliding scale with payments dropping to 50% at incomes above $170,000.  Families with incomes above $180,000 will have childcare reimbursements capped at $10,000 per year, an increase of $2,500 over the current level.

While the spending will not kick in until 2017, shares of the childcare providers have already gotten a boost.  To the three mentioned by Canaccord we add a 2014 IPO – Think Childcare and Education Ltd (TNK).   Here is a price movement chart for the industry leader, G8 and the second largest childcare stock by market cap, Folkestone Education Trust.

Now let’s look at the other two stocks that could be winners – Affinity Education and Think Childcare.

However, as soon as further details were released in the budget, investor ardour towards these four stocks cooled a bit.  This could be perhaps due to the timing of the added spending; or the hurdles of getting spending cuts (needed to pay for the increases) passed in the Senate.  The spending program is meant to get more people into the labor force, with government estimates of a potential 240,000 new entrants.  Are these four likely to be long-term winners?  

G8 Education has been one of the hottest stocks on the ASX, up more than 300% since the company went public in 2007 under the name Early Services Limited (ELY).  A March 2010 merger with another operator led to the company under its current name, G8 Education.  At the time the new entity operated about 80 childcare centres.  Through acquisition the company has grown to more than 400 centres. GEM pays a fully franked dividend, with a current yield of 5.3%.  Total shareholder return over three years is 71% with 54.3% over five years.  

Despite its stellar performance some experts question the long term sustainability of GEM and others in this sector; they are low margin, high cost operations with a limit to how much fees can be raised.  The limit is not regulatory but rather a matter of what clients can realistically afford and with more subsidies centre operators may find it easier to raise fees to cover costs and remain profitable.

Stock analysts, however, are bullish on these four companies.  The following table lists all four with some relevant metrics.

Company

(CODE)

Market Cap

 Share Price

Dividend Yield

Forward P/E

2 Year Earnings Growth Forecast

Analyst Consensus Rating

G8 Education

(GEM)

$1.6b

$4.10

5.3%

12.84

+31%

Outperform

Folkestone Education Trust

(FET)

$534m

$2.19

5.5%*

5.3

Outperform

Affinity Education

(AFJ)

$252m

$1.11

12*

+21.6%

Outperform

Think Childcare

(TNK)

$41m

$1.05

8.08*

+61%

Buy

 

Folkestone is a REIT (Real Estate Investment Trust) that owns and leases child care centres.  In 2014 the entity merged with another REIT, the Folkestone Social Infrastructure Trust (FST) with holdings in healthcare and government properties as well as early childhood education centres.  The move raised the total childcare centres owned by FET to over 400.

The following chart from the Folkestone Website shows the revenue distribution for the trust by child care operator.

Note that G8 is the only publicly traded provider leasing space from FET.  Goodstart is a non-profit operation, the largest in Australia with about 640 centres.  Goodstart grew out of the collapse of ABC Learning and as a non-profit is not a likely acquisition target.  However, 33% of the FET revenue comes from operators that could get acquired.   Goodstart reportedly has 12% of the current market, with G8 holding 5%, and Affinity Education controlling 1%.  Think Childcare controls less than 1%.  Do the math and it seems about 81% of the market is available for takeovers from the likes of GEM, AFJ, and TNK.

G8’s financial results reported for the Half Year 2014 and the February release of Full Year Results were outstanding.  For the Half Year the company posted a 59% revenue increase and a 48% profit increase.  Full Year results saw a 79% increase in revenue and a 70% increase in net profit.  Yet the share price is down almost 7% year over year.

Affinity Education came on the ASX in 2013 with an issue price of $1.00.  The company is following the acquisition model with approximately 90 centres added since the company went public.  Currently the company owns about 150 centres.  

Investors were apparently unimpressed with AFJ’s Full Year revenue increases and focused on the profit loss of $4.1 million, an improvement over the 2013 loss of $8.9 million.  The report was released on 27 February and in a matter of weeks the company went into a voluntary trading halt pending an announcement about another acquisition and a capital raise.  Market participants were even more unimpressed with that news and the share price plunged again.  Here is the chart.  

While the company has yet to turn a profit it does have a respectable earnings growth forecast and analysts like the stock.  The P/E ratio included in the table is a current P/E not a Forward P/E.  Considering the Sector P/E is 18.46 shares of AFJ do not seem overpriced.  Affinity has some impressive support, with a $100 million debt facility with Commonwealth Bank of Australia.

Think Childcare and Education Limited made its debut on the ASX on 23 October, 2014.  The company operates 30 childcare centres, with 28 in Victoria and 2 in New South Wales.  TNK has a $29 million dollar debt facility with Australia and New Zealand Bank.  The company plans to follow its competitors with an acquisition strategy to grow.  While its 61% earnings growth forecast is impressive, that represents a rise from a loss of $0.209 per share in 2014 to positive earnings of $0.124 by FY 2016.

With government support behind them these stocks appear like winners.  However, considering that acquisition seems to be the only way these companies have to grow, increased consolidation in the sector is sure to drive up the price of acquisition as we now have three for-profit operators on the stage.

Perhaps the clearest potential winners to emerge following the budget announcement were a select group of retailers.  The budget included a stimulus package for small businesses consisting largely of tax breaks.  Businesses with revenues under $2 million get to write-off up to $20,000 in asset purchases.  Allowable assets include just about anything a business needs to operate from phone systems to furniture to computers to basic hardware and yes, even to the office coffee machine!

Unlike other budget provisions, this one takes effect almost immediately – 1 July of this year.  This is a 100% write-off with a limit ballooning from the previously allowable threshold of only $1,000.

In addition the tax rate for incorporated small business has been reduced from 30% to 28.5% with breaks for unincorporated businesses as well. Finally, the fringe benefit tax on work laptops, phones, and tablets has been eliminated.

There are several consumer discretionary retailers that stand to benefit here but the two that got the biggest initial bump were consumer electronics retailers JB HiFi (JBH) and Dick Smith (DSH).  Here is a price chart showing the move.

There are other retailers in line to reap the potential benefits including the hardware operations of both Woolworths (WOW) and Wesfarmers (WES); electronics retailer Harvey Norman (HVN); computer hardware retailer Dicker Data (DDR); and mobile phone retailer Vita Group (VTG).  Of this group, DDR looks especially attractive with a 2 year earnings growth forecast of 41.7%; a fully franked dividend with a current yield of 5%; and a 2 year dividend growth forecast of 48.7% – all this without the boost from the small business stimulus.

In the scramble to explain to investors how the budget could affect stocks, it is somewhat surprising more attention has not been paid to another “Maybe” Sector – infrastructure stocks.  The budget calls for $5 billion in infrastructure spending across Northern Australia.  Beyond a generic listing of projects ranging from road to rail to port to power, there are no details except to look for a White Paper to be released “later this year.”  There is also mention of $50 billion to go toward improving the rail and road network across Australia, with no specifics.  

Without specifics of any kind this Sector is a definite “Maybe” but most major companies in infrastructure have seen share prices drop in the wake of the decline in mining construction.  Here is a list of stocks for your watch list that have seen more than 10% declines year over year.

•    Downer EDI (DOW)         down 10%

•    UGL Limited (UGL)        down 72%

•    Decmil Group (DCG)        down 40%

•    WorleyParsons (WOR)        down 36%

•    Monadelphous Group        down 46%.

Investors who follow the Top Ten Short Lists for opportunities to benefit when the shorts get it wrong should take notice that WOR, UGL, and MND are all currently in the Top Ten.

Please note that TheBull.com.au simply publishes broker recommendations on this page. The publication of these recommendations does not in any way constitute a recommendation on the part of TheBull.com.au. You should seek professional advice before making any investment decisions.