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A new childcare centre near my house has apparently been swamped by demand. Getting quality child-minding, at an affordable price, is becoming an even bigger issue – and positive trend for companies that provide such services or those who own the properties.
Business forecaster IBISWorld says the Australian childcare services industry grew a staggering annualised 14.3 per cent over 2012-17. IBISWorld predicts 5.8 per cent growth for 2017-22. Most industries would kill for that growth rate in a patchy economy.
A rising maternal workforce participation rate over the past five years has boosted demand for childcare and greater government assistance for families wanting formal care arrangements for their children has helped the industry’s revenue.
Regulation changes that allowed childcare centres to register as kindergarten providers have helped them compete directly with Preschool education. Providing early-learning services, in addition to child care, has boosted margins at some centres.
The bad news is ongoing regulatory uncertainty and fears that the Federal Government will reduce long-term funding because of fiscal challenges. Pressure to increase childcare worker salaries (rightly so) is another industry threat. Irrational competitors entering the industry and paying too much for centres is a further risk.
Investors with longer memories will recall the disaster that was ABC Learning – the one-time star childcare operator that grew too quickly through acquisitions and crashed. ABC’s demise was enough to put investors off listed childcare companies for good.
Newer operators have had more sustainable performance. The best known, G8 Education, has a five-year annualised total return (assuming dividend reinvestment) of 47 per cent. G8’s 7 per cent total return over 12 months was affected by a sharp sell-off after a weak first-half result and market concerns that the company’s golden run may be ending.
G8’s recent guidance that 2016 Earnings Before Interest and Tax (EBIT) will be $158-162 million was in line with market expectations. Management’s comment that centres acquired in 2016 were performing in line with company expectations was another positive.
Four of seven broking firms that cover G8 have a buy recommendation, two have a hold and one has a sell, consensus analyst forecasts show. A median share-price target of $3.75 suggests G8 is trading near fair value. Morningstar is more bullish. Its valuation for G8 of $4.50 a share suggests the company is significantly undervalued at the current $3.61.
G8’s forecast Price Earnings (PE) multiple of 13.3 for FY17, based on consensus estimates, is not excessive for a leading player that has can increase its market share through acquisitions in a fragmented, growing industry. But regulatory uncertainties and concerns that childcare price rises might lead to occupancy declines at G8 centres are risks. 
Still, G8 deserves a spot on portfolio watchlists in anticipation of better value this year, and to wait for signs that the company’s blip in first-half performance was temporary. The stock suits experienced, risk-tolerant investors given its higher debt levels.
Chartist will watch closely to see if G8 stays above the critical $3 support line on its chart. 
G8 EducationSource: The Bull
I prefer Australian Real Estate Investment Trusts (A-REITs) as a more conservative way to play the childcare theme. It is the old story of buying the companies that sell the picks and shovels rather than those doing the digging. Childcare property owners benefit from rising demand for formal care arrangement, without the risk of having to operate centres. 
The Folkestone Education Trust A-REIT owns more than 390 externally managed childcare centres in Australia and in New Zealand. 
Like many A-REITs, Folkestone rallied sharply in the FY16 as investors could not get enough of listed property trusts and their yield, and niche A-REITs were in demand. Folkestone soared from $2.20 in February 2016 to above $2.80, only to be sold off as capital rotated out of interest-rate-sensitive sectors and into growth stocks after Donald Trump’s election win.
Folkestone fell to $2.40 in December and has since recovered to $2.54. That has created a long-term buying opportunity for an A-REIT that has reasonable gearing (below 30 per cent) and relatively secure earnings because of its lease structures. Tenant risk is the main concern because Goodstart Early Learning accounts for a big chunk of Folkestone’s total rental income. However, Goodstart looks in fine financial health. 
Folkestone Education Trust Source: The Bull 
The smaller Arena REIT is another good performer in childcare property. Arena listed in June 2013 after raising $75 million at $1.01 a unit through an IPO and now trades at $1.90, having hit a 52-week peak of $2.44. 
Like Folkestone, Arena has fallen since September, amid the A-REIT sector’s broader sell-off.  Early learning centres make up 189 of Arena’s 207 properties (it also invests in healthcare and development projects).
The well-run Arena continues to achieve solid increases in the value of its property portfolio – most recently an 8.8 per cent valuation uplift in the December half. 
Like Folkestone, Arena looks a lot more attractive after recent share-price falls, particularly given its improving operational performance and trailing yield of about 6 per cent.
Arena REITSource: The Bull

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Tony Featherstone is a former managing editor of BRW and Shares magazines. The information in this article should not be considered personal advice. The article has been prepared without considering your objectives, financial situation or needs. Before acting on the information in this article you should consider its appropriateness, regarding your objectives, financial situation and needs. Do further research of your own or seek personal financial advice from a licensed adviser before making any financial or investment decisions based on this article. All prices and analysis at January 12, 2017.