On 25 October of 2017 investors in one market darling of the time – G8 Education (GEM) – were thrilled to read an analyst upgraded the target price for the stock 11%, to $5.10 when the stock was trading at $4.58.
On 4 December of 2017 G8 management downgraded its earnings forecast due to slower growth in occupy rates at its childcare centres. The downgrade followed a less than spectacular Full Year 2017 Financial Results released last February. This should have come as no surprise to informed investors who took the time to read cautionary warnings about occupancy rates that began appearing in the financial press earlier in the year. The stock price plummeted.
Three years ago, conventional wisdom leaned towards investing in the childcare sector given the supply shortage faced by Aussie parents at the time, not to mention increasing government support in the form of tax subsidies for childcare payments.
The result was a rush to cash in on a sector with high demand backed by government subsidies for parents. Research analysts were quick to slap the sector with an “investment grade assets” class. The stampede in a sector dominated by smaller independent operators led to an acquisition binge from both private operators and the publicly traded G8 Education, not to mention private equity firms. The results should have been predictable. The number of centres opening and the cost of acquisitions went up 25% in 2017.
Investors and analysts alike could have benefited from a review of the demise of ABC Learning, once the largest publicly traded childcare centre operator in the world. The company’s staggering market cap of $4.1 billion dwindled to $296 million by the time it went under, suffering from declining profit and an inability to service its debt load of over one billion dollars spent in large part on costly acquisitions.
G8 Education’s business model also calls for growth by acquisition and the company has piled on high levels of debt, although the company has lowered its long-term debt, aided by a 2017 capital raise. The G8 business model also relies on multiple locally branded centres instead of a more cost-effective national brand, with a single marketing operation as a prime example of cost savings.
On 2 July the federal government combined two existing subsidy programs – the child care benefit and the child care rebate – into the Jobs for Families Child Care Package. It is estimated the new program will infect about 15% additional subsidies, which some see as a lifeline for the troubled sector.
The analyst community appears to be shying away from SELL recommendations, as two of the three ASX listed childcare operators – G8 and Think Childcare (TNK) still have OUTPERFORM ratings, as do the two ASX listed Real Estate Investment Trusts with portfolios of childcare centre properties – Folkestone Education Trust (FET) and Arena Reit (ARF). The ratings are updated daily on the Reuters financial website.
On 13 August UBS raised its price target on GEM to $2.80 in the belief over time the new subsidy package will rebalance childcare supply and demand. An RBC Capital Markets analyst is also optimistic about the impact of the new subsidy program but cautions it could be 2019 before improvements in occupancy figures begin to appear. In its latest financial reporting, G8 Education management agreed, stating “we are not forecasting a material improvement in market conditions until mid-2019.” The short-sellers are hovering over GEM like vultures, driving the stock to ninth place in the ASX Top Ten Short List.
Even at the height of the booming market sentiment for childcare operators there were analysts pointing to the centre property owners as a less risky way to play the sector. The logic should be self-evident as there is no sliding scale allowing rent payments to go down as occupancy rates soften. Investors wary of sticking their toes in the childcare sandpit might be heartened by the news diversified ASX property fund manager Charter Hall Group (CHC) is acquiring Folkestone, leaving Arena as the remaining option for investors, another sign of the long-term health of the sector property owners.
Arena Reit has a moderately diversified portfolio of real estate assets, with 207 childcare centres and 7 healthcare centres, all with 100% occupancy. The company’s properties are distributed throughout Australia.
Arena’s largest tenant is Goodstart Early Learning, a non-profit operation with 7.2% market share, trailing only G8 with 7.9%. Arena listed in 2013 and its early investors have been well-rewarded.
The average annual rate of total shareholder return over three years is 18% with 22.7% over five. The company’s current dividend yield is 5.4%.
Full Year 2018 Financial Results were solid, with a 22% increase in net operating profit while statutory net profit dropped 64% due to property reevaluations. Arena reduced its gearing from 27.5% to 24.7%. The company added 14 Early Learning Centre properties in FY 2018 with an additional five in the pipeline.
The following table lists some price movement, performance, and financial metrics for the three publicly traded ASX child care operators.
While a sector as fragmented as childcare – with an estimated 80% of centres still family or individually owned – may be good for an acquisitive business model, the competition from non-profits is something some investors overlook. Goodstart does not share the complexities of a publicly traded company like G8.
G8 listed on the ASX in 2007 and its long-term performance record could be used as a case study highlighting the pitfalls of growth by acquisition.
Buying up competitors can increase revenue and profit initially but for the longer-term efficiencies become important. New acquisitions need to maintain high occupancy rates for the company to grow organically. For the Half Year 2018 G8’s occupancy rate fell from 79.1% to 70.1%, below the 2016 rate of 72.6%. While revenues for the period rose 7.6% profit fell 22.1%. Of further concern to investors is the reported 19 centres remaining in the G8 pipeline – down from 30 – with completion expected in the next two years.
The company operates 512 centres, primarily in Australia with some in Singapore, with 27 different brands. The company has averaged 20.8% dividend growth over the last five years, with a current yield of 7.7%, although the dividend was cut from $0.24 per share in FY 2016 to $0.18 in FY 2017
Think Childcare (TNK) listed on the ASX in October of 2014 with the share price booming once the sector got hot, cooling off substantially as occupancy concerns began to emerge.
Think Childcare owns 45 centres, with about 80% of the centres located in Victoria where oversupply from new openings has been setting records. Like G8, the company is pursuing growth by acquisition. The oversupply conditions are more challenging for smaller operators, with many facing the prospect of selling out. Ideal for acquirers but still presenting organic growth issues over time for the buying company.
The company’s business model calls for immediate improvements to acquired operators, including enhanced local marketing and cost benefits of companywide purchasing.
Think Childcare managed to post a small profit increase in FY 2017 along with a 22% revenue increase. Half Year 2018 results were disastrous, with a 4.7% revenue increase and a 74% dip in net profit after tax. The results announcement included the troubling phrase common to all the publicly listed operators – “18 of our centres faced new competition that negatively affected performance.” To complete the disaster, the company reduced its calendar year 2018 earnings guidance by 38%.
Nevertheless, Think management remains optimistic, characterising the new subsidy program as “once in a generation”, moving the cost of childcare from its decade highs to the lowest cost in history.
Mayfield Childcare (MFC) come on the ASX in the boom days, beginning trading in November of 2016. After a rocky start the share price rose only to get crushed amidst the oversupply conditions.
The company added 3 new centres in 2017 to its existing 16. Full Year 2017 results saw an 1100% increase in revenue and a lift from a 2016 loss of $1.2 million to a profit of $3.4 million. Half Year results were solid as well, with revenue up 20% and profit up 62%.
On 17 August the company downgraded its calendar year earnings from operations guidance from $4.1 million to $3.5 million, citing a similar tune as its competitors – declining occupancy rates and increased competition.
All three of the ASX listed operators continue to pursue acquisitions as a key driver of growth. It is interest to note that the websites of all three include at the top of the page a button entitled “Sell Your Centre.”