Company overview - G8 Education Limited provides developmental and educational child care services. The Company's principal activities include the operation of early education centers owned by the Company and its subsidiaries, and the ownership of early education center franchises. It provides quality care and education facilities across Australia and Singapore through a range of brands. The Company's portfolio consists of approximately 490 in Australia and over 20 in Singapore. These centers provide a total combined licensed capacity of approximately 38,710 places. It offers brands, such as First Grammar, reative Garden, Kindy Patch Kids, buggles, Sandcastles, World of Learning, jellybeans, Kinder Haven, Pelican Childcare, Nurture One and Penguin Childcare. The Company's subsidiaries include Sydney Cove Children's Centre B Pty Ltd, Sydney Cove Property Holdings Pty Ltd, World Of Learning Licences Pty Ltd, Kindy Kids Operations Pty Ltd, Alfoom Investments Pty Ltd and Cherie Hearts Corporate Pte Ltd.

GEM Details

G8 Education Ltd (ASX: GEM) is gaining momentum on a continued basis and has found support from its first half year 2017 results at the back of drivers such as stimulating demand, acquisition activity and improved financial performance.

H1FY17 earnings driven by lower finance costs: For H1FY17, G8 reported 2.1% yoy (year on year) growth in revenue at $368.7m while posting 22.6% yoy growth in net profit at $30.5m. Underlying EBIT growth in 1H17 was 6.3%, mainly due to wage efficiency in the LFL centers, while 2016 acquisitions performed in line with expectations to deliver EBIT contributions of $3.8m. The Group completed the divestment of 17 centers in 1H17 and recorded a loss on disposal of $0.7m. The divested centers had a combined EBIT loss of $350k pa. Reported NPAT was mainly driven by lower finance costs with 1H16 including the write off of borrowing costs associated with the refinancing of the SGD260m bonds ($7m). GEM’s reported EPS grew 13.8% while underlying EPS was impacted by recent share issues. Notably, the cost efficiencies established in 2H16 continued in the current half-year, enabled the group to generate better profit growth despite the lower occupancy levels. GEM’s margins also improved through efficiencies, notably wages. The company maintained guidance for full-year underlying EBIT to be mid-$170m.


Consolidated income statement; (Source: Company reports)
 
Reduction in Gearing Levels:  During the period, the G8 Board conducted a comprehensive review of the Group’s capital management strategy. The objective of the review was to discuss the Group’s access to committed debt and equity funding to enable it to implement its strategy and growth activities, while ensuring there is the right balance between financial flexibility and providing good levels of ongoing earnings for shareholders. Moreover, the key outcomes of the capital management strategy review are a reduction in current and targeted gearing levels, implementation of a new club bank facility and a transition to a proportionate dividend policy.

During H1FY17, the group raised $195m via a $100m domestic institutional placement (at $3.20 per share) and a $95m private placement to CFCG Investment Partners International (Australia) Pty Ltd (at $3.88 per share). In turn, it has decreased the group’s Net Leverage from 2.2x at 31 December 2016 to 1.2x at 30 June 2017. G8’s target Net Leverage level has been reset from 2.0x to 1.5-1.7x, ensuring the group has sufficient financial flexibility to execute its strategy. On 18 August, G8 successfully executed a $200m 3-year club bank debt facility with CBA, Westpac and Sumitomo Mitsui Banking Corporation. The facility, which increases the Group’s committed debt facilities by $150m, has market standard financial ratios covering Fixed Charges, Net Leverage and Gearing. The facility is available to meet the Group’s working capital requirements, including the acquisition of further child care centers.


Key Financial Ratios; (Source: Company reports)

Changes to dividend policy: The company announced changes to its dividend policy which will better position G8 to continue to implement its strategic framework, including the group's ambition to grow revenue and Earnings Per Share. From 1 January 2018, G8 will pay dividends on a semi-annual basis with those dividends being declared in the full year and half year results announcements. It will also transition to a proportionate dividend policy under which the Board intends to pay out 70- 80% of underlying NPAT in dividends. In FY18, the Board intends to make dividend payments which have the effect of transitioning G8 towards the new policy. Accordingly, the Group will pay dividends of 10c per share in both March and September 2018, resulting in a total dividend of 20c per share in 2018. This equates to a fully franked dividend yield of more than 5% based on current share price. Further, the Group will continue the Dividend Reinvestment Plan (DRP), with a discount of 2% applying to the DRP. This will provide shareholders with an ongoing opportunity to reinvest their earnings into G8 at attractive prices.
 
Current Occupancy levels ahead of last year:  Overall national supply increased by 3.7% over the last 12 months (as on 21 August 2017) with 7,166 LDC centers operating as at 30 June 2017. This is higher than estimated growth in market demand of 2%-2.5% and 12 month rolling occupancy to June 2017 has decreased 3.4% pts from 1H16. Primarily, the causes of the occupancy decline are increased supply in certain areas such as inner Sydney and ACT coupled with macroeconomic weaknesses in markets such as WA and North Queensland; and Centre specific issues. Currently, with several initiatives are in place to drive occupancy with cost performance for 2H17 to date in line with 1H17. Further, the Group expects to complete 8 acquisitions in 2H17 while earnings from 2017 acquisitions are forecasted to be circa $3m for FY17. Moreover, the group has been increasing prices, while focusing on costs to offset the occupancy pressure. From a market perspective, affordability has been impacted by continued sluggish wage growth as well as current industry settings such as the $7.5k rebate cap. However, this is expected to be mitigated by the recently introduced jobs for families’ package in July 2018. Since February, momentum has improved relative to the previous year, with the LFL occupancy increased between March and July at 1.3%pts higher than the equivalent increase in 2016.


Occupancy - LFL; (Source: Company reports)
 
Centre Performance Breakdown:  During 1H17, LFL (Like for Likes calculated based on ownership) EBIT performance was 1.9% higher than prior corresponding period (pcp) with savings in Wages and Childcare costs more than offsetting the increase in Rent expense. Importantly, LFL fee increase of 2.4% was offset by lower occupancy in H1 (down 3.41% vs pcp). Further, 1H17 revenue and profits were significantly impacted by the timing and quantum of Net LDCPDP Funding Revenues. However, adjusting for the impact of Net LDCPDP (Long Day Care Professional Day Care Funding Less P&L costs relating to the funding) funding ($6.8m) resulted in underlying EBIT improvement of 19.2%, with organic center EBIT growth of $8.1m (12.4%). Additionally, discounts were $2.4m higher than previous year driven by the change in holiday policy to be in line with market and an increase in early bird re-enrolment discounts. Wage performance improved by 1.1%pts compared to pcp, as the positive impacts of roster improvements from 2H16 flowed into the current period while other costs are 1%pts lower than pcp, driven by good childcare cost control and savings in repairs and maintenance from a unit cost perspective.


Centre Performance Breakdown; (Source: Company reports)
 
Robust performance in FY16: For FY16, G8 Education Ltd (ASX: GEM) reported a revenue growth of 10.2% yoy to $77 million driven by fee increases and acquisitions in 2015 and 2016.  Underlying EBIT growth was 10.5%, with growth increasing to 11.6% in H2 as wage and other cost efficiency momentum continued into H2FY16. Further, 2015 and 2016 acquisitions performed in line with expectations to deliver EBIT contributions of $21.5m and $8.4m respectively. Underlying NPAT grew by 7.1% for the year, lower than EBIT growth due to higher financing costs, and prior year gain on sale of shares in Affinity of $7.3m after tax. During FY16, acquisition activity was lower with 21 centers being settled against 44 in the FY15.


FY16 Financial summary; (Source: Company reports)
 
 
Recommendation: The stock has moved up 9.9% over the past three months, while it is up 24.3% in the last one year (as on September 01, 2017). The group has a strong brand reputation in the childcare center segment in Australia and continues to make an investment for center upgrades and refurbishments. Further, acquisition activity is expected to have a significant contribution in FY18 while the group is poised for executing its strategy with new club bank facility in place. Moreover, performance on cost containment, improved balance sheet and funding environment are expected to provide further momentum. We give a “Buy” recommendation on the stock at the current price of $3.770
 

GEM Daily chart; (Source: Thomson Reuters)
 

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