The Australian economy is showing initial signs of recovery, following the lifting of border closures and the re-opening of Victoria State. An increase in consumer spending spurs retail sales and improved business sentiments favouring export growth. In a survey by the Australian Bureau of Statistics, 25% of businesses were reported an increase in revenue in December 2020 over last month. The proportion of business reporting revenue declined each month from July through November 2020.

A report by the Australian Bureau of Statistics mentioned that final output across industries (excluding exports) improved by 0.5% in December 2020 quarter (on a QoQ basis). This was aided by the construction of houses particularly in Queensland and Western Australia, increase in domestic gas output due to price rise. While manufacturing output rose by paltry 0.3%, led by metals (copper, silver, etc.), aluminium smelting, and meat processing.

The services sector posted a strong growth particularly driven by rentals, car hiring services, and child care services. Rentals and hiring services posted a 4.1% growth in December 2020 over the preceding quarter and 4.7% growth over the prior year. The easing of travel restrictions helped Australians to venture out places for summer holidays. Also, the reduced supply of cars available for hiring improved the output.

Figure 1. Passenger Car Rentals Lifted the Overall Rental and Hiring Services Output:  

Source: Data from The Australian Bureau of Statistics, Chart Created by Kalkine Group

Passenger car rental output was lifted by solid growth in intrastate travel by Australians. The border closure saw Australians increasingly spent on domestic travel. In addition, the work-from-home and stay-at-home protocols resulted in Australians moving to regional hometowns. More than capital cities, travellers preferred to drive-down regional areas which are exhibited by resilient growth in intrastate travel trends. Spending on intrastate travel increased particularly in Northern Territory, Western Australia, New South Wales, among others in October 2020 over the prior year.

Figure 2. Intrastate Travel Proved Its Resilience:

Source: Data from Tourism Research Australia, Chart Created by Kalkine Group

Equipment rental services are less correlated to the economic swings as it resembled a flat growth during the periods of economic contraction created by the pandemic. The output grew by 1.6% in December 2020 over the preceding quarter. Australians created a demand for construction equipment rentals with increased spending on home renovations and alterations during the pandemic. Housing markets showed a strong revival with the surge in dwellings for the commencement of new residential houses driven by demand for single-family detached houses as shown by The Australian Bureau of Statistics. The recent data showed approvals for private residential houses rose 6.1% in November 2020 over the prior month. Queensland, Western Australia, and South Australia showed a strong increase.

Figure 3. Dwelling Commencement for New Residential Construction Improved:

Source: Data from The Australian Bureau of Statistics, Chart Created by Kalkine Group

Mining is core to Australia’s GDP contributing ~10.4% in September 2020 quarter. Australia exports high-grade hematite iron ore to Asian countries particularly to China. Mining activity showed resilience during the pandemic with demand for equipment rentals, less affected.  Iron ore exports touched a new record in October 2020 with $10.9 billion. Imports by China have been steadily increasing off late.

As per the data by the Australian Bureau of Statistics, the increase in final output was also driven by child care services which had improved by 7.8% in December 2020 quarter (on a QoQ basis). Australian government offered free childcare during the initial phase of the pandemic. Post-July 2020, a transition payment totalling $708 million was earmarked between July 2020 and September 2020 through a subsidy of up to 25% of fee revenue for childcare centres. This replaced JobsKeeper subsidy for the childcare sector. The government announced a recovery package of up to 25% of pre-COVID revenue to childcare services in Victoria until the end of January 2021. There is an additional 15% for Victoria Outside School Hours Care Services, increasing the total support to 40% of revenue.  Increased fees from childcare service providers following the end of transition payment subsidy lifted the output of childcare services in December 2020.

Figure 4. Government Funded ~$2.6 Bn to The Childcare Services During the Pandemic:

Source: Data from The Department of Education, Skills and Employment, Chart Created by Kalkine Group

Key Risks: Spending on equipment rentals is largely affected by business sentiments and expansion plans by companies. The data by the Australian Bureau of Statistics mentioned that private capex spend fell 3.0% in the September 2020 quarter (on a QoQ basis). Spend on equipment, plant and machinery declined by 2.2% in the same period. Plant closures and slow recovery in demand and order books may result in a decline in capex spend. Manufacturing companies are yet to show full recovery as indicated by manufacturing output for December 2020 quarter which is lower than last year by 0.3%. Although residential construction showed an improvement, engineering construction activity is yet to gain steam. The value of work done for private-sector engineering construction declined by 4.2% in September 2020 over the preceding quarter.

Figure 5: Key Risks in Rentals and Childcare Services:

Source: Chart Created by Kalkine Group

Outlook: The increasing trend for regional tourism is expected to drive demand for rental cars. The government injected ~$250 million to boost regional tourism with $200 million towards better regional infrastructure and $50 million towards the regional tourism recovery initiatives. In addition, the government allotted $100 million dedicated to tourism-related infrastructure. Increasing infrastructure spend is also likely to lift the demand for equipment rentals. The government’s spearheading the sector with an infrastructure investment of $110 billion over the next 10 years in a number of programs will spur national freight transportation. This includes the Melbourne Airport Rail Link program with a commitment of $5.0 billion, $4.6 billion towards Roads of Strategic Importance initiatives. Higher freight movement is expected to positively contribute to vehicle rental demand. Considering the above facts and trends in rental services and childcare centres, we have figured out 4 stocks on ASX that are set to see the momentum from the development.

(1) Emeco Holdings Limited (Recommendation: Buy, Potential Upside: Low Double-Digit)

(M-cap: A$ 609.34 Million, Annual Dividend Yield: 0%)

The Surge in Iron Ore and Gold Projects: Emeco Holdings Limited (ASX: EHL) provides renting of earthmoving equipment to the mining industries in Australia and Indonesia. EHL experienced a strong pull from the Western Region Rental business for iron ore and gold projects translating to a 16.3% growth in overall revenues in FY20 over pcp. The company won long-term contracts in Western Region including maintenance services and EOS. Whitehaven has extended an additional 3 years contract which will support its Eastern Region Rental business. The company’s EBITDA grew by 21.1% in FY20 due to improvement in utilization of its fleet assets and various cost savings initiatives. Acquisition of Pit N Portal business in February 2020 drew capex to the tune of $110.3 million. Nevertheless, EHL reported a surge in free cash flows to $71.2 million in FY20 as compared to $5.0 million in pcp. EHL was able to deleverage the balance sheet through equity fund rising, resulting in leverage ratio at 1.46x as of June 2020 as compared to 2.0x in pcp.

Outlook: The company sees strong bidding activity for rental assets across the region and in the Pit N Portal business. This may provide an offset to the softening coal market. EHL is expecting Western Region to show traction in both open pit and underground mining, particularly for iron ore and gold. But increased costs as a result of the pandemic, are expected to remain for some time. EHL is expecting operating EBITDA to be in the range of $115-$118 million for H1 FY21. Gold revenues is likely to represent 38% of the group’s revenue in H1 FY21, up from 12% over pcp. Capex is projected to be $55-60 million to support Mincor underground mining services contract. 

Valuation Methodology: Price/Cash Flow Multiple Based Relative Valuation (Illustrative)

Price/Cash Flow Multiple Based Relative Valuation (Source: Refinitiv, Thomson Reuters)

Note: All forecasted figures and peers have been taken from Thomson Reuters, NTM-Next Twelve Months

A-VIX vs EHL (Source: Refinitiv, Thomson Reuters)

Stock Recommendation: The stock posted positive 3-month and 6-month returns of ~46.26% and ~19.46%, respectively. However, the stock corrected in the last one month with negative returns of ~5.07% implying accumulation opportunity. The stock is currently trading below to the average of 52-week high price of $2.402 and 52-week low price of $0.457. EHL changed its revenue mix to increase rental revenues from iron ore and gold projects which are expected to drive revenue growth given the improvement in open pit and underground mining activity in Western Australia. The stock performed well over the market volatility index. We have valued the stock using the Price/Cash Flow multiple based illustrative relative valuation method and arrived at a target price of low double-digit upside (in percentage terms). We believe that the stock might trade at a slight premium as compared to its peer median Price/Cash Flow (NTM Trading multiple), considering its focus on iron ore and gold projects for equipment rentals, decent EBITDA margin ahead of industry median in FY20, while also taking into account its historical discounted trading multiple versus peers. For this purpose, we have taken peers such as NRW Holdings Ltd. (ASX: NWH), Perenti Global Ltd. (ASX: PRN), MACA Ltd. (ASX: MLD). Considering the adequate capitalization, dividend announcement, valuation and current trading levels, we give a “Buy” recommendation on the stock at the current market price of $1.075 down by 4.018% on 1^st February 2021.  

(2) G8 Education Ltd (Recommendation: Buy, Potential Upside: Low Double-Digit)

(M-cap: A$ 961.78 Million, Annual Dividend Yield: 5.28%)

Equity Rising and GreenField Projects to Support Growth: G8 Education Ltd (ASX: GEM) operates child care centres in Australia and Singapore. It also provides child care centres management, and industry-related project management, services, and consultancy. The introduction of child care subsidy by the Australian government saw an increase in occupancy rate to 75.9% in FY19 as compared to 74.8% in pcp. In addition, the divestment of 25 child care centres boosted the occupancy rate at Western Australia. An increase in wage efficiency and fee growth translated to an EBITDA margin of 20.5% in FY19 vs. 17.4% reported in the prior year. Profitability was affected by increased spend on greenfield projects. It had spent capex of $50 million towards the acquisition of 15 centres in FY19. Debt levels surged with incremental borrowings of $25 million to fund acquisitions.

GEM experienced lower occupancy at 69% in H1 FY20. Its organic revenue slumped 27.9% in H1 FY20 over pcp. The company did not implement March 2020 fee hike due to the government subsidy program. Its EBITDA margin turned negative in half-year ending June 2020 resulting from lower revenues and fee growth. There was a one-time non-cash impairment to the extent of $237 million which eroded profitability. It had raised equity capital of $301 million to support capex and growth. GEM obtained waiver relaxation until December 2021 from banks.

Outlook: GEM is expected to show recovery in FY20 with 10 new greenfield projects to open with a capital outlay of circa $4 million. The company is expecting strong returns from these projects in the medium term. The company to resume capex spend of $10 million in FY20. It is actively progressing to exit from 27 underperforming centres that were impaired in August 2020.

Valuation Methodology: EV/EBITDA Multiple Based Relative Valuation (Illustrative) 

EV/EBITDA Multiple Based Relative Valuation (Source: Refinitiv, Thomson Reuters)

Note: All forecasted figures and peers have been taken from Thomson Reuters, NTM-Next Twelve Months

A-VIX vs GEM (Source: Refinitiv, Thomson Reuters)

Stock Recommendation: The stock is undergoing correction with 1-month and 3-month negative returns of ~-3.81% and ~-1.30%, respectively. It is currently trading above to the average of 52-week high price of $1.769 and 52-week low price of $0.436. GEM is expected to show recovery in FY20 with 10 greenfield projects to open and closure of 27 underperforming centres which will improve occupancy rate. The stock performed well over the market volatility index. We have valued the stock using the EV/EBITDA multiple based illustrative relative valuation method and arrived at a target price of low double-digit upside (in percentage terms). We believe that the stock might trade at a slight premium as compared to its peer average EV/EBITDA (NTM Trading multiple) considering returns of new greenfield projects, exit from underperforming projects to drive profitability, in addition to equity fund raising. While also taking into account its historical discounted trading multiple versus peers. For this purpose, we have taken peers such as Mayfield Childcare Ltd. (ASX: MFD), Think Childcare Ltd. (ASX: TNK), 3P Learning Ltd. (ASX: 3PL), to name a few. Considering an improvement in asset quality, adequate capitalization, valuation and current trading levels, we give a “Buy” recommendation on the stock at the current market price of $1.135 as on 1^st February 2021.

(3) Evolve Education Group Ltd. (Recommendation: Buy, Potential Upside: Low Double Digit)

(M-cap: A$ 170.58 Million, Annual Dividend Yield: 0%)

Acquisitions to Ramp-Up Revenues: Evolve Education Group Ltd. (ASX: EVO) provides early education for children. The company provides offers teacher-led and parent-led services in Australia and New Zealand. EVO experienced stabilization in occupancy levels following the pandemic. It had benefited from the acquisition of 10 centres in Australia during the year. It had curtailed fee discounts and reduced fees paid to its Board. It had witnessed strong EBITDA growth specifically in Q2 FY20. It had reported a net loss of NZD 13.3 million solely due to impairment loss to the tune of NZD 12.3 million.

In the interim update, EVO reported lower revenues by 6% in H1 FY21 owing to the closure of centres and disruptions caused by COVID-19. The company kept a streamlined support office which contributed to EBITDA margin expansion in H1 FY21 to 37.7% as compared to 20.2% in pcp. In addition, EVO also undertook various cost-savings measures. It had experienced green shoots in the New Zealand operations. It closed H1 FY21 with a cash balance of NZD 39.3 million as of September 2020.

Outlook:  EVO intends to grow early childcare education centres in Australia through acquisitions. It had kept acquisition on hold due to the pandemic. As per the latest trading update, the company has resumed pursuing acquisition targets. Management mentioned acquisitions particularly in Australia in the range of $20 million to be funded with cash and internally generated funds.  

Valuation Methodology: EV/EBITDA Multiple Based Relative Valuation (Illustrative) 

EV/EBITDA Multiple Based Relative Valuation (Source: Refinitiv, Thomson Reuters)

Note: All forecasted figures and peers have been taken from Thomson Reuters, NTM-Next Twelve Months

A-VIX vs EVO (Source: Refinitiv, Thomson Reuters)

Stock Recommendation: The stock posted positive 3-month and 6-month returns of ~71.35% and ~60.53%, respectively. However, in last one month the stock is undergoing correction with returns of ~-4.69%, implying accumulation opportunity. It is currently trading above to the average of 52-week high price of $1.480 and 52-week low price of $0.376. EVO is expecting to show a rebound with green shoots in New Zealand and acquisitions to drive growth in early child care centres in Australia. EVO has completed the consolidation of 8 shares for 1 EVO shares held with total issued shares stood at ~139.826 after consolidation. The stock performed well over the market volatility index. We have valued the stock using the EV/EBITDA multiple based illustrative relative valuation method and arrived at a target price of low double-digit upside (in percentage terms). We believe that the stock might trade at a slight premium as compared to its peer average EV/EBITDA (NTM Trading multiple) considering strong improvement in EBITDA margin ahead of industry median in H1 FY20, acquisitive growth strategy in Australia, favourable conditions for New Zealand business, while also taking into account its historical discounted trading multiple versus peers. For this purpose, we have taken peers such as G8 Education Ltd. (ASX: GEM), IDP Education Ltd. (ASX: IEL), Think Childcare Ltd. (ASX: TNK). Considering the robust growth in merchant sales and customer additions, valuation and current trading levels, we give a “Buy” recommendation on the stock at the current market price of $1.220 as on 1^st February 2021.

(4) Transurban Group (Recommendation: Hold, Potential Upside: Low Double Digit)

(M-cap: A$ 36.23 Billion, Annual Dividend Yield: 2.34%)

Lockdown Restrictions Impacted Toll Revenues:  Transurban Group (ASX: TCL) is one of the largest toll-road operators. The company builds and operates urban toll networks in Australia, Canada, and the United States. Lockdown restrictions reduced toll revenues with Melbourne showed subdued results due to renewed restrictions. The company completed three projects in FY20 and M8 opening to traffic and tolling to commence on the M5 East.  Its West Gate Tunnel Project is now expected to be completed by 2023. The group-level traffic was down by 25% in July 2020 over last year. Lower toll revenues affected EBITDA by 8.6% YoY in FY20. Costs also increased related to ongoing projects. Its profitability was affected by net losses at the WestConnex acquisition to the extent of $272 million. It had raised $8.6 billion in debt during the year resulting in a gearing ratio of 35.8% in FY20 as compared to 32.0% in FY19. It also raised $0.8 billion in equities from institutional placement to fund M5 West. It has a weighted average maturity of debt at 8.4 years.

TCL experienced reduced average daily traffic by 25.2% in September 2020 although volumes increased in Brisbane, Sydney, the Greater Washington Area, and Montreal from low during April 2020. The company raised an additional US $900 million notes. It is also looking to bring equity partners in the Greater Washington Area asset.

Outlook: TCL is expecting traffic improvements in Brisbane, Sydney, GWA, and Montreal following the easing of restrictions. It is anticipating FY21 dividends to be in-line with free cash, excluding capital releases.

Valuation Methodology: EV/EBITDA Multiple Based Relative Valuation (Illustrative)

EV/EBITDA Multiple Based Relative Valuation (Source: Refinitiv, Thomson Reuters)

Note: All forecasted figures and peers have been taken from Thomson Reuters, NTM-Next Twelve Months

A-VIX vs TCL (Source: Refinitiv, Thomson Reuters)

Stock Recommendation: The stock posted negative returns in last 3 months and 6 months with ~0.23% and ~4.95%, respectively. It is currently trading above to the average of 52-week high price of $16.440 and 52-week low price of $9.100. TCL is expecting toll revenues to show recovery, following the easing of restrictions. The company roped banks and equity partners to bring capital to fund pipeline projects.

Comparative Price Chart (Source: Refinitiv, Thomson Reuters)

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