With the recent not-so-pleasant results, G8 Education (ASX: GEM) has raised a lot of speculation in the market. Many experts have considered this to be a lackluster result and think GEM to be following the track of ABC Learning Centres that collapsed. There seems to be a divided view among brokers. Let us understand this through the following points:
Top line growth:G8 Education continued to report a solid top line growth of 16.2% to $361.2m driven by rising fees and acquisitions for 1H16. Moreover, the operating revenue has increased by $53.4m which reflects a growth of 17.5% in H1 2016 with the increase being split between LFL centres ($23.1m, 8.0% increase) and centers acquired in 2015 and 2016 ($30.3m). The group has operated 478 centers in Australia and 20 centers in Singapore bringing the total licensed places to 37,045. Moreover, GEM is expecting to settle a further 12 centers for $32.0m in the second half of 2016, with the purchases being funded by internal operating cash flow. However, revenue did miss the consensus estimates by 4.2%.
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Centre Portfolio as on first half of 2016 (Source: Company Reports)
Increasing costs could be a concern:GEM’s EBIT in 1H 2016 grew 8.5% as the additional ratio related headcount impacted Q1 wages along with the significantly improved performance in Q2. Moreover, investment in staff training and center refurbishment, was substantially offset by savings in other areas. The increase in support office costs, is on the back of additional board and senior executive appointments, higher expenses at LFL centers and due to the rising support office and public company costs impacting the margins. The support office costs have increased by $1.4 million in the period due to higher wages while incurred over $0.7 million from new executives and the board member alone. Bank charges were $0.3 million which involved the bank debt facility while FBT charge was $0.4 million. All-in-all, the weakening margin is witnessed on the back of a 10% increase in wages owing to the imposition of higher carer-to-child ratios that were enforced in January 2016.
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Rising Support Costs (Source: Company Reports)
Organic growth is decent but still dependent on acquisitions:GEM’s acquisitions performed in line with the expectations with EBIT contribution of 2015 and 2016 purchases of $8.4m in the first half of 2016. However, the acquisition activity was lower in H1 2016 than the prior year, with 9 centers being settled versus 21 in the prior year. Conversely, refurbishment related activity has increased by around 65% in 2016 which is an increase of $4.5m. The group has been generating a decent organic growth in first half of 2016, instead of depending on just acquisitions growth. For 1H2016, the group was able to deliver an organic growth of 2.3% and 7.4% from those assets acquired in 2011 and 2012.
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Like for Like Centre Performance Breakdown (Source: Company Reports)
Capital Management concerns: GEM’s net debt to Underlying EBITDA rose 2.28x during the period, from 2.14x in the same period of last year, adding concerns. Net Debt to Capital also increased to 37.8% in 1H16 from 33.5% in the prior corresponding period. Annualized Post Tax Return on Equity has successfully refinanced the SGD 2017 bonds that were maturing in May 2017, extending the term to May 2019 and fully hedging the FX exposure. The group witnessed a total $161.5m cash outflow from financing activities during the first half of 2016 mainly due to repayment of the SGD unsecured bond facility for the Affinity Education acquisition facility. On the other side, G8 had access to $39.8m cash and $30m in committed bank debt facilities as at 30
th June 2016, has stated that it is well positioned for further operations and growth. Moreover, GEM’s cash conversion is now at 102% (the group calculated this metric as operating cash flow plus interest and tax paid divided by underlying EBITDA). However, cash acquisitions cost is said to be equal to operating cash flows and the strategy of raising debt for funding capital expenditure is seen to be a risky proposition. Rising cost or fall in revenues might create a more challenging situation.
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Capital Structure as on 30
th June 2016 (Source: Company Reports)
Management and other Changes:GEM’s executive team is now complete with new CFO starting after the first half year end. GEM’s former Chief Financial Officer Chris Sacre had left after ten years of the service. Three new members Gary Carroll, David Foster and Maria Forgione joined at the higher level. Gary has joined as the Chief Financial Officer, David has joined as a Non-Executive Director and Maria has joined as the company secretary. However, resignation of GEM’s auditor, HLB Mann Judd, in November 2015 after six years has raised few concerns.
Stability in costs in last five years:Looking at the five-year trend, many experts also have reported for stability with regard to employee expenses as a percentage of revenue (below 60% of revenue from continuing activities). There has been stability in the occupancy costs as well, which are said to be about 12% of revenue.
The stock has fallen about 18% in the last one month (as at September 02, 2016) amidst the challenging environment. At the same time, we also see some shareholders, such as Greencape Capital Pty Ltd and Challenger Ltd increasing the voting power interests in the company while some are having bearish stance. Some consider that the recent result may rebase consensus expectations reflecting current cost growth rise and a slower acquisition profile. Overall, it may be too early to decipher the fate of the company as that of defunct ABC Learning Centres.
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