Rapid Growth Continues At G8 Education

This story features G8 EDUCATION LIMITED. For more info SHARE ANALYSIS: GEM

-Strong record in integrating centres
-Growth both organically and acquisitions
 

By Eva Brocklehurst

G8 Education ((GEM)) has caught the attention of two more brokers, with Macquarie and BA-Merrill Lynch deciding its time to initiate coverage. Australia's largest listed child care company has had a stellar run in acquisitions, supported by a very fragmented market. Since March 2010, G8 has acquired more than 200 centres and both brokers expect the company to continue with an aggressive acquisition strategy.

In 2013 revenue rose 55%, reflecting organic growth as well as acquisitions. Macquarie expects earnings to grow 65% in 2014, driven largely by another 63 centres that are expected to settle in April. While there's risk in bedding down any acquisition the broker considers G8 has delivered a strong track record in integrating centres. The broker has kicked off with an Outperform rating and $4.20 price target. The key to the stock's value is management's ability to identify potential acquisitions in strategic locations, acquire them at reasonable cost and then realise efficiencies as they are incorporated into the company. Macquarie is attracted to the fact that, on estimates, smaller private operator child care centres make up 83% of the market in Australia yet G8 holds just 3.3% market share of the long day care market. G8 also owns 18 centres and 50 franchises in Singapore.

The industry is also receiving government support, improving the affordability of day care. Macquarie expects the industry to also be underpinned by a higher level of household disposable income as the level of female participation in the workforce rises. This is a key factor in any decision to use child care services. Population trends are also supportive, with Australian statistics showing the number of children aged 0-14 are expected to increase by 8.5% out to 2016, from 2011.

Where are the risks? There is increased competition. A number of consolidators entered the market in 2013, according to Macquarie, and this could affect acquisition multiples and G8's longer term strategy. Changes to government assistance can also impact on child care affordability and affect the company's growth outlook. Macquarie does find it difficult, given the pace at which the company has grown, to track just what growth is internally generated and what is acquired. There is a risk that such an aggressive acquisition strategy could mask underperformance in the base operations. Still, at this point, Macquarie finds no evidence this is the case with G8.

Merrills has initiated with a Buy rating and $5.00 price target, noting the company is benefiting from increasing demand for child care services. This broker also hails the strong track record in integrating centres. Merrills thinks the rapid growth in numbers gives the company the opportunity to lift occupancy rates and fees and maximise floor space. The broker likes the potential for value accretive growth in a market where around 80% is available for consolidation. On the organic side, Merrills sees approximately 32% of earnings growth out to FY15 driven by revenue synergies and operational efficiency improvements.

Merrills observes the child care service industry, as a whole, has relatively low profitability. Average pre-tax profit margin of the not-for-profit centres ranges from 1-2%. Still, the broker believes there's opportunity for G8 to produce margins well in excess of the average and, indeed, the company sustained a 14.5% pre-tax margin for 2012. Occupancy rates are also considered one of the risk factors as, given the cost constraints of an increasingly qualified workforce, a minimum of 75-80% occupancy is required for profitable functioning.

As at December last year the company owned 252 centres and managed another 48. On the FNArena database the latest two brokers join CIMB and Citi covering the stock. All have Buy ratings. The consensus price target is $4.18, suggesting 7.1% upside to the last share price. Targets range from $3.70 to $5.00. The consensus dividend yield is 4.0% on FY14 estimates and 4.8% on FY15.
 

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