Treasure Chest: Competition To Bite G8

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Canaccord Genuity has downgraded G8 Education as the addition of new child care supply accelerates.

– New centre count accelerating
– Government funding delayed
– risk of demand/supply imbalance
 

By Greg Peel

In the March quarter 2017, 113 new child care centres were opened in Australia, Canaccord Genuity notes. This compares to only 70 in the March quarter 2016 and 61 in the December quarter 2016. Even if a moderation of this growth rate is assumed for the rest of the year, the broker estimates the number of new centres for 2017 could exceed 350, representing a 5% increase in supply.

Canaccord believes the supply increase is a response to proposed changes to government funding initially tabled in 2015, with implementation expected on July 1, 2017. But given a delay in getting the changes through parliament, increased funding appears unlikely to be available until July 1, 2018, the broker suggests.

The rapid increase in supply is likely to create pockets of demand/supply imbalance. In recent discussions with a number of private sector child care operators, the broker learned that the typical ramp-up in centre occupancy early in a year has been slower than expected this year. Canaccord suspects this is not an issue of lower demand, but of increased supply absorbing typical demand.

This is alone an issue for listed child care operator G8 Education ((GEM)), but more so because there appears to the broker to be an increase in the number of centres within close proximity to G8’s exiting centres. Of the 113 new centres opened in the March quarter, 45 are located within a three kilometre radius of a G8 centre and 20 are located within two kilometres.

That compares to 6 in the December quarter within 2km, and 35 out of the total 250 opened in 2016.

Canaccord recognises this trend is not lost on G8, and management is attempting to position the business to address the increase in supply. But this will not happen overnight. The broker warns supply risk is likely to increase over the next twelve months. This will have a flow-through impact on child care pricing and further acquisition opportunities.

The stock is not trading on a demanding PE multiple, the broker acknowledges, and near term catalysts such as bank funding and the aforementioned government funding changes remain. However the supply issue has the potential to weigh on earnings growth and investor sentiment, and thus on share price.

Canaccord, not one of the eight stockbrokers monitored in the FNArena database, cuts its earnings forecasts and its target price to $3.80, down from $4.30, representing a 10% discount to the average Small Industrials PE.

The broker downgrades to Hold from Buy.

The four brokers in the FNArena database covering G8 Education have not updated since the company’s earnings result in February. At the time, increasing capacity was flagged by analysts but this was overshadowed by the announced placement of a 12.5% stake in the company to China First Capital Group, allowing for debt reduction and providing funds for further acquisitions.

The database currently shows three Buy (or equivalent) and one Hold rating. The consensus target is $4.05.
 

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