Affinity Education: High Growth Plus Dividends (Soon)

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

-Substantial earnings growth expected
-Discount to GEM to narrow
-Takeover appeal heightened
 

By Eva Brocklehurst

Affinity Education ((AFJ)) has rapidly become the third largest child care provider in Australia, with a strategy to grow via acquisitions in this fragmented industry. As a result of acquisition activity over the past 12 months, the company is gaining considerably more scale outside of its home state, Queensland, having expanded to 144 owned child care centres and 12 managed centres.

Canaccord Genuity forecasts 2015 earnings growth of 72.5%, underpinned by a full year's contribution from acquisitions made in 2014. 2016 growth is expected to be more moderate, but still a solid 22%. The broker's Buy rating and $1.90 target are underscored by the strong earnings growth profile and attractive pricing relative to peers, in particular the 35% discount to its listed competitor G8 Education ((GEM)). The discount is based on G8 Education's higher margins, larger scale and liquidity. A discount is warranted but Canaccord Genuity expects the gap will narrow as Affinity establishes a track record and the dividends flow. The 2015 implied price/earnings ratio is 14.5, which the broker considers reasonable given the strong earnings growth potential and low risk.

The broker envisages potential for 58% upside to the target price and also likes the probability of healthy dividends in 2015 as well as the stock's takeover appeal. The takeover appeal comes from the reasonable scale achieved so far, an open register and relatively conservative balance sheet – suited to either G8 Education or private equity. Dividends are expected to commence this year, with the company having a stated pay-out ratio of up to 60% of profit.

The ability to frank dividends in 2014 was affected by an aggressive acquisition strategy and the broker expects this will result in the expensing of acquisition costs and a small statutory loss in 2014. Nonetheless, Canaccord Genuity estimates the company could pay 6.0c a share, fully franked, in 2015 and expects this to lift to 9.0c in 2016. This would put Affinity on a prospective yield in 2015 and 2016 of 4.8% and 7.2% respectively.

Potential catalysts include the 2014 results, which should demonstrate the acquisitions have been integrated well and establish a solid base for a track record – which is so far lacking. The government's response to the Productivity Commission's report, likely February/March, should be benign for Affinity as the draft recommendations were on the positive side for operators and the broker expects it would remove some uncertainties in any case.

The company was established in May 2013 and is focused on long day care for children from birth to school age. Canaccord Genuity notes the portfolio has a skew towards regional and outer metro areas which is a key differentiating factor compared with G8 Education. In this way, under the Productivity Commission's recommendation that those families with income below $160,000 should receive more funding support for child care, Affinity could be well place to benefit from the potential response from the government to those recommendations.

The child care industry is viewed favourably because of underlying drivers such as population growth, increasing fees and strong government support. Canaccord Genuity observes that acquisition multiples paid by Affinity are considerably higher than those paid by G8 Education but the actual prices are not as far apart as these multiples suggest, implying that the difference is determined largely by the respective forecasts from each company. Affinity is expected to concentrate on earnings-positive transactions rather than paying the lowest multiple.

Risks come from any stumble in terms of due diligence on asset acquisition. Any miscalculation could result in a poorly performing asset, and the pace of acquisition growth has been been hectic at over 150% in just over 12 months. Moreover, the broker cites anecdotal evidence which suggests activity around developing new centres is escalating, and this could have an impact on occupancy rates at existing centres.

Find out why FNArena subscribers like the service so much: "Your Feedback (Thank You)" – Warning this story contains unashamedly positive feedback on the service provided.

Click to view our Glossary of Financial Terms