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Morningstar | Charter Hall Education Trust Still Undervalued Despite Improving Occupancy Rates

Market sentiment towards child care stocks has improved significantly over the past month, triggered by Think Childcare’s announcement that occupancy rates are improving at its child care centres. Think attributed improvement to the recently introduced Child Care Subsidy, or CCS, which appears to be offsetting the effects of the build in oversupply of child care centres over the past few years. As further evidence of improvement, G8 Education, the largest listed child care centre operator, reiterated Think's comments the following week, which pushed its shares up 60% over the next month.

The occupancy news didn’t surprise us as we’ve long thought the CCS would provide a  boost to the industry, as outlined in our January 2018 report "How to Play the Australian Childcare Bonanza." Before the news, we believed the market was unjustifiably extrapolating weak occupancy rates, an oversupply of child care centres, and potential consequences for the leveraged business models of some players. Aside from CCS benefits, we’re also of the view G8 Education’s corporate culture has improved significantly over the past couple of years which is helping drive more rational behaviour in the industry.

From the landlords’ perspective, improving occupancy rates are positive but less beneficial than for the operators. Landlords already have strong and defensive businesses due to their standard 15-plus years leases, and the defensive nature of child care services which are largely funded by the federal government. The oversupply of child care centres has also led to a withdrawal of lending for new developments, in addition to broader credit tightening triggered by the Financial Services Royal Commission which will benefit existing providers. We don’t expect Charter Hall Education responds to improving conditions by increasing development activity, but we do expect the price/fair value gap to continue to close towards our AUD 3.20 fair value estimate as sentiment improves further.