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Morningstar | Labor’s Childcare Proposals Support Long-Term Industry Growth Trends

A Labor victory in the forthcoming federal election would be positive for the childcare sector but a Coalition victory wouldn’t be disastrous by any means. Both parties have consistently argued for increasing government childcare spending and we expect this to continue for the foreseeable future. However, Labor’s current proposals are particularly generous, including higher wages for childcare workers, an increase in pre-school education funding, and an increase in the childcare subsidy, or CCS.

If enacted, Labor’s proposals would be particularly positive for childcare centre operators, such as G8 Education, which are highly sensitive to changes in demand and supply. We don’t expect a material direct benefit on the childcare real estate investment trusts, including Arena REIT and Charter Hall Education Trust, although tenant credit risk would decrease slightly, and rental growth may be slightly higher in the long-term.

Labor’s proposals come at an interesting time for the childcare sector, which has been impacted by an oversupply of new childcare centres in recent years but boosted by the introduction of the childcare subsidy, or CCS, since July last year. We expected the CCS to continue to boost the childcare sector, as detailed in our February 2018 special report: How to Play the Australian Child Care Bonanza, and the improvement in childcare occupancy rates in recent months confirms our thesis.

If Labor’s proposals are enacted, we estimate they could boost our long-term occupancy rate forecast for G8 Education by around 1% to 2% percent and our fair value by around 15%. We estimate the childcare REIT’s fair values could increase by around 5%. Both childcare REITs have benefited from improving childcare investor sentiment and lower bond yields in recent months meaning both are now overvalued. However, G8 is undervalued and an enactment of Labor’s proposals would only reinforce our view.

The federal government estimated the CCS would boost childcare subsidies by around AUD 3 billion per year, or 40%. The precise impact of the CCS is difficult to quantify as the subsidy varies by family based on a range of factors and the impact is likely to be felt gradually. It’s also impossible to know exactly what families will do with the extra money received under the CCS. However, broadly speaking, we expect the CCS to boost childcare demand and particularly childcare centre occupancy rates. Labor’s CCS proposal is reasonably complex but could boost the CCS by another AUD 1.2 billion per year, or around 17%. This would represent a material increase to childcare subsidies soon after the introduction of the CCS is starting to take effect.

Our analysis of previous increases in government subsidies indicates the impact of both the existing CCS and Labor’s proposed CCS policy could be greater than the government expects. For example, every government budget forecast for childcare subsidy spending between 2010 and 2015 was exceeded. In addition, the 2008 increase in childcare subsidies, from 30% to 50% of fees incurred by families, resulted in a 44% increase in government childcare subsidy spending in the following year and the childcare sector was undersupplied in some areas until 2015.

Although we expect the CCS proposal to have the largest impact on the childcare sector, Labor’s proposals to increase pre-school education funding should also be positive. Under the current system, four-year-old children are entitled to subsidies for 15 hours of pre-school education per week, which can be delivered in a dedicated pre-school or in a long day care centre, as is operated by G8 Education. Labor proposes to extend the current system to include three-year olds which looks likely to cost the federal government an extra AUD 500 million per year by 2022. Beyond this, it’s difficult to quantify the impact, in part because the pre-school programmes are ultimately funded by the state governments. However, we expect the expansion of the education system to include younger children to continue and underpin demand growth for the childcare sector.

Labor’s proposal to increase childcare wages is the most unusual of its three policies because it appears to involve the federal government paying a proportion of childcare workers’ salaries directly. This should be positive for childcare centre operators, like G8 Education, as it’s likely to incentive new employees into the market. Considering the federal government already bears most of the cost of childcare fees, the concept that it would also directly incur employee costs, which are by far the largest cost, is surprising. However, we don’t expect nationalisation of the childcare sector due to the political sensitivities and other complexities of doing so. A more likely outcome is that regulation will increase, particularly of childcare fees, which we expect to lift the barrier for new entrants. However, at this stage, the details of the wages policy are extremely vague, and the magnitude seems relatively small, for example, the proposal implies a 20% pay rise over 8 years. It’s also worth bearing in mind that a similar system was introduced by the Gillard Labor federal government in 2013 but was scrapped only months later by the newly elected Abbott Coalition Liberal government.