EUR 850.00 For Business Accounts Only

Morningstar | Market Ignoring Steady Improvement at G8 Education

The market appears to have ignored the reiteration of earnings guidance by G8 Education last week, with the shares increasingly undervalued since the 2018 financial result in February. G8’s share price almost doubled from its lows last October as the introduction of the child care subsidy, or CCS, drove a turnaround in occupancy rates. However, it’s possible that much of the rally was due to the reduction in the previously large short-selling position in the stock, from 11% to 3% of shares outstanding, rather than a significant improvement in sentiment among long investors. For investor sentiment to improve, we expect investors will want to see hard evidence of financial improvement at the interim result in August 2019.

G8 is a company that’s always had its doubters, in part due to the legacy of the collapse of ABC Learning during the global financial crisis but also due to the negative connotations of "roll-ups," the general lack of an economic moats in the industry, and the no-moat rating of G8 specifically. We don’t disagree that the industry is likely to experience cyclical periods of childcare centre oversupply that may temporarily impact corporate profits. However, we also think that the long-term outlook for the sector is good and that the introduction of the CCS should help occupancy rates improve in the medium term.

Specifically, management expects occupancy growth to be at the upper end of 1 to 2 percentage points in 2019, versus our forecast of a 2-percentage-point improvement. This is in line with our long-term investment thesis that assumes an improvement in occupancy rates from 74% in 2018 to 80% in 2021. We have maintained our earnings forecasts and AUD 3.50 fair value estimate. At the current market price of AUD 2.98, we believe the shares are undervalued and that the 2019 price/earnings, or PE, ratio of 15 is attractive. The current price implies an attractive and sustainable dividend yield of 5% or 7%, including franking credits.