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Morningstar | Navitas' FVE Cut to AUD 4.22 as Investor Day Raises Margin Concerns

The most notable aspect of Navitas' annual investor day was the downgrade of management's long-term group EBITDA margin guidance to 17% from 18%, including corporate costs. However, the 20% EBITDA margin guidance for the SAE division was maintained, which comprises 16% of group EBITDA, and we estimate this implies a long-term EBITDA margin of around 22% for the University Pathways, or UP, division, comprising 75% of group EBITDA. In fiscal 2018, Navitas reported EBITDA margins of 13% for SAE, 22% for University Partnerships, and 15% for the group, with guidance continuing to imply a strong rebound for SAE’s margins. Maintenance capital expenditure guidance of AUD 20 million per year is in line with our forecasts but excludes costs associated with new initiatives, which we expect to be quite low.

Although small in magnitude, the margin downgrade is notable as Navitas' group EBITDA margin has already declined to 15% in fiscal 2018 from 19% in fiscal 2011. At the investor day a year ago, the company laid out a clear set of long-term KPIs to move forward from the disappointment of recent years, such as the loss of the Macquarie, Curtin, and AMEP contracts. However, we are increasingly concerned historical margin compression may be more reflective of competitive pressures, and the lack of an economic moat, than isolated incidents which won't repeat.

We have cut our group EBITDA margin forecast to 16.8% from 18.3% which incorporates a margin of 22% for UP and 19% for SAE. This implies an average EBITDA margin over the next five years of 16.8%, or about the same as the 16.3% achieved over the past five. Our lower forecasts have cut our fair value estimate to AUD 4.22, meaning we now view the stock as overvalued. We forecast an EPS CAGR of 7% over the next decade, an improvement from the 1% CAGR achieved over the past five years. Our fair value implies a fiscal 2019 price/earnings ratio of 20 and a dividend yield of 4.2%, or 5.7% including franking credits.

Aside from the margin downgrade, the investor day focused on growth opportunities which is understandable considering EPS weakness in recent years--declining at a CAGR of 6% over the last three years. Although it is pleasing to see management focus on growth, we were disappointed with the lack of detail. For example, management highlighted digital products as a source of growth but did not outline a revenue model and said software would be bought from third party vendors rather than developed internally. We are also curious why these opportunities haven't already been exploited considering the number of senior executives with long tenures at the company.

Although the defensive nature of the business, long-term demand growth, and reasonably sticky nature of contracts are appealing investment attributes, Navitas only looks likely to generate mid-single-digit revenue growth in the coming years and this assumes no further material contract losses. Our key concern is that a lack of innovation and revenue growth will make the company increasingly vulnerable to competitive pressures. We were encouraged by the launch of Navitas Ventures nearly two years ago but are increasingly concerned management aren't embracing this opportunity as much as they should in order to evolve the business model.