Over the past six months, leading childcare provider G8 Education Ltd (ASX: GEM) reported a 70% increase in profit and a 20% increase in its full-year dividend to see its share price beaten down 30% by the market.
A Productivity Commission report released in late February which suggested a number of changes to the current government childcare subsidy system appears to have spooked investors.
The shares are currently trading around $3.80 and offer investors a fully-franked dividend yield of 6.4%, or 8.3% gross, and potential for future capital growth. Is now the time to buy?
Growth by Acquisition
G8 Education currently operates 455 child care centres across Australia and Singapore, with 203 of those added to the company's books after an acquisition spree in 2014. It operates a simple growth by acquisition business model, adding private childcare centres in high demand areas to its portfolio.
Source: G8 Investor Presentation, February 2015
The future growth of the company relies on further acquisitions at a good price. The company aims for all acquisitions to be completed at an earnings before interest and taxes (EBIT) multiple of 4 times, which is often achieved.
The purchase of Sterling Early Education's 91 childcare centres in 2014 was settled at a premium of 5.79 times EBIT. Whilst it is above their target price, the number of quality centres picked up in this transaction appear to be worth the price.
G8 Education has achieved impressive returns over the past five years, attracting the attention of competition. Affinity Education Group Ltd (ASX: AFJ) listed on the ASX in December 2013 and recently announced it is now operating 152 childcare centres.
The increasing competition may result in G8 paying higher price multiples for future acquisitions, although this has not occurred yet. The price paid of acquisitions in the future is the key to continued growth for the business and investors must watch it closely.
Improving performance
The latest data indicates that the management team are making more profitable acquisition decisions with each passing year. The margin (EBIT/Revenue) for centres acquired pre-2011, during 2011 and 2012 is shown below.
Data source: G8 Investor Presentation, February 2015
The EBIT margin for the centres acquired pre-2011 is around 20% compared to 25% for centres acquired in 2012. The EBIT margin for centres acquired during 2011 has increased significantly from 20% in 2012 to over 24% in 2014. There is a huge difference between the stores acquired before 2011 and after.
It is important to note that the number of acquisitions made during 2011 and 2012 were relatively small compared to the those made in 2013 and particularly 2014. Investors should follow this area closely and monitor the performance of the recent acquisitions.
The data provided by G8 also shows that occupancy rates have been improving across all centres, but appear to be reaching a steady state. Again, the pre-2011 centre occupancy rate of 80% is lagging the later acquisitions which have an occupancy rate around 89%.
Dividends
The Group recently announced a dividend increase to 24c per share for the full year. After declaring a maiden dividend of 2 cents per share in 2012, the 2015 fully franked dividend of 24 cents per share implies a compound growth rate of 64%! At current prices the stock yields over 6% and the grossed up yield is almost 8%. That certainly beats the paltry 2-3% you might earn with cash sitting in the bank.
What investors need to watch
1. The price paid for future acquisitions
With increasing competition entering the industry time will tell if G8 Education can continue acquiring childcare centres around their target price of 4 times EBIT. Investors must watch this in the future.
2. Government changes to regulations and subsidy payments
Proposed changes to childcare subsidy payments, including the possibility that nannies will be eligible for childcare reimbursement payments, pose a certain degree of risk to the industry. However, considering the importance of childcare I doubt any changes to regulations will be passed that are crippling to the providers of this essential service.
3. Integration of new centres
With a huge number of centres added to the books during 2014 it may be a challenging task to successfully integrate them all into the company with the same success as those in 2011 and 2012. With years of experience in this area it is likely that G8 management will continue to improve the margins and performance of the new centres.
Should you buy?
G8 Education is a good business executing its business strategy seamlessly at this stage. The company results indicate that recent acquisitions are more profitable and located in higher demand areas.
Expected earnings and dividend per share in 2015 of 27 cents and 24 cents respectively implies a forward P/E multiple of 14 and a fully franked dividend yield over 6%. With potential for significant capital growth into the future, I think now is the perfect time to buy G8 Education.
