The G8 Education Ltd (ASX: GEM) share price has grown by 33% over the last six months, is it worth a purchase at this price?
G8 Education is one of the largest Australian childcare providers with a market capitalisation of $1.67 billion.
It has a number of factors that work for and against it which makes an investment decision fairly complex:
The bull case
G8 Education has successfully run its acquisition strategy over a number of years. It has identified new childcare centres that are in good locations and bought them at an attractive price. Its strength as a listed entity has allowed it to issue new shares and take on debt whenever needed.
The demand for childcare has been growing for a number of years which has boosted G8 during its listed life. As long as G8 can maintain high occupancy rates and grow revenue per child, then it can take advantage of this trend.
The government want to make childcare as attractive as possible, which hopefully encourages parents to go to work and add to the Australian economy. The subsidies provided by the government may not cover all of the cost, but it certainly encourages some parents to put their child into a centre.
In its half-year report to 31st December 2016 G8 management disclosed that not only did it complete a $200 million capital raising, but it may also expand into China. The Chinese market would be a huge opportunity for G8 to expand, particularly as China's one child policy was recently lifted.
The bear case
G8 has built up a lot of debt over the last few years. Arguably it is justified in doing so, but it is putting the balance sheet under strain. As interest rates rise it could find that the interest payments stifle any future profit growth. Investors should closely watch for any similarities with ABC Learning.
The more G8 expands through acquisitions, the less potential opportunities there are out there. Management will need to focus on increasing the profitability of each of its current centres. This could be difficult as wages are one of its main expenses and there was recently a national strike over pay.
There is increasing competition from other large providers such as Think Childcare Ltd (ASX: TNK) which could hamper future margins and acquisition targets too.
Foolish takeaway
G8 is currently trading at 14.4x FY17's estimated earnings with a grossed-up dividend yield of 8.24%. For investors purely looking for income it may be a decent option, but I wouldn't buy expecting much capital growth at the current price.
If you're a G8 shareholder who has experienced the growth of the share price, it may be prudent to take some (or all) of your profits off the table and invest the capital in these three fast growing shares.
