In the past I've written several times that G8 Education Ltd (ASX: GEM) looked like an opportunity, especially when shares plunged to $3 in the wake of August's results. I wrote in several pieces that the company had a good track record of keeping costs under control, and with the 7% fully franked dividend, it was too good an opportunity to pass up.
I'm not as keen on G8 now as I was, for two reasons:
- Worsening business performance
Occupancy dived to 80% for the full year, a level not seen since 2012. Higher competition was also reported and management announced an increase in its capital expenditure on centres in response. Continued high occupancy is important because the company requires a high level of occupancy just to break-even on its costs. To give an overly-simplistic illustration, if your break-even occupancy level is (just say) 73% and your actual occupancy is 80%, every 1% decline in occupancy could reduce your earnings by 1/7th, or 14% (assuming all other factors stay constant). With competition reportedly increasing, I think a greater weighting should be given to the importance of G8's occupancy figures.
- Price
At $4.17, shares are 30% above a price that I thought allowed for a range of possible outcomes (good and bad), providing some margin of safety. Factor in the recent capital raising (each share owns less of the business than previously) add the risks and costs of an expansion into China, and I think buyers today are being too optimistic and overlooking concerns in the business.
While the company continues to grow aggressively, it does require low-cost debt to remain available and/or that its shares are priced highly enough to raise capital at a reasonable cost. Although the recent capital raising lowered overall debt, I'm wary that this simply could provide the firepower for more big acquisitions in the future. To put it another way, I'm concerned that G8 is a company whose primary business is buying childcare centres, not running a childcare service.
Big acquisitions have been OK in the past – this is a company that grows by acquisition after all – but there are limits to that strategy, and the cost of childcare and continued availability of government subsidies also remains a concern. I simply think that at today's prices, the future is not certain enough to make G8 a buy, although its dividend does remain attractive if you were lucky enough to have held from a lower price. I'd call it a 'Hold'.
