GEM is in good shape

FIIG have come out with their review of GEM  as it relates to their bond offerings.  Most of it is a rehash of the company's AR, so may not be worth repeating here.  Their summary, though, may be of interest (my emphasis):

1. G8 Education Ltd (G8) is the largest ASX listed (ASX: GEM) child care centre operator in Australia with a market capitalisation of $1.5bn at 26 May 2016 (ASX top 200 company)
2. The G8 business model is to acquire centres with lower margins to the performance KPI’s that G8 achieves then improve the performance of these centres and ultimately reduce gearing to their long run objective
3. Acquisitions generate operating profits at the centre level that immediately deliver earnings to the company. There are no greenfield developments
4. Management has stated G8’s fastest growth period is over, with any future acquisitions to be self-funded by retained earnings, cash and some additional debt. The company does not have any acquisition quotas, and will only acquire businesses which are deemed attractive
5. G8 is the largest private for-profit operator of childcare centres in a fractured Australian sector with limited competition in centre acquisition. G8 is therefore able to pick the centres that both perform and fit with the company’s existing centre portfolio
6. The group has a track record of bringing acquired centres up to the group level evidenced by the strengthening EBITDA margin of the company. Any centres that are unable to meet the group expectations or are not a good strategic fit are divested
7. Sound credit metrics with moderate gearing of 40.5% in FY15 against target gearing of 45% and leverage of 2.0x in FY15 (net debt to EBITDA) against an objective of 2.0x or under. EBITDA interest coverage is solid at 5.6x in FY15
8. The group maintains good levels of liquidity with cash holding of $193.8m in FY15 and a $50m undrawn overdraft facility. As a service business G8 is capital light with minimal working capital requirements and therefore generates strong cashflow with a near 1:1 cash conversion ratio
9. G8 does not have a large tangible asset base as it is a service organisation. G8’s value is derived from its ability to generate future profits. The child care centres can be sold as a going concern if required. The book value of the centres represented by intangibles represents the historic prices paid, and does not account for improvements G8 has made to the assets including higher occupancy, better margins, systemisation e.c.t
10. The fundamentals of the childcare industry remain strong. Statistically Australian families continue to move towards two income households which helps drive the demand for childcare services and demographic fundamentals also remain a positive for the sector
11. The performance of individual child care centres is largely driven by occupancy rates. These rates are affected by the performance of the overall economy, and in particular unemployment rates. When unemployment rises significantly, occupancy levels can be expected to drop
12. While demonstrating a conservative acquisition appetite to date, any changes to this could negatively affect the group’s credit profile. Further as G8 continues to expand it is likely it will use an increased proportion of debt to continue to deliver shareholder growth. To the extent this results in an increased level of gearing, G8’s credit profile could deteriorate over time.

The past 4 years has seen a monotonic increase in profitability.  With the focus now moved to business improvement, rather than acquisition, there is an expectation that this trend will continue, all else being equal.