UBS Global Research 26 August 2019 G8 Education Ltd Outlook...

UBS Global Research
26 August 2019
G8 Education Ltd
Outlook disappoints….. again – downgrade to Neutral

Longer term value on offer… but consistent headwinds pushing out upside
We remain believers that GEM offers long-term value - from self-help initiatives and
industry demand/supply rebalancing leading to improved occupancy, together with the
maturity of GEM's greenfield portfolio. However, it is hard to ignore the consistent
additional headwinds that have arisen during the journey. At face value GEM screens
cheap, on a 1yr fwd PE of 12.0x, while offering hypothetical 3yr (CY20-23E) EPS CAGR
of +16%. That said, we recognise that we have been too optimistic on the earnings
growth trajectory to date, and we want to see tangible signs of a collective
improvement before becoming more positive. As such, we downgrade to Neutral.

Strong organic growth, but acquisitions a material underperformer
Rev. $430m (+9% yoy / -1% vs UBSe), EBIT $51.6m (+7% yoy / +6% vs UBSe), NPAT
$26.2m (+2% yoy / +5% vs UBSe). The headline results had a number of positives: 1)
U/L EBIT margins better than feared, down 23bps yoy to 12.0% but above UBSe
(11.1%); 2) Occupancy LFL up +1.5ppt to 71.3% in line with UBSe; 3) Strong operating
cash conversion of 108%; and, 4) Solid organic centre performance (+14%). However,
this was offset by material underperformance of acquisitions/greenfields: CY18 cohort
(CY19 EBIT to be -$3m below prior forecast) and CY19 cohort (2H19 EBIT -$4m below).

Substantial reductions to forecasts given challenging outlook
GEM guided to CY19E proforma EBIT of $140-145m, well below pre-result consensus
of $151m and UBSe $154m. Weak outlook commentary is underpinned by: 1) CY18
and CY19 greenfield centres to be an ~$8m drag on FY19E EBIT; 2) Supply continues
to take longer to moderate compared to expectations, with GEM noting 89 of 500
centres face new supply within 2km radius; and, 3) Occupancy LFL guidance for mid-
1ppts, down from implied previous guidance of 1.5-2.0%. Our analysis suggests u/lying
EBIT growth falls from 14% in 1H19, to a range of -4% to +6% in order to achieve
guidance – which must be driven by increased costs. Our revised forecasts reflect FY19E
EBIT of $140m and a slower benefit from greenfields/occupancy improvements beyond
- which translates to FY19-22E EPS downgrades of 12-17%.

Valuation: reducing PT to $2.25 (from $3.80), downgrade to Neutral
Our $2.25 PT is based on a 50%/50% weighting to our $1.90 1yr fwd PER / $2.64 DCF
valuations. Given the uncertainty around the earnings improvement trajectory, we now
incorporate a -50% discount to the Small Industrials (ex fin.) index and a beta of 1.7x.