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2 ways to invest in education

Glenn Freeman  |  25 Jul 2016Text size  Decrease  Increase  |  

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Education is always a hot topic in Australia, especially in the lead-up to Australia's recent federal election. But it also presents an attractive theme for investors seeking to diversify their portfolio outside the usual balanced mix of financials and resources stocks, and cash.

If you're able to live with a little risk, G8 Education (ASX: GEM) may be worth considering.

While it lacks an economic moat, and has a high amount of uncertainty around its fair value rating, Morningstar believes it represents value at its current price.

The 2016 election shone a spotlight on education, and as a result, the passage of key child-care legislation is likely to be delayed, says Gareth James, Morningstar senior equity analyst.

"However, in the long term, the company's prospects are brighter as demand and government funding for early childhood education and care services are likely to grow," he says.

"Both the Liberal and Labor parties propose increasing early childhood education centre funding, but the method, magnitude and timing remain uncertain."

G8 Education operates more than 400 child-care centres in Australia, along with a small Singapore operation. This has increased from 35 Australian centres at the end of 2009.

It has benefited from a number of external factors, including the global financial crisis, which saw the collapse of competitors ABC Learning and CFK Childcare Centres. However, another large competitor, Goodstart Early Learning, also emerged.

"G8 is in a reasonably strong competitive position, with highly fragmented vendors, a growing population of children, and supportive federal government policy," James says.

While Morningstar analysis suggests greater competition is expected to disrupt G8 in the short term, the extended delay in this happening has played a large role in its success to date.

The company's expansion from a low base is another factor, though despite rapid growth, it has only a 7.5 per cent market share.

Child-care property

If you're seeking a different type of exposure to the education and child-care industry, and the favourable government funding arrangements they benefit from, Folkestone Education Trust (ASX: FET) offers an alternative.

While investing in G8 offers investors exposure to the operators of child-care centres, Folkestone provides access to the owners of the properties they operate from, with greater certainty of near-term earnings along with mid-term earnings visibility and security.

Folkestone Education Trust is a real estate investment trust that holds a diversified portfolio of 333 Australian long day care centres, with 53 per cent of these in metropolitan regions and the remainder in regional locations.

As a result of high customer switching costs and long leases on the properties leased to child-care centre operators, Folkestone is regarded as having a narrow economic moat.

"We expect child-care operators and by extension, the owners of the child-care centres themselves, such as Folkestone Education Trust, to benefit from positive macroeconomic trends," says Morningstar equity analyst Johannes Faul.

"We anticipate government funding for long day child-care to continue growing in real terms above the population growth rate. Also, a continuously growing child-care consumer base, of children up to 5 years old, is expected to drive demand for child-care places."

G8 Education ranks among its main tenants, representing 9 per cent, along with Goodstart (60 per cent) and Only About Children (5 per cent).

Folkestone also operates 51 properties in New Zealand.

Total future rental levels, increasing rents and occupancy rates are the key drivers of Morningstar's fair value estimate--along with additional income from acquisitions and developments.

"Folkestone Education Trust offers a relatively low-risk income stream underpinned by long leases where the tenant is responsible for nearly all outgoings," Faul says.

"It provides exposure to an attractive sector with tailwinds coming from population growth, rising costs of living placing pressure on mothers to return to the workforce, and government subsidies to encourage higher female workforce participation."

However, this optimism must be viewed alongside a number of external challenges, including potential tightening eligibility criteria for government child-care incentives, and the impact of higher interest rates on property valuations and earnings.

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Glenn Freeman is Morningstar's senior editor.

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