Outlook upbeat for G8 Education despite big first-half loss

Morningstar’s senior equity analyst Gareth James believes G8 Education’s half-year results were better-than-expected despite a big statutory loss.

Australia’s largest private sector childcare operator on Monday reported a $239 million loss for the six months to 30 June.

This was mainly a result of a $237 million non-cash impairment that it had flagged in June, reflecting a writedown of goodwill and underperforming childcare centres following the impact covid-19 on its business.

Excluding the impairment charge, underlying profit for the half year declined to $11.6 million from $26.2 million a year ago.

Shares in the G8 Education (ASX: GEM) dived 11 per cent on Monday immediately following the results, which James said was surprising since several metrics exceeded expectations and the underlying performance was good.

“The result was significantly distorted by a range of factors, and the huge reported loss may have concerned some investors,” he said.

G8 shares had recovered 7 per cent on Tuesday, rising to 99 cents, but are still significantly undervalued to Morningstar’s fair value estimate of $2 each.

G8 Education (GEM) - 1YR

Source: Morningstar Premium

The company, which currently operates 475 childcare centres in Australia and 17 in Singapore, has said the pandemic exacerbated a “challenging industry supply environment that has been in place for the past 12-24 months”.

The sector had been hit after parents pulled out children from centres due to covid-19 related lockdowns, but received a boost after the federal government announced a free childcare package.

That package, however, ended in July and was replaced by a new system under which parents would incur some costs, triggering concerns of a fall in enrolments.

But chief executive Gary Carroll said the impact had been lower than expected, with enrolments down just 3 per cent, instead of the anticipated 15-20 per cent.

For the first half, overall occupancy levels were 66.3 per cent in 2020, down from 72.2 per cent a year earlier.

Numbers have rebounded in states other than Victoria, with enrolments close to 70 per cent and physical attendance 63 per cent in other states—close to normal levels.

G8 said its enrolments nationally, including in lockdown-impacted Victoria, are currently at 69 per cent.

The company received significant government support, with the federal JobKeeper wage subsidy package covering around 8600 staff, as well as through payroll tax relief.

Morningstar’s James said the impairments came at a convenient time for G8, allowing it to avail government subsidies. 

“We expect the sector would have collapsed had it not received financial assistance, and it’s a very good thing for the economy that it didn’t,” he said.

“But government bailouts create political risk for those that receive them and it’s important that G8 isn’t perceived to be profiting at the expense of the taxpayer.”

The company said it has also sought rent relief from landlords, so far securing $4.8 million in waivers and deferrals of $3.4 million.

G8 generated $44 million in free cash flow in the first half and James forecasts it to remain cash generative in the second half.

He expects fiscal 2020 to be the low point for earnings before interest and tax (EBIT) margins with the introduction of the childcare subsidy in July 2018 driving increased occupancy rates and margin improvement.

The company is set to benefit from several favourable long-term trends, such as a growing population of 0- to 5-year-olds, an increasing proportion of children using childcare, increasing female workforce participation rate, and rising childcare fees.

G8 Education, which raised $301 million in an equity raising in April, said it will divest its 17 centres in Singapore, calling the operations sub-scale in that country.

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