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Election2019: Labor's childcare plans back long-term growth trends

Morningstar Analysts  |  17 May 2019Text size  Decrease  Increase  |  
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Labor and the Coalition have consistently argued for increasing government childcare spending and Morningstar expects this to continue for the foreseeable future.

However, Labor's current proposals are particularly generous, including higher government-subsidised wages for childcare workers, an increase in pre-school education funding, and an increase in the childcare subsidy, or CCS.

If enacted, Labor's proposals would be particularly positive for childcare centre operators, such as G8 Education (ASX: GEM), which are highly sensitive to changes in demand and supply.

We don't expect a material direct benefit on the childcare real estate investment trusts, including Arena REIT (ASX: ARF) and Charter Hall Education Trust (ASX: CQE), although tenant credit risk would decrease slightly, and rental growth may be slightly higher in the long term.

Labor's proposals come at an interesting time for the childcare sector, which has been affected by an oversupply of new childcare centres in recent years but boosted by the introduction of the childcare subsidy, or CCS, since July last year. Morningstar expected the CCS to continue to boost the childcare sector.

If Labor's proposals are enacted, Morningstar estimates they could boost Morningstar’s long-term occupancy rate forecast for G8 Education by around 1 per cent to 2 per cent and its fair value by around 15 per cent. We estimate the childcare REITs' fair values could increase by about 5 per cent.

Both childcare REITs have benefited from improving childcare investor sentiment and lower bond yields in recent months meaning both are now overvalued. However, G8 is undervalued and Morningstar says an enactment of Labor's proposals would only reinforce this view.

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The federal government estimated the CCS would boost childcare subsidies by about $3 billion per year, or 40 per cent. The precise impact of the CCS is difficult to quantify as the subsidy varies by family based on a range of factors and the impact is likely to be felt gradually.

Nor is it possible to know exactly what families will do with the extra money received under the CCS. However, broadly speaking, Morningstar expects the CCS to boost childcare demand and particularly childcare centre occupancy rates.

Labor's CCS proposal is reasonably complex but could boost the CCS by another $ 1.2 billion per year, or about 17 per cent. This would represent a material increase to childcare subsidies soon after the introduction of the CCS is starting to take effect.

Morningstar analysis of previous increases in government subsidies indicates the impact of both the existing CCS and Labor’s proposed CCS policy could be greater than the government expects. For example, every government budget forecast for childcare subsidy spending between 2010 and 2015 was exceeded.

In addition, the 2008 increase in childcare subsidies, from 30 per cent to 50 per cent of fees incurred by families, resulted in a 44 per cent increase in government childcare subsidy spending in the following year and the childcare sector was undersupplied in some areas until 2015.

Morningstar expects the CCS proposal to have the largest impact on the childcare sector but says Labor's proposals to increase pre-school education funding should also be positive. Under the current system, four-year-old children are entitled to subsidies for 15 hours of pre-school education per week, which can be delivered in a dedicated pre-school or in a long day care centre, as is operated by G8 Education.

Labor proposes to extend the current system to include three-year-olds which looks likely to cost the federal government an extra $500 million per year by 2022. Beyond this, it's difficult to quantify the impact, in part because the pre-school programmes are ultimately funded by the state governments.

However, Morningstar expects the expansion of the education system to include younger children to continue and underpin demand growth for the childcare sector.

Labor's proposal to increase childcare wages is the most unusual of its three policies because it appears to involve the federal government paying a proportion of childcare workers' salaries directly. This should be positive for childcare centre operators, like G8 Education, as it's likely to create incentive for new employees to enter the market.

Considering the federal government already bears most of the cost of childcare fees, the concept it would also directly incur employee costs, which are by far the largest cost, is surprising.

The full version of Morningstar's special election report entitled A Coalition Defeat Need Not Be Labor-ious for Your Portfolio can be found here.


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