Too many education stocks have provided a lesson in bad investing. For all their potential, they have mostly disappointed and a larger listed educational sector in Australia has not formed.
Scandals in vocational education and training (VET) have plagued the sector. Vocation collapsed within two years of raising $253 million in a December 2013 Initial Public Offering.
A 2014 float, Australian Careers Networks, investigated for fraud, also sunk into administration.
Shares in New Zealand-based Intueri Education Group, a $162 million IPO in 2014, crashed in January on reports that the Fraud Squad Office sought information on one of its colleges. Intueri is down almost 78% over one year.
Academies Australasia and RedHill Education have also been affected by the poor sentiment, down 51% and 38% respectively over one year.
Problems in vocational education are now well known: some private providers chased student enrolments at any cost to secure State and Federal government funding. The scandals reinforced the risks when private operators target sectors with lax regulatory scrutiny.
Education providers in different sector have also disappointed over the years. Tutoring group Kip McGrath Education Centres (KME), slowly edging higher, has never fulfilled its potential. The same is true of 3P Learning (3PL), the 2014 float that was oversubscribed many times.
3P, owner of Mathletics, has fallen from a $2.50 issue price to 77 cents after earnings disappointments and management changes.
Investors with longer memories will recall the disaster that was ABC Learning. The provider of early childhood development centres, once a share market star, spectacularly collapsed in 2008 under a mountain of debt.
I could go on with other examples of disappointing education companies. But every stock has it price and the education sector has three tailwinds that are starting to converge.
The first is the coming middle-class boom in Asia. International education, already Australia’s third-biggest export earner after iron ore and coal, has a long way to grow as Asia’s middle-class population expands by an expected 2 billion people to 2030, on OECD estimates.
Rapidly improving universities in Asia will soak up part of this demand, but continued solid growth in the number of international students, particularly from India, doing Australian degrees is likely. That’s good news for stocks such as Navitas (NVT) and IDP Education (IEL).
The second tailwind is disruption. Australia’s higher-education sector is ripe for change as government funding cutbacks force universities to cut more costs. Greater use of technology in education, including free online courses, is another threat and opportunity.
Having taught for many years at university (and written for many newspapers over the years), I see eerie parallels between academia and the media sector. Like print media, academia has significant revenue challenges ahead, a high fixed-cost base and is slow to change.
One can envisage insurgent technology-based education providers successfully competing at the fringes against incumbent providers in a range of areas, from early childhood learning to vocational and higher education. The sector is full of potential for companies with lower-cost, online models and a developing-country focus.
Lower valuations are the third tailwind. Stocks such as G8 Education (GEM) and 3P Learning (3PL) look interesting after share-price falls this year. Both are on undemanding valuation multiples.
However, prospective investors need care when investing in education stocks. There is not a great selection on ASX and several are too small and speculative for conservative investors. Micro-cap education stocks have a habit of disappointing investors.
I’ve nominated IDP Education (IEL), G8 Education (GEM), Folkestone Education Trust (FET) and 3P Learning (3PL) as the most attractive listed education stocks at current prices. IDP is the clear preference, followed by G8, which makes the list on valuation grounds. Folkestone is one to watch and wait for better value, and 3P is a punt.
Navitas (NVT) looks fully valued after recently reporting FY16 earnings that were slightly ahead of market forecasts. A forward Price Earnings (PE) multiple of almost 20, based on consensus analyst estimates, could look stretched given the risk of contract losses next year.
1. IDP Education (IEL)
IDP has been one of the market’s best floats in the past few years, rallying from a $2.65 issue price to $4.40 after raising $331 million and listing in November 2015.
Seek, previously a 50% shareholder in IDP, divested its stake; Education Australia, which represents 38 Australian universities, kept its stake.
Chart 1: IDP
[1]Source: Yahoo
IDP is superbly leveraged to long-term growth in international education in Australia through its international student-placement services and English-language testing services. IDP co-owns IELTS, one of the world’s leading English-language tests, as well as English-language schools in South East Asia. These are terrific, well-established businesses.
English-language training in Asia has excellent growth prospects as more people in developing markets look to study overseas or work for foreign companies, or can do freelance work via employment sites that help Western companies take advantage of lower wage costs in the East.
IDP comforted the market in May when it extended the term of its agreement with the British Council to distribute IELTS to China to June 30, 2017.
The big question with IDP is valuation. It trades on a forward PE multiple of 26 times and at $4.40 is slightly ahead of the consensus of a small number of broker forecasts. But IDP warrants a significant valuation premium given the strength of its market position and growth prospects.
The forthcoming release of IDP’s maiden full-year result could be an excuse for profit-taking after strong price gains this year. It could also be an opportunity for long-term investors to buy into one of the best-quality education companies at a lower price.
2. G8 Education (GEM)
The childcare-centre operator disappointed the market this month with a weaker-than-expected first-half result for FY16. G8 has fallen from a 52-week high of $4.19 to $3.04 – a rare blot after an exceptional share-price rally late 2014.
Higher wage costs are an issue for G8 and a reason why solid top-line revenue growth did not translate into sufficient growth in underlying earnings. Wage pressures in childcare, driven by industry-award pay increases and higher staff headcounts, are a big issue in such a labour-intensive industry.
G8 also backed away from double-digit earnings guidance, suggesting a more challenging outlook over the next 12 months, particularly in Western Australia and the Australian Capital Territory (almost a fifth of group occupancy).
At $3.04, G8 trades on a forward PE of 11 times, based on consensus analyst forecasts. Six of nine brokers that research the stock have a buy recommendation, two a hold and one a sell. A consensus target price of $3.75 suggests G8 is undervalued.
The PE looks undemanding given G8 is a dominant player in an attractive industry and has good prospects to expand by acquiring smaller centres in the fragmented childcare space. G8 has a solid record of acquiring centres at a reasonable price and integrating them.
I suspect the market overreacted to G8’s full-year result. But finding a catalyst to rerate the stock in the next 12 months is hard. Prospective investors will need to be patient as G8 prepares for its next leg of growth. A grossed-up forecast yield of 10% in the interim appeals.
Technical analysts will need confirmation G8 can hold support around $3. Any significant break below would confirm a bearish charting pattern.
Chart 2: G8
[2]
Source: Yahoo
3. Folkestone Education Trust (FET)
The AREIT owns more than 330 externally managed childcare centres in Australia and over 50 in New Zealand. It also owns an 8% stake in ARENA AREIT, a high-performing owner of childcare centres that I have identified previously for the Super Switzer Report.
Folkestone provides exposure to a sector that has a favourable long-term outlook, thanks to population growth and supportive government policy, without the risks of specialist childcare-centre firms. Folkestone owns rather than operates childcare centres.
Folkestone this month reported underlying earnings per unit of 14 cents for FY16, broadly in line with market expectation. The AREIT is well managed, conservatively geared at 26% and has excellent occupancy rates and a good lease expiry profile.
The challenge is valuation. After rallying from a 52-week low of $1.82 to $2.85, Folkestone trades at a hefty premium to its $2.14 net tangible assets per unit. Morningstar values it at $3.10.
I like Folkestone’s long-term outlook, but like most of the in-demand AREIT sector, it is due for a price pullback or consolidation and best bought at lower prices.
Still, it deserves a spot on portfolio watchlists given its operational performance.
Chart 3: Folkestone
[3]Source: Yahoo
4. 3P Learning (3PL)
Let me say up front: I was caught out on 3P Learning, one of the IPO market’s bigger disappointments in recent years. I favourably reviewed 3P for the Super Switzer Report in November 2015 when it traded at $2.30. It is now 77 cents.
3P should be a star. It a fabulous product in Mathletics, used by more than 3 million students worldwide, and Reading Eggs, which it distributes. Like all good software companies, it should benefit from recurring revenue, high margins and a global market.
But 3P arguably confused its sales strategy and focused on too many products. Managing director Tim Power resigned in January 2016 after many years at 3P, replaced by well-regarded technology executive Rebekah O’Flaherty.
New management has a big task ahead to turn 3P around by focusing more on the flagship Mathletics product and refreshing sales channels. 3P needs to deploy its internal resources more effectively and get some wins in the next 18 months to restore market confidence.
For all the challenges, 3P has market-leading products, a genuine global footprint and will benefit from the continued move towards online learning. There’s considerable medium-term potential if it can ramp up its sales execution. Its 40% investment in the fast-growing Learnosity suggests there is value within 3P not recognised by the market.
Macquarie Equites Research values 3P at $1 a share. The trouble is finding a near-term catalyst to rerate the stock. Its turnaround will take time and has plenty of risk. Don’t be surprised if more bad news emerges when 3P reports its full-year result, just as this report publishes, and the price falls further.
Most new CEOs I know like to get as much bad news out as early in their tenure as possible, as they lower market expectation and clear the decks for a recovery.
I doubt the market will tolerate too many more disappointments with 3P: a reason why I included it in the Switzer Super Report takeover portfolio last year. If 3P cannot make the most of its assets, a predator will swoop when the company is undervalued.
3P clearly suits experienced investors who are comfortable with speculative small-cap turnaround situations and have a 3-5 year perspective.
Chart 4: 3P Learning
[4]Source: Yahoo
Tony Featherstone is a former managing editor of BRW and Shares magazines. The information in this article should not be considered personal advice. The article has been prepared without taking into account your objectives, financial situation or particular needs. Before acting on the information in this article you should consider the appropriateness of the information, with regard to your objectives, financial situation and needs. Do further research of your own or seek personal financial advice from a licensed adviser before making any financial or investment decisions based on this article. All prices and analysis at August 24, 2016.
Important: This content has been prepared without taking account of the objectives, financial situation or needs of any particular individual. It does not constitute formal advice. Consider the appropriateness of the information in regards to your circumstances.