C+ for Curro

After two years of lacklustre results, management needs to knuckle down and work hard, writes

or the past 12 months the listed private education sector of the JSE has been caned hard. For many years investors rewarded the JSE’S private education stocks with good report cards, but they have been severely marked down over the past year, with concerns growing over slowing profit growth due to the weak economy.

The PSG Group-aligned counters of Curro Holdings (a private schools business) and Stadio (a tertiary education hub) have declined the most — falling 44% and 52% respectively. The most enduring education counter, Advtech, which was listed in 1987, has declined 30%.

There are many reasons for the sector weakness. Concerns over school fee price points as well as emigration from higher-end/higher-margin schools have troubled Advtech of late.

At Curro, some attrition at the top-end schools has also occurred, but a combination of factors in 2018 and 2019 has unsettled investors.

IM wrote in July 2019 that Curro (then trading at R24.15) was gearing its balance sheet for a hefty expansion that would test management and the business, with R2bn invested in new schools. This would bring higher debt servicing costs as well as some margin issues.

FThis should materialise in coming results and has resulted in the market’s turn in sentiment towards Curro. For a counter that at one point was tagged to an earnings multiple of 100, the love affair that a besotted market had with Curro has turned rocky. Curro’s share price has capitulated from a record high of R60 in 2015 to under R15 at the time of writing.

This, by any stretch, is a dramatic unwind. The big question at this point is whether this kind of jaundiced sentiment — usually reserved for stocks facing a serious financial squeeze — is justified at Curro.

Could investors be looking at a situation where the market has overdone the correction, allowing patient investors a chance to buy into a quality business with solid growth prospects for the longer term?

For many years Curro expanded rapidly, which, naturally, excited the market in view of growing evidence that the public school system was far from perfect.

To fund this rapid growth, Curro held a series of rights issues, backed by majority shareholder PSG Group, which owns 55% of the business.

The funding supported a rapid rollout of schools nationwide as well as selected acquisitions. The scorecard will show that more than R9bn was poured into Curro to get to its network of 164 schools that accommodates more than 57,000 pupils.

Profits and earnings rose rapidly, and the market seemed willing to grant the stock a heady earnings multiple on the assumption that rapid growth in school development and commensurate profit growth would go on unhindered.

But the bright growth scenario became a little cloudy in 2018 when Curro started showing signs of vulnerability.

When a company — Naspers is another example — enjoys a

heady earnings multiple rating, the market expects growth to be executed perfectly.

When such a stock starts to show signs of strain, a strong market rating can unwind very fast. In the case of Curro, the first signs of operational creaking appeared at its low-end school division, Meridian, and this was soon compounded by concerns over debtors and working capital.

Between 2017 and 2018 Curro’s recurring headline earnings grew at a rate of 23% from 49c a share to 60.1c a share. But the market wanted more.

At this point investors started questioning whether Curro had embarked on an “expansion for expansion’s sake” strategy since there was latent capacity that was seemingly underutilised at existing schools. At the same time there was evidence of rising debtors and some lower-than-expected learner growth numbers. Curro was also dealing with its problems at Meridian, and this lower-fee schools joint venture model started to look like a philanthropic exercise rather than a profitable venture.

At the start of 2018 Curro was trading at R42. The counter is off 70% and is now at a near 52-week low. On a price movement chart, that may seem like a juncture for recovery. But IM is not forecasting a rosy near term for Curro.

By the time this publication is on the newsstands Curro should have released a voluntary trading update, and IM is expecting results for the year ended December 2019 to be released in early March.

From the 60.1c a share headline earnings reported in financial 2018, IM is not forecasting a glittering financial 2019.

Interim results for Curro to June 2019 were modest. Recurring headline earnings rose by only 7% to 37.1c a share as the cost of expansion of new schools, lower pupil growth numbers and bad debts impacted results.

In hindsight, Curro would probably admit that its expansion drive — which saw 17 new campuses added in two years and building in more underutilised capacity — was a push too far.

The new schools were needed as primary school pupils migrated into secondary schools, with about 40% of Curro’s campuses set to grow into high schools.

But the expansion coincided with a waning local economy and a point where it was clear that high-fee school pupil growth was slowing relative to low(er)-fee schools. In other words, there was a dangerous disconnect between expansion and potential returns on that capital expenditure.

The market latched onto this quickly — perhaps informed by events at Advtech, which had seen weakening margins from its higher-end/higher-fee schools. Though Curro remained well positioned in terms of more affordable price points, the group could not escape the more cynical market mood for private education stocks.

For the 2019 financial year, IM is pencilling in modest single-digit growth from the 60.1c a share posted in 2018.

It would appear that from a slow interim period in 2019, there were further challenges for Curro in the second half.

The key development was that higher-fee select schools saw some softening of demand as some price points were adjusted. Advtech saw a similar trend. This development would have taken the shine off schools that had been reliable cash cows for Curro.

There was also the cost of the new campuses in the operating base that would not yet have seen the benefit of learner revenues.

What’s more, there have also been niggling issues over rates and taxes in Johannesburg as well as municipal billings. These might also take some cents off the year-onyear growth — even though any overpayment should be recovered in the first half of the

2020 financial year.

If IM’S predications for financial 2019 earnings are accurate, there could be further short-term weakness in Curro — no matter the share trading near its 52-week low.

But not all is lost. IM would use any post-results market weakness to start building a position in Curro.

Management has taken a prudent decision to pare its growth projects in new greenfield sites and rather grow into its underutilised capacity. Improved utilisation and lower capital expenditure in the 2020/2021 financial years should lead to better prospects for earnings.

IM understands that pupil growth remains strong and the intake numbers into 2020 should please the market. Looking through to the next two years, IM reckons the transition of pupils moving in to the “new build” high schools will kick into the so-called Jcurve effect with profound impacts on margin and profitability.

Overall, IM continues to be supportive of private education given the failing quality of public schools education. Demand will continue for quality private school education. Curro, with its mix of schooling price points, is arguably in a better position than its rivals.

A possible report card for Curro management for 2019 might reflect a “they must try better” C+. IM believes management will knuckle down and work hard, securing much better prospects for 2020/2021 and a resumption in real earnings growth after two years of lacklustre results.

Management has taken a prudent decision to pare its growth projects in new greenfield sites and rather grow into its underutilised capacity