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ADVTECH WINHOLD THE JAPANESE NIKKEI CASHBUILD
Education, along with healthcare, is an emotive issue in South Africa. This i s due
largely to two dynamics: the failure of Government to maintain an acceptable standard of both public healthcare and education, and a relative lack of supply or competition in the private sector, resulting in the fees that are charged by private providers remaining
unaffordable for many. However, those who can afford the fees will still pay up due to the alternatives being so poor. In the case of private schooling, this is clearly evidenced as many top ‘ brand name’ private schools are charging upwards of R100 000 per annum for tuition and still have long waiting lists.
These dynamics make for great investment fundamentals: a mature private school can generate EBITDA (earnings before interest, taxes, depreciation and amortisation) margins north of 50%, and cash f lows tend to be much stronger than earnings due to the tendency for many parents to pay fees upfront at the beginning of each academic year. Curro has capitalised heavily on this opportunity in recent years, listing in 2011 and aggressively raising equity capital to grow its base of schools (via both acquisitions and new builds) from 12 in 2011 to 26 currently, with a target of 80 schools by 2020.
The fundamentals of this business are fantastic, but unfortunately, we argue that the market has already handsomely rewarded shareholders for this outlook, with the share arguably looking too expensive (it probably generated EPS of 12c/share to December 2013 vs share price of R27) – even taking into account the low-capacity stage of life of many of its schools.
By comparison, ADvTeCH is a business that has been ‘ ignored’ by the market in recent years, with difficulties in its tertiary education (poor enrolments) and staff resourcing divisions holding back overall earnings growth while management has arguably been slow to capitalise on the growing demand for private schooling. We believe the dynamics are starting to change: enrolments appear to be improving in the tertiary division while the resourcing division has shrunk to the point of being fairly irrelevant in the mix, but unlikely to incur losses.
Importantly, t he group’s private schools business (represented by Trinity House, Abbotts College, Crawford Schools and Junior Colleges brands) now represent 70% of group profits and this is where we believe the group is becoming more aggressive with its investment plans: ADvTECH has over R1bn of capex approved (1/3 of current market cap), while a further R1.7bn worth of projects are under investigation. We also believe the current profit base of the schools division remains well below potential (due to immature schools/new development spending) as evidenced by its 17% EBIT margin – this should leave significant scope for future profit upside.
We estimate that ADvTECH trades at an 18 times P/E multiple to December 2014 – while this appears optically expensive, we believe this valuation is reasonable for the quality of the core schooling business and is a far cheaper entry point for investors than Curro. In essence, private schools represent a ‘ discounted cash f low calculation’ on pupils, where revenues are almost guaranteed for an extended time period once a child is enrolled. In addition, tuition fees tend to rise well ahead of overall costs given the demand/supply imbalance: we don’t foresee this dynamic changing anytime soon, and this should result in growing margins.
We like businesses where margins and returns on capital are high and where there is a substantial opportunity to deploy incremental capital – given ADvTECH’s strong balance sheet (R85m net cash; NAV = R809m) and high demand for private schooling, we believe this should be a winning investment over time. The stock has rerated sharply this year, but remains acceptably valued to continue delivering good returns.