Curro: Earn­ing a C+; must try harder

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

Financial Mail - Investors Monthly - - Front page - writes An­thony Clark

For 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. This 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

Pic­ture: 123RF — IQONCEPT

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