Motley stock of the week: G8 Education

We all remember the collapse of the early childhood education aggregator, ABC Learning, and the subsequent (and much more recent) bankruptcy of its founder, Eddy Groves.

The company collapsed in 2008, having taken on excessive debt and amidst substantial profit declines. Groves was forced to sell his entire stake in the company owing to margin calls as the share price collapsed.

With that background, you’d think it’d be a brave company that tried to replicate (at least the best parts of) the ABC Learning model. While similarities abound, G8 Education (ASX: GEM) seems to have avoided the pitfalls that claimed its predecessor and is forging a profitable growth path.

Same, same but different

There are some similarities between ABC Learning and G8 Education that go further than just its industry. Like ABC, G8 is seeking to grow sales and profits by running existing childcare centres in Australia and overseas, as well as actively seeking additional acquisition opportunities. While the US was ABC’s market of choice, G8 has taken an interest in Singapore, though the company expects that business to be a smaller proportion of its results over time as the Australian business grows.

Indeed, in the most recently completed financial year, G8 added 33 centres to its stable (and divested one), providing 28% more childcare places than it had at the end of the prior year.

Strong growth, (relatively) conservatively financed

That increase in places went much of the way to delivering a 26% increase in revenue for the company, to $180 million, while profits grew 11%, thanks to growth in expenses and a higher tax bill. According to the G8, the ‘underlying’ net profit grew 42%, after allowing for one-off expenses.

(As a general rule, management adjustments can either genuinely add transparency to a company’s results, or can be used to the numbers in management’s chosen positive light. There’s no reason to believe G8 have taken anything other than the former path, but investors should always view ‘one-off’ expenses with a critical eye.)

Importantly, given the investor nervousness that still remains in the light of the ABC Learning collapse, G8 is maintaining a relatively conservative balance sheet. While no debt is most conservative of all, the company finished the year with a moderate level of debt relative to its assets. Bear in mind, though, that the overwhelming majority of those assets come from ‘goodwill’, an accounting entry that exists on paper only).

The company also shows a disciplined approach to acquisitions, paying around four times operating profits for each centre it buys, and has raised capital as recently as last month to ensure it keeps debt under control as it acquires new centres. Given the recent ‘dividend fever’ that has stuck Australian investors, a recent 25% increase in the company’s dividend will also be attractive.

Foolish takeaway

For investors, the key questions are whether G8 can continue to grow the centres it owns (rather than growing simply by acquisition), can continue to make the same level of profit in the face of potential future increases in wages for childcare workers and whether it can keep debt under control while buying prudently.

So far, so good, and for investors who are keen to take advantage of the undeniable potential for growth available through aggregation of childcare centres, G8 is certainly one to consider – as long as the risks are also factored in.

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