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Morgans is betting this out of favour small cap will bounce back on its big dividend yield

Could the bad run for G8 Education Ltd (ASX: GEM) be finally coming to an end? The stock bounced strongly yesterday despite a falling market and Morgans thinks the stock represents good value after its 30% plunge from grace over the past year.

But the childcare centre operator may be starting to feel some love again as its share price rallied 2.9% to $2.83 yesterday even as the All Ordinaries (Index:^AORD) (ASX:XAO) took a 0.6% dive into the red.

The stock represents value that is hard to ignore, according to Morgans which points out that G8 is trading on an enticing 7% yield (and that is before franking credits) and a FY18 price-earnings (P/E) multiple of around 12 times, which is nearly a 30% discount to the S&P/ASX SMALL ORDINARIES (Index:^AXSO) (ASX:XSO).

However, investors have thrown a tanty and dumped the stock on earnings disappointments and worries of an oversupplied market for childcare services.

Its 2017 full year results that were released last month didn’t make for pretty reading. Management couldn’t even deliver on its already downgraded guidance, and that’s not helpful in rebuilding trust with investors.

But operating conditions may actually improve over the next 6 to 12 months, according to Morgans.

“Market conditions are expected to remain challenging in 1H18 (largely supply driven, however supply expected to moderate), although the Federal Government’s ‘Jobs for Families’ Child Care Package (starting July 2018) is expected to drive demand (likely to see evidence 2H18/1H19 – pricing/improved occupancy),” said the broker.

G8 has lifted fees to offset falling occupancy rates at its centres and it has noticed that occupancy rates have stabilised in January.

The new management team is also looking to improve efficiencies and cost savings across the organisation, which has given the company a stronger balance sheet. This means there is scope for G8 to undertake acquisitions to expand its network of centres.

But acquisitions aside, there is scope for G8 to post some positive trading updates over the coming months that could show that the company has turned a corner.

At these valuations, G8 wouldn’t need to produce much in the way of profit growth. It just has to prove that its earnings and cashflow is sustainable.

If it can do that, G8 would be a worthwhile addition to any income portfolio given that its yield is ahead of many favourite dividend paying stocks, such as Telstra Corporation Ltd (ASX: TLS), Commonwealth Bank of Australia (ASX: CBA) and AMP Limited (ASX: AMP).

Morgans has an “add” recommendation on the stock with a price target of $3.53 per share.

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Motley Fool contributor Brendon Lau has no position in any of the stocks mentioned. The Motley Fool Australia owns shares of and has recommended Telstra Limited. The Motley Fool Australia has recommended G8 Education Limited. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. This article contains general investment advice only (under AFSL 400691). Authorised by Scott Phillips.

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