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Why the G8 Education Ltd share price is going nuts today

Shares in child care centre aggregator and operator G8 Education Ltd (ASX: GEM) have soared 12% today after the group provided a better-than-expected trading update.

The Queensland-based group has reported that occupancy levels, as a key measure of overall profitability, are trending higher over the second half of calendar year 2018. According to G8’s management “occupancy levels continue to show above trend seasonal improvement”, with overall occupancy growth slightly ahead of management expectations.

Occupancy levels are important for child care centre operators as costs are relatively fixed in terms of staffing and rental overheads, which means the operators are reliant on sufficient paying customers all of the time to generate a profit. This is a similar concept to occupancy levels at hotels, where costs are also relatively fixed.

G8 Education’s growth strategy has also largely been acquisitive in that it can consolidate the fragmented childcare industry across Australia, by rolling up centres under its own umbrella and saving on shared costs such as payroll, compliance, and training.

The model relies on a mixture of debt and equity raisings to fund the acquisitions, with the idea being that an arbitrage can be achieved by raising equity at a cheaper cost to that paid for the same asset.

This time last year investors were buying into the success of the business model with the shares at around $4.50 and the group paying out 24 cents per share each year in dividends.

However, shares came crashing down alongside forecast dividend payments in December 2017 after the group warned that the all important occupancy levels were falling due to oversupply of child centres and weak economic conditions outside Australia’s east coat urban hubs.

The group is now forecasting earnings before interest and tax of around $136 million to $139 million in calendar year 2018, with ambitions to keep growing either by acquisitions or its own greenfield developments.

A junior roll-up rival in the sector is Think Childcare Ltd (ASX: TNK), which has seen its shares crumble around 34% over just the course of 2018.

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Motley Fool contributor Yulia Mosaleva has no position in any of the stocks mentioned. The Motley Fool Australia has no position in any of the stocks mentioned. 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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