Should you invest in ASX 200 childcare shares during stage 4 lockdown?

With Melbourne in stage 4 lockdown and the Federal Government paying for childcare, should you invest in ASX 200 childcare shares?

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With Melbourne in stage 4 lockdown and increasing restrictions on state-based travel due to the coronavirus pandemic, childcare operators like G8 Education Ltd (ASX: GEM) and Think Childcare Ltd (ASX: TNK) have come under intense pressure.

But with the Federal Government paying for childcare since April, should you invest in S&P/ASX 200 Index (ASX: XJO) childcare shares during stage 4 lockdowns?

Investing in ASX childcare shares

The industry was already heavily subsidised before the government started covering the costs of childcare. As a result, there has been a built-in incentive for operators to grow rapidly and increase the capacity of old locations or build new ones.

Being supported by the government can be a blessing and a curse. On one hand, you have a direct (or indirect) customer that you know is going to pay. On the other hand, this can increase competition within the industry and put pressure on your prices.

Why the additional government support?

Childcare is a necessity for many people. It enables them to go to work (or work from home) and earn a living. That’s a major reason why the government has provided additional support to the industry during the pandemic. Another reason was to keep the sector operating through the massive drop in attendances as a result of coronavirus lockdowns.

However, once the pandemic is over, the government will stop fully paying for childcare and the market will return to some kind of normality. Unfortunately, this environment isn’t likely to favour childcare operators, with demand significantly down versus supply.

As an investment, I prefer industries that are self-sufficient. The economics are often better and the winners tend to win handsomely.

Roll up, roll up

Childcare operator G8 Education has previously employed a roll-up strategy to grow their business. That is, they have grown via the acquisition of childcare and early learning centres at what they deem to be a reasonable valuation.

This strategy, when executed well, can be extremely profitable in absolute terms. Unfortunately that isn’t the case with G8. The G8 share price has slumped 69% below its 52-week high. This has mostly been driven by an oversupply in the market when compared to demand.

Given the structural issues within the industry, as well as the massive drop-off in attendances due to the pandemic, G8 recently completed a highly dilutive $301 million equity raising.

Foolish takeaway

Given the uncertainty around the pandemic, demand and supply imbalance within the industry and recent capital raising, there are better investment opportunities out there than ASX 200 childcare shares.

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Motley Fool contributor Lloyd Prout has no position in any of the stocks mentioned and expresses his own opinions. 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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