18 November 2019
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Howling with pain

Tim Boreham
7 September 2018

The listed childcare sector has been popular with investors, but emerging oversupply and affordability issues mean that all is not well in the sandpit. The operators are banking on the government’s revised subsidy scheme to revive their fortunes.

While a fresh report on the childcare sector highlights a dearth of places for under two year olds in some non-urban regions, oversupply is emerging in the main cities and the three listed childcare providers are howling with pain.

With the once-booming sector placed in the naughty corner, the federal government’s $3.5 billion Jobs for Families childcare package – effective from July 1 – could not have come quickly enough.

Childcare centres have been a popular asset class for property investors because they offer stable long-term leases, with the lease payments partially underwritten by the taxpayer.

Childcare has been less vulnerable to cyclical property variables and is often perceived as a stronger long-term income prospect.

About 80% of centres still owned by families and individuals, making for an “uneven and fragmented” industry (in the words of a Centre for Independent Studies report on the sector). According to agent Peritus Childcare Sales, 101 childcare centres changed hands in 2017 for an average $4 million, 25% higher than the previous year.

The trouble is the sector became too popular with too many investors chasing too few suitable locations, especially in non inner city areas. In 2017, 825 development applications were lodged in NSW, Victoria and Queensland.

According to the listed property trust Arena (ARF), 224 new centres have opened in calendar 2018 so far (net of closures), with 300 under construction.

At the same time, securing bank funding has become more difficult and fewer development applications are proceeding to construction.

The operator of 17 Victorian centres, Mayfield Childcare (MFD) set the early tone before the earnings season, downgrading its calendar 2018 earnings expectations from $4.1m to $3.5m.

The company cited soft occupancy rates (that is, not enough kids) and higher competition that has stymied price increases.

The company also cited the lag effect of the discontinuation of the Howard era Baby Bonus, which has affected birth rates.

At the same time, Mayfield’s acquisitive intentions have been hampered by a lack of quality stock. In some cases, greenfields sites have opened almost empty, which at least makes it easier to clean up after the finger painting!

Think Childcare (TNK) then posted a good old Barry Crocker -- the sort of unexpectedly numbers rarely seen in today’s world of tight earnings guidance.

Think’s first-half earnings tumbled 74% to $700,000, with calendar 2018 guidance shaved by 38% for earnings and 10% for sales.

Think owns 45 centres, 80% of which are in Victoria where new openings have been at record levels for the last 18 months. Of its cohort of centres, 18 faced specific new competition.

Think chief Mathew Edwards says the old childcare system meant that enrolments were “untraditionally” flat between February and June.

“We expected to see a rebound and as a sector didn’t fully appreciate the depth of fees stresses families were experiencing.”

G8 Education (GEM) was the last of the listed trio to release its numbers, but sadly it wasn’t the case of leaving the best to last.

G8’s half-year earnings fell by 22% to $23.7m, with management also calling out “unprecedented” oversupply issues and regulatory change.

G8 shares sunk by 16% on the day to five-year lows, more on the outlook than the predictably downbeat numbers.

“We are not forecasting a material improvement in market conditions until mid 2019 and are adopting a conservative approach to occupancy growth forecasts (in the current half),” the company said.

G8 has also curtailed its acquisition of greenfields sites from an intended 30 to 19.

G8 is the biggest listed operator with 512 centres and the second biggest overall behind the not-for-profit Goodstart, which picked up most of ABC Learning’s centred when Eddy Groves' baby went bust after an orgy of (over) expansion.

At a macro level, there are still plenty of supportive factors for the sector. Female participation in the workforce is increasing – as is the population -- and the easing supply should result in improved occupancies and returns.

The new funding scheme – replacing the cumbersome childcare benefit and childcare rebate schemes  – should support the sector after the widely-reported teething problems abate.

The government claims 94% of parents will be better off under the arrangement, which, unlike the former scheme, does not cap subsidies for families earning an income of up to $185,710.

Think’s Edwards says the new “once in a generation” subsidies means childcare has gone from being the most expensive in a decade to the cheapest in history.

For parents, that’s not before time: the Centre for Independent Studies estimates that even with Canberra’s subsidies out-of-pocket expenses have increased by 50% since 2011.

We bet their salaries haven’t.

RBC Capital Markets analyst Garry Sherriff assumes a “gradual improvement in occupancy levels from calendar 2019 and beyond, noting that the new childcare reforms and moderating industry supply growth will take time to cycle through the system.”

Over the last 12 months G8, Think and Mayfield shares have tumbled 45%, 22% and 18% respectively.

It remains to be seen whether it’s a case of an over stimulated sector in need of an afternoon nap, or whether there’s something more disturbing happening in the sandpit.

For investors who prefer freehold ownership without the travails of being an operator, Arena owns 207 centres valued at just over $600m.

Folkestone Education Trust (FET, $2.81) owns 354 centres worth $890m, but has just agreed to be acquired by Charter Hall in a $200m cash deal.

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