Income Report / Income Note: Childcare stocks have been hit hard, are there opportunities? (SUL, GEM, CQE, ARF)

The ASX has opened higher this morning testing the 6000 level once again. A solid effort coming off the back of yesterday’s broad based ~4% rally thanks to more stimulus talk coming from the US. Overnight, economic data was on the positive side, particularly retail sales which printed a rise of +17.7% from April to May, smashing expectations for an 8% bounce. Clearly the economic outcomes we’re seeing are better than first feared and this, coupled with massive stimulus is supporting stocks.

On our market today, real-estate stocks are leading the way higher which is topical given today notes while financials and materials are lagging, but not materially so.

The ASX 200 is currently trading up +20pts/0.34% to 5962.

ASX 200 Chart

The Income Portfolio gave back some performance over the last week with a fall of -3.07%, though this was better than the ASX200 accumulation which fell closer to 3.5%. Most of the weakness came from stocks which have outperformed through the recent rally. IGL fell nearly -20%, PPT -13.64% and SYD and WPL were both around 10% lower. With just 2 weeks left in the financial year, the portfolio has declined by -5.31% versus its absolute benchmark (RBA cash +4%) of +4.50%, and a market that is off around 10%.  Since inception, the portfolio has added +10.17% vs. the benchmark of +15.42%. 

Super Retail Group (SUL): On Monday they provided a trading update plus launched an equity raise to pay down debt - the stock has since rallied. In terms of the trading update they said the 26.2% decline had been more than offset by a 26.5% increase in May and they were on-track to grow sales by nearly 2% on last year, not a bad effort given the restrictions in place and the ‘deep’ recession we’re in. The market was a lot more bearish than this with expectations for a decline year on year closer to 3%.

They also launched a ~$200m capital raise to pay down debt, structured as an accelerated pro-rata non-renounceable rights issue. For those needing an explanation, this simply means done over a short time period and for every 7 shares we own, we get to buy 1 more at $7.19. The non-renounceable part means this right cannot be sold (renounced). The retail offer opens on the 22nd July. MM will be taking this up.

Super Retail Group (SUL) Chart

Childcare stocks have been hit hard, are there opportunities?

We covered our views around property stocks last week with a skew towards retail landlords, the conclusion being that recent strength in the sector we think is a selling opportunity.  This week we’ll look at Childcare and include 2 real-estate stocks exposed to this area, along with one operator, G8 Education (GEM) which is holding their AGM today.

Childcare is a sector heavily influenced by regulation and Government policy during normal times, however with Covid-19 playing out, governments have further involved themselves in the sector, this time providing much needed support by introducing the Early Childhood Education and Care Relief package in early April. This has underpinned the sector which clearly suffered with fewer kids being sent to day care. Broad occupancy levels were sitting around 50% at best and while that package has provided support, lower revenue hurts operators as well as landlords, the key question being, for how long?  

Earlier this month the Government announced an end to that package with a move back to the prior funding scheme which is means and activity tested, however they are providing a transition period which seems generous to operators in the near term, with the Government paying 25% of an operators pre-covid-19 revenue from July until September. With booked occupancy now back to 74% across the sector, this provides a near term boost, however the question MM is asking today is whether or not there is more sustained value in this beaten up area if we take a 12 month view?

1 G8 Education (GEM) 95c

The childcare operator has had a tough few year with the COVID-19 impact simply coming on the back of a thread of continued challenges, mainly stemming from weak occupancy levels. This is a stock we’ve looked at on numerous occasions given valuation, yield and its strong industry footing. The catalyst would be a sustained improvement in occupancy and while they experienced growth here in FY19 (the first in 4 years) the recent pandemic has worked against this trend.  

We once again question whether or not the stock is cheap enough?  

In early April GEM tapped the market in a big equity raise ~$300m at 80c which recapitalised their balance sheet, but also increased their share count by 80%.  While the changes back to a more normal payment model (with support in the interim) is a positive, we’re more concerned about the resumption of the occupancy growth that started last year.

GEM have their AGM today and while they spoke to the current challenges, they also spoke to the improvement in the business over the past few years that were starting to bare fruit. In short, it seems to me this is a business that was showing signs of turning around pre-Covid and while the recent hit has hurt, perhaps not as much as the market is implying. Earnings and therefore dividends are difficult to determine short term, expectations for FY21 show a dividend of 9.5c fully franked,  putting it on a potential yield of ~10% using consensus numbers. This compares to the 10.75c that was paid in FY19.   

MM see’s GEM as a strong turnaround play with optimal entry under 90c, leaving room to accumulate down to 80c

NB Deep value manager Allan Gray has this week increased their stake in the company to 12.83% buying another ~10m shares, a sign of value but also an indication that patience will be required.

G8 Education (GEM) Chart

2 Charter Hall Social Infrastructure REIT (CQE) $2.45

This real-estate investment trust is the biggest investor in social infrastructure in the country which is mainly childcare centres at the moment however they are targeting a broader mandate after changing their name in October of 2019. They have around $1.3bn worth of property mainly tenanted to larger childcare operators as well as Governments and they have a strong track record of delivering consistent returns over time.

They also raised capital recently, topping up their coffers with a ~$115m equity raise in early May at $2.20. This is a very conservatively geared operator (<20%) with tenants on long leases (WALE >11years).  So, with the balance sheet in very good shape, and a recovery likely in the sector in time, is their nearly 7% yield sustainable?

In MM’s view the yield is sustainable between 6-7% (unfranked) and unlike GEM, distributions are more consistent.

MM is bullish CQE for yield with optimum entry ~$2.15 

Charter Hall Social Infrastructure REIT (CQE)

3 Arena REIT (ARF) $2.35

ARF has a wider mandate that includes childcare, healthcare, education and government tenanted facilities with the overall objective of returns that are stable & predictable, no doubt something some subscribers would appreciate in this environment! As with both operators above, ARF also tapped the market in June for additional equity however unlike GEM, they raised capital to fund growth which we’d describe as an offensive rather than defensive equity raise.

Again, this is a very conservatively geared operator (<20%) although they do have the capacity to get to 35-40% if required. Importantly, ARF has confirmed their FY20 dividend guidance of 13.9-14c implying 6% yield at current prices and with contracted growth of around 3%pa for the life of their leases (WALE >14years).  

This is a conservative yield investment with some modest growth potential over time.

MM is bullish ARF for yield, with optimal entry ~10% lower

Arena REIT (ARF) Chart

Conclusion (s)

While the sector has had recent challenges, taking 12-month view valuations look attractive, particularly given the lack of new supply any time soon.

GEM is a high-risk turnaround story that is unlikely to pay dividends this year, recommencing in FY21. We are bullish below 90c

CQE & ARF are conservatively run REITS, paying attractive yields. We are bullish on both.

Have a great day!

James & the Market Matters Team


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