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Are we reading too much into Curro’s lofty share price?



Are we reading too much into Curro’s lofty share price?

We’ve learnt that you don’t need to know a person’s exact weight to know if they are fat or not

Chris Gilmour

There is a direct and obvious relationship between the calamitous decline in the quality of state education and the growth in demand for private education. With an almost entirely dysfunctional state school system, the alternative is for parents to send their children to private schools.
Established in 1998, Curro is the leading independent school provider in southern Africa. It develops, acquires and manages independent schools for pupils from the age of three months to Grade 12.
Curro’s prices are regarded as being “affordable” insofar as they fall into the middle band and appeal to middle-income parents who want to give their children a good start in life but at an affordable price. And for as long as the state fails to provide a decent primary and secondary school education for South Africans, the background and outlook for the private school industry should be positive.However, parents are now becoming financially squeezed, unemployment is rising, and emigration increasing, which all should surely limit growth in demand for private education. Yet the latest set of interim results to June 30 2018 belies the perception that demand for Curro’s products may be under pressure.
On an 18% rise in revenue, headline earnings per share from continuing operations rose by 22% to 33.6c. Ebitda margin increased from 23% to 27%. Bad debts were surprising well contained, considering the tight economic conditions prevailing – and at 1.5% of revenue, they are forecast to stay at that level to year end. In growing operating profit, all administration functions have been centralised at head office, and professional fees such as architects and quantity surveyors reduced by incorporating those functions in-house.
The ultimate objective is to lift that margin to 40% but according to small-cap analyst Keith McLachlan of Alpha Wealth: “This is not realistic, and, in fact, the 33% ebitda margin being achieved in the mature portion of their portfolio indicates that they are likely to come quite short of this target.”
The group remains lowly geared at 40% net debt/equity, and although this is likely to increase over the next few years due to debt required for new campus expansion, management doesn’t see the need to raise additional equity. There are currently 57 campuses, and the group remains on track to achieve 80 by 2020. The number of pupils is 50,691, and although the pupil/teacher ratio has been increasing slightly, from 15 in 2014 to the current figure of 17, it is still a very comfortable average class size.Curro doesn’t publicly publish its fees but it is believed that the current average is around R40,000 per year. This kind of figure is comparable with fees at good state schools such as King Edward VII school (KES) in Johannesburg, but significantly lower than Crawford College fees within the Advtech group. Inevitably in this poor economic climate some parents will simply no longer be able to afford these charges, and in certain circumstances Curro will advance loans to them so their children can to complete their education.
Curro has always been an expensive share in terms of its price-earnings ratio, and according to Reuters, its five-year high on this metric was 182 times. Earnings growth has been good but not strong enough to justify the previously rarified and currently very high, and still unappealing, share price.
After crunching his J-curve analysis, McLachlan believes the share is overpriced: “Curro’s current returns are too low to justify the capital it is deploying. In fact, its returns are even lower than its cost of debt and, thus, the more Curro builds and the more capital it deploys, the more shareholder value that gets destroyed.” He thinks it still looks very much overvalued, commenting that the exact amount of that is academic. “As they say, you don’t need to know a person’s exact weight to know if they are fat or not.”
Chris Gilmour is an investment analyst

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