G8 Education Limited (GEM) Earnings Call Transcript & Summary

Thank you for standing by, and welcome to the G8 Education Limited Financial Year 2019 Annual Results. [Operator Instructions] I would now like to hand the conference over to Mr. Gary Carroll, CEO. Please go ahead.

Thanks, Travis. So good morning, everyone, and welcome to the 2019 full year results presentation for G8 Education Limited. As Travis said, my name is Gary Carroll, I'm the CEO and Managing Director of G8. I'm joined on today's call by the group's CFO, Sharyn Williams. What we'll do is we'll walk through the investor presentation that was posted on the ASX earlier this morning and then provide time at the end for any questions. Starting with Slide 5, which sets out the key highlights for the year from both an operating and a strategic perspective. In 2019, the group made solid progress despite a challenging environment. Over the last 2 years, we've been investing in quality and capability to be the center of choice for families in every neighborhood, and these investments started to bear fruit in 2019. During the year, we delivered solid like-for-like occupancy growth, the first growth in 4 years, with this growth translating to good like-for-like EBIT growth. While the overall group earnings result was impacted by our investments in quality and the ramp-up of our greenfield centers, the consistent occupancy growth trend across our 2017 and 2018 cohorts provide us with confidence in the future earnings profile for our greenfield portfolio. The group continued to demonstrate strong cash flow conversion and maintains the balance sheet capacity to execute its strategy. From a strategic perspective, 2019 delivered record results in terms of center manager turnover, center quality and safety. As flagged in our November update, the focus is very much on leveraging these enhanced capabilities to convert the people and quality results into earnings growth in both our organic and greenfield portfolios. In the latter part of 2019, we made good progress with respect to portfolio optimization, completing the sale of 25 centers in Western Australia to lift group quality and occupancy without materially impacting profitability. We also have a full-time team largely in place to drive earnings growth at pace in our network with clear actions in place for around 50 centers in the first quarter of 2020. We recognize it's taken longer than forecast to translate improvements in quality to earnings growth, and our focus in 2020 is accelerating the pace of earnings growth. This includes a strong focus on driving cost efficiencies to respond to market conditions and help fund the acceleration program. Slide 6 sets out a summary of the 2019 EBIT result, and Sharyn will unpack the line-by-line detail later in the presentation. Underlying EBIT was $132.5 million, in line with guidance provided in November. The result was driven by the performance of our like-for-like portfolio, which turned its 1.1 percentage point occupancy growth into $10.9 million EBIT growth even after accounting for $4 million in license fee revenue in the prior corresponding period. This like-for-like growth came from both our organic portfolio as well as growth in the 2017 and 2018 center cohorts. Now this strong growth was offset by start-up losses of $6 million relating to the 2019 greenfield centers as well as an additional $6.4 million investment in support office to drive quality and capability. Both of these investments are forecast to drive earnings growth in future years. Turning to the drivers of financial performance starting with occupancy, the group's occupancy performance is outlined on Slides 7 and 8. Please note that when I'm referring to occupancy, it's a reference to like-for-like occupancy. The occupancy growth result was driven by both the market environment in the form of the new government subsidy as well as group specific initiatives. From a market perspective, the new subsidy has improved affordability with the impact being felt both in terms of new families entering the sector and existing families taking additional days. From a G8 perspective, the group's investment in quality from an education, physical assets and in-center resources point of view, has driven a strong improvement in the group's portfolio quality. The customer engagement center performed in line with expectations to drive inquiries for tours, and our investment in leadership and team engagement has had a positive impact on team retention. From a geographic perspective, all states grew occupancy except South Australia, which is continuing to absorb the impact of new supply. Slide 8 provides some more detailed trend data in relation to occupancy. In 2019, occupancy tracked above the prior year before ending in line with the prior year as growth slowed in the fourth quarter. Occupancy grew in both halves, 1.6% in half 1, 0.6% in half 2, with the second half results being achieved despite cycling the introduction of the new childcare subsidy in the prior corresponding period. Turning to wages. Slide 9 provides an overview of wage performance for the year. Wage efficiency improved in 2019 with the group rebounding from a disappointing performance in the third quarter to record a strong result in quarter 4. Wage performance varies across the network with key variables being the occupancy levels, the age mix of the center as well as the relevant regulatory requirements, and these vary by jurisdiction. The group's new rostering system is on track to be rolled out between March and May, with resulting improvements in roster performance from improved visibility and increased automation. Note that the cost benefit of the new system will not be material in 2020 given the rollout timing and the need to absorb increased ECT wage costs flowing from the change in regulations to ECT levels in most states. Slides 10 and 11 set out the performance of the group's greenfield acquisition portfolio, starting with the occupancy of the more mature 2017 and 2018 cohorts, which is on Slide 10. The key takeout from this slide is the consistency in occupancy performance of both cohorts. This provides confidence in the future earnings potential of these cohorts as the occupancy growth is translated into EBIT growth over time. An overall view of the greenfield centers is provided in Slide 11. The first point worth noting is that half that portfolio is still in the early stages of development in growth with ramp-up of these immature centers being closely monitored. While each cohort has a mix of locations, the returns of the more mature cohorts are trending in line with our medium-term return on capital targets. The 2019 cohort has a small number of larger centers with these centers having the potential to produce higher financial returns if they achieve the targeted level of occupancy. These centers are a key focus of the dedicated team that has been established as part of the group's acceleration program. The group's opened 5 new centers thus far in 2020 with a further 3 centers being forecast to open in the first quarter and the last remaining centers to be opened in quarter 2. As stated earlier, the group incurred $6.4 million in additional support costs in 2019. There were 4 areas that drove the incremental spend, with these being set out on Slide 12. Firstly, safety, both in terms of child safety and team member safety. This is a critical area, and it's really pleasing to see the strong early results from this investment. Secondly, it was clear that the central plank of our strategy to leverage our scale advantage is the development of market leading, engaging, learning environments in each of our centers. The recruitment of a dedicated early learning and education team in 2019 has already had an impact on center practices and programs and further improvements are expected in the coming months. Thirdly, to leverage our scale advantage in terms of both employer of choice and operating efficiencies, we needed to provide additional support for center managers in terms of centralizing some activities as well as in relation to enhanced HR practices, training and induction and compliance. This is good practice for a company of our scale and complexity. And lastly, we needed to future-proof our business in terms of our technology platforms, systems and support. It's worth noting that by the end of 2020, we are forecast to have replaced and upgraded every key operating technology platform for the group, providing for greater efficiencies and security. This investment in our support platform provides the capabilities to support the group's medium-term growth objectives. With the scalable platform in place, the focus in 2020 is on driving cost efficiencies to support the EBIT acceleration program and respond to prevailing market conditions. I'll now hand over to Sharyn to provide a detailed overview of 2019 financial performance in relation to profitability, cash flows, capital expenditure and capital management.

Thank you, Gary. I will now talk through the financial drivers for the group. From a P&L perspective, both our underlying EBIT result and earnings from acquisitions were in line with guidance previously provided. The group continued to produce strong cash flows and following the refinance of the Singapore notes, has increased debt tenor at a lower average cost of debt with more flexible covenant arrangements. Slide 15 sets out the statutory results for the year. Like a number of other companies with a significant lease footprint, the group's reported results have been materially impacted by the introduction of the new lease accounting standard. The impact of the standard on the group was as outlined in August. Under the lease adoption method selected, the prior year financial statements are not restated for AASB 16, so adjusted numbers for the current year have been provided to allow comparability. Turning to the calendar year 2019 snapshot on Slide 16. We have outlined the profit and loss both from a statutory and a lease-adjusted perspective. The group grew revenue by 7% during the year through occupancy growth, expansion of our center network and fee growth. At an EBITDA level, the $149 million result was flat year-on-year reflecting the investments in both greenfield ramp-ups and support office. After depreciation is taken into account, underlying EBIT was $132.5 million, in line with November guidance. I note the prior year included a nonrecurring license fee of $4 million. After backing this year, EBIT was flat compared to the prior year. Finance costs were slightly lower this year with the first half expenses being $17 million, reducing in H2 to $12 million, reflecting the restructured debt facilities. Cash conversion remained strong, with EBITDA to lease-adjusted cash conversion of 97% and 107% after adjusting for a 27th payroll payment on the last day of the year. A fully franked final dividend of $0.06 per share has been declared, taking the calendar year '19 dividend to $0.1075. This represents a full year payout ratio of 70% of lease-adjusted NPAT outlined on Slide 16. Turning to a more detailed overview of operating performance, which is contained on Slide 17. The group translated the 1.1% like-for-like occupancy growth into a 6.6% increase in like-for-likes in the EBIT. Organic center EBIT grew 3% year-on-year, after absorbing increased investments in quality and capability, such as the customer engagement team, repairs and maintenance and in-center resources. Property-related costs grew by 4.4% year-on-year. This above-inflation growth rate was driven mainly by increases in outgoings and on costs, such as rates and land tax, while annual rent reviews increased by a lower rate of 3.5%. The EBIT result also includes the impact of increasing depreciation charges associated with refurbishment activity. The strong like-for-like EBIT result of circa 7% was partially offset by losses from greenfield centers opened during the year. After factoring in these losses, total center EBIT grew by 1.6% over the prior year. The incremental investment in support office of $6.4 million during the year resulted in a bottom line underlying EBIT of $132.5 million, 2.8% lower than prior year. Turning now to Slide 18, which outlines the cash conversion of the business measured on a lease-adjusted basis. The strength of the business continues to be the generation of strong operational cash flows, with over 100% of this period's lease-adjusted EBITDA converting to lease-adjusted operating cash flows. A continued focus on working capital is a driver of this year's high conversion particularly after the implementation of the new childcare subsidy, where additional account support has been provided for both parents and our center-based teams during the first 12 months of the new subsidy. Slide 19 outlines the cash flow statement of the group. As a reminder, the AASB 16 leases implementation has no impact on the net cash flows generated by G8. To assist investors, we have again provided pre-AASB 16 numbers to allow comparability. There is a presentation impact of the standard, which is to increase operating cash flows with an offsetting outflow in financing activities. Effectively, the rental payments include a principal repayment on the lease liability, similar to a mortgage where the repayment is comprised of interest and principal. The principal portion during the year of $63.7 million can be seen in the table moving from operating to financing cash flows with net cash flows remaining unchanged. During the year, operating cash flows of $90 million was sufficient to fund maintenance CapEx of $40 million and the dividend payments of $45 million. The $50 million of acquisitions during the year, comprising 2 brownfield and 13 greenfield centers, were funded by the WA divestment proceeds of $6 million cash reserves and borrowings. In terms of cash flows relating to financing costs. During the year, the lower cost syndicated facility was drawn to repay the $270 million of Singapore bonds with the other key financing outflow being the $45 million of dividends that were paid to shareholders. Looking ahead for the calendar year '20, the greenfield funding requirement is expected to be $10 million for the remaining 4 centers, taking the entire spend to circa $155 million for 44 centers and concluding the committed development pipeline. Outlined on Slide 20 is a breakdown of the $40 million of capital invested during the year into CapEx. We've also outlined the CapEx investment for the coming year. These investments support a number of our target areas, particularly the acceleration program by continuing to build the quality of centers as well as building the foundational systems and infrastructure to ensure our platform is scalable, efficient and customer-focused. The center refresh and refurb program continues with $21 million invested during the year. This CapEx specifically relates to investment made in the physical centers such as playground and yard upgrades, painting, flooring, air conditioning and kitchens. In so doing, we improved the physical appeal of our center network as well as enhance the everyday experience for both families and our teams within centers. The remaining investment was invested in technology, educational equipment and furniture used in centers as well as continued investment in our foundational systems, predominantly the system investment related to the rostering and workforce management system and further expansion of our childcare management system to provide enhanced communication to families. The WiFi infrastructure upgrades for centers continued this year. This investment supports the delivery of the customer-facing elements of our childcare management system and the workforce management project. Forecast 2020 CapEx is estimated at $40 million as we continue to strengthen the quality of our center portfolio, particularly in centers that are part of the acceleration program. Turning now to our capital metrics on Slide 21, the group's key financial ratios, our net debt-to-EBITDA leverage, fixed charge cover and gearing. Net debt levels ended the year at $350 million, in line with the level at the end of June, resulting in $150 million of available debt facilities and cash. The leverage of 2.25x at the end of the year was as flagged at the half year. And with the final 4 development centers to be delivered in first half '20, leverage is still expected to be at or below 2.5x at the half. As the development pipeline is completed and earnings from these greenfield centers continue to grow, leverage is expected to reduce through the second half of 2020. The current leverage levels of above 2x reflects the growth phase of the company as we execute on the greenfield development pipeline with these earnings lagging the initial capital investment. The fixed charge cover ratio remained stable during the year and continues to reflect the timing variance between rental commitments from the greenfield pipeline coming online and the earnings being realized. The group remained conservatively geared. We continue to be comfortable with our capital position based on having sufficient headroom available relevant -- relative to our covenant levels, strong relationships with our lenders and approximately $100 million in committed debt facilities and cash available even at peak debt levels. From a return perspective, on Slide 22, return on capital employed has reduced during the calendar year '19, reflecting the increase in capital as the greenfield pipeline is delivered and further CapEx is invested in the quality of the network. Return on capital employed is expected to trend higher as the core portfolio delivers organic growth and the greenfield centers mature. Turning to Page 23. In terms of capital management, as indicated previously, $270 million of foreign-denominated Singapore bonds were repaid. This repayment completed the transition of the group to lower cost of debt, improved covenant arrangements and a staggered debt maturity profile. The second half reflected the lower cost of debt with finance costs reducing as expected. Borrowing costs for calendar year '20 are expected to be circa $25 million. The Board declared a fully franked dividend of $0.06 per share, resulting in a full year dividend of $0.1075 and a payout ratio at the lower end of the 70% to 80% of lease-adjusted NPAT dividend payout range. I will now hand back to Gary for the strategy update.

Thanks, Sharyn. We'll now turn to an update on implementation of the group's strategic plan. Before doing so it's worth providing an overall view of the market supply/demand environment with an update on supply environment being set out on Slide 25. From a macro perspective, after reducing steadily for the first 3 quarters, supply growth picked up in the fourth quarter and brought the full year annualized growth rate to 4.2%. As stated in previous presentation, while the macro results are useful, the key indicator of the impact of competition in our sector is the movement in supply in each local area. The best proxy for this is the number of centers that have opened within a 2-kilometer radius of an existing center. While G8's network has been significantly impacted by supply, with 270 centers impacted by new competitors over the last 3 years, this supply growth moderated during 2019. The number of G8 centers impacted by new supply increased by 1% during 2019, well below the macro growth level. Countering the impact of supply growth is a key focus of our acceleration program, as the evidence continues to demonstrate that high-quality centers can successfully mitigate the impact of new supply. As outlined in our November 2019 Investor Day presentation, the focus in the next 12 to 18 months is firmly on utilizing the group's enhanced capabilities to accelerate earnings growth. Slide 26 outlines our pathway to accelerated EBIT growth with the focus and priorities being in 2 areas. Firstly, driving growth in our turnaround and greenfield centers primarily through the establishment of a full-time team that will utilize the methodology established in the pilot program that was conducted in 2019. The team is largely in place and activities have been targeted for around 50 centers in the first quarter of 2020. And an update on progress of such activities will be provided at the group's AGM in May. Secondly, optimizing the center network by actively reviewing and taking action in relation to underperforming centers as well as continuing to evaluate acquisition opportunities in a disciplined manner. Costs are also a focus in terms of optimization, and we'll be driving cost efficiencies to support EBIT acceleration and to respond to prevailing market conditions. The cost of the full-time team forms part of the overall $10 million cost of the acceleration program with these costs being outlined in Slide 27. The $10 million of costs are broadly evenly split into 3 areas. Firstly, the full-time turnaround team, which consists of temporarily seconded resources as well as consultants. As the seconded team members will return to operational roles within 12 to 18 months, these incremental costs are considered to be one-off. Secondly, $3 million in increased training costs related to major system changes, such as the new rostering system. On the basis that major system-related changes will be completed in the next 12 to 18 months, these incremental costs are also considered to be temporary. And then thirdly, the cost of in-center resources to accelerate quality improvements at our centers, such as repairs and maintenance costs and learning environments. Once these environments are up to standard, the level of ongoing investment reduces significantly. The cost of the program will be phased and monitored to ensure all acceleration program costs are funded by benefits or cost efficiencies that flow from our optimization activities. Turning to the group's current trading and outlook for 2020, which is set out on Slide 29. There has been significant instability in the market to date in calendar year '20 due to events such as bushfires and the coronavirus. This has flowed through to the group's occupancy with year-to-date like-for-like occupancy slightly behind prior year. Given the recent and continuing market volatility, it is too early to form a clear view on the group's underlying occupancy performance. The impact on group profits have been and will continue to be mitigated by cost management. We will continue to monitor conditions in the marketplace and be agile in our response. Year-to-date wage performance is in line with expectations and the activities associated with the acceleration program are on track with costs of the program being phased and monitored to ensure they're funded by incremental earnings from turnaround and greenfield centers in calendar year '20. The group looks forward to providing a further update on trading performance and progress of our strategic program at the Annual General Meeting in May 2020. So that, Travis, that concludes the formal part of the presentation. I'll now hand back to you to start the Q&A session.

[Operator Instructions] The first question today comes from Scott Hudson from MST.

Gary and Sharyn, just a couple of questions. Firstly, in relation to the center support -- support costs inflation in '19, what sort of carryover of full year impact is that going to have on calendar year '20?

So we're not expecting significant annualization price increases off that cost, Scott. Most of the costs were incurred in the early part of the year, so 2019 will be a good proxy for 2020.

Okay. And then just in relation to the $10 million costs associated with the acceleration program, is that just existing staff being reallocated into different roles for the year? Is that how we think about it?

Yes. So we've seconded people from their normal operational roles into a full-time project team and backfilled them in their operational roles. Once those projects finished, they then step back in those operational roles and those backfilled people who are contracted resource then disappear.

And then lastly, in relation to the, I guess, the commentary around the volatility through early calendar year '20, I mean is that very regionally focused? Or was it quite broad-based depending on -- in terms of impact?

So about 1/4 of our centers were impacted by bushfires over a number of months out there in communities that were impacted by bushfires. So that was reasonably widespread, albeit temporarily impact for the centers in question from a closure point of view. In terms of coronavirus, it is to date, has been predominantly along the Eastern seaboard, although -- and more in Sydney, Melbourne. I guess like everyone, we've got a bit of a wait-and-see approach as to how that develops.

So that's an ongoing impact?

I guess we -- sitting here today, I'm unable to predict exactly how it's going to go. So I can't be more definitive than that at this point, unfortunately.

And then lastly, in terms of, I guess, identifying underperforming centers, what sort of percentage or how many of the -- what number of centers have you identified as sort of underperforming and under review?

Yes. So we talked in our November presentation of our turnaround program being around the 80 centers. We're pretty comfortable with that number.

Then in terms of your sort of portfolio optimization, is there any potential closures to come within that 80 centers?

No. Now there are turnarounds where we're confident that we can improve the level of profitability back to their historical levels. In terms of loss-making centers, our WA sale took a fairly sizable portion out of our total loss-making portfolio. You would have noted that we closed 16 centers at lease expiries during the year. So we think we've gone a fairly long way in terms of cleaning up our portfolio of lossmakers.

The next question comes from Peter Drew from Carter Bar Securities.

Gary and Sharyn, just a couple of questions. Firstly, with that $10 million investment, where will that be reflected in terms of, I guess, how you disclosed the results? Will that be included in support costs?

Yes, predominantly, Pete. We'll take it as -- within EBIT. So to start, we'll give people a separate breakdown, but it will come through as support.

Yes. Okay. And how should we think about -- will it be fairly evenly weighted through calendar '20 in terms of first half, second half? Or will it be more front-end?

It'll be pretty evenly weighted. Although, as we called out in the presentation, we're going to be quite agile in how we manage that because we want to make sure that we're getting the balance between benefits and costs.

Yes. Yes. Okay. And in terms of, I guess, the expectations of how you'll see the positive impact to EBIT come through. Can you give us a sort of guide as to what you're thinking the improvement will be relative to that $10 million spend, maybe this year and next year?

Certainly, for this year, we're quite clear that the benefits from the program need to cover the cost of the program. So we're not going backwards from an EBIT perspective this year. When we achieve that that sets up good momentum leading into next year.

Yes. Okay. And then just in terms of CapEx, can I just clarify, is there still the $31 million of CapEx for those 10 centers to be paid in, effectively, in first half '20? Or is there some component of that that's already been prepaid?

For our greenfield pipeline, Peter, we've got around $10 million left for this fiscal.

Okay. So that means that $21 million is already being paid?

Correct.

In calendar '19?

In calendar '19, all we've got left of that $155 million is around $10 million in terms of cash flow.

Yes. Okay. And then I guess just the last one, just in terms of trading performance. I mean you said that occupancy is tracking slightly below the PCP, but you're talking about having mitigated, sort of, I guess, maybe some of the impact in terms of better cost management. Can you provide any sort of maybe a guide in terms of how you're tracking from an EBIT perspective so far in the year relative to the same period last year?