Overseas Education Limited

I have re-initiated a long position in the shares at 82 cents a share. Whilst I don't consider the shares a screaming buy, I do think this is a quality business with limited down-side and reasonable upside.. What made me reconsider ?

(1) Share price retrenched from high of $1+ last year and around 90 cents in May of this year. It is still trading at a trailing 12 months PE of almost 16x but that ignores the potential effects of (3) and (4) below

(2) TOP has been successfully obtained and (certainly looking from the outside) , the school looks pretty impressive.

(3) The school has hiked school fees again - effective for the start of the school year in August, bringing them more or less into line with other top schools. My reading of this is that management is confident that it will not lose too many students despite the move from a central Orchard Road location to Pasir Ris (also not that United World Collage has its second campus nearby). Hopefully, this will also provide a boost to the bottom line but that depends on whether wages for teachers can be kept under control.

(4) The school has current enrolment of around 3,600 students but capacity for 4,800 so there is a 33% upside and with a 20% + net income margin, that really boosts the bottom line (although I read somewhere that any increase in students beyond current levels would be subject to LTA approval due to concerns of traffic congestion caused by more school busses)

(5) Overall, the international school market continues to be strong. The only laggard being GEMS which suffered from delays in starting the school year (Aug 2014 - June 2015) due to construction delays.

Whilst I don't think this share will make you rich, I do think it can go to $1 - 1.20ish propelled by an increase in student numbers and potentially a higher PE multiple as investors recognise it for a nice, boring but stable business with growth in line with inflation (once current capacity have been filled) and a decent dividend. Given the strong cash flow generation, the $150MM bond should be easy to repay which will free up $8.1MM in annual cash (pre-tax) compared with net income in 2014 of $22MM

One potential negative point is whether the annual maintenance costs of the new school will be substantially higher than the old one. I suspect so but hopefully higher school fees and an increase in student numbers will more than offset that.

Vested in the shares and the bonds

The only advice I have for many in Education stocks is that CON jobs are aplenty within the sector. W

Locally, we have already seen the demise of several darlings - InfoMati in the 90s, Raffles Edu post GFC.

In Australia, there are repeated high profile flops.

Education is an essential service especially in Asian societies. However, traditionally, education is also a public good that needed invisible hand support.

On a big picture front, should there be a major external shock - we can expect expats to return in droves and hence with a substantially higher fixed costs to cover, one can expect operational leverage of OE to be much higher.

Not Vested
Kay Poh As Usual

(20-07-2015, 10:55 PM)GreedandFear Wrote: I have re-initiated a long position in the shares at 82 cents a share. Whilst I don't consider the shares a screaming buy, I do think this is a quality business with limited down-side and reasonable upside.. What made me reconsider ?

(1) Share price retrenched from high of $1+ last year and around 90 cents in May of this year. It is still trading at a trailing 12 months PE of almost 16x but that ignores the potential effects of (3) and (4) below

(2) TOP has been successfully obtained and (certainly looking from the outside) , the school looks pretty impressive.

(3) The school has hiked school fees again - effective for the start of the school year in August, bringing them more or less into line with other top schools. My reading of this is that management is confident that it will not lose too many students despite the move from a central Orchard Road location to Pasir Ris (also not that United World Collage has its second campus nearby). Hopefully, this will also provide a boost to the bottom line but that depends on whether wages for teachers can be kept under control.

(4) The school has current enrolment of around 3,600 students but capacity for 4,800 so there is a 33% upside and with a 20% + net income margin, that really boosts the bottom line (although I read somewhere that any increase in students beyond current levels would be subject to LTA approval due to concerns of traffic congestion caused by more school busses)

(5) Overall, the international school market continues to be strong. The only laggard being GEMS which suffered from delays in starting the school year (Aug 2014 - June 2015) due to construction delays.

Whilst I don't think this share will make you rich, I do think it can go to $1 - 1.20ish propelled by an increase in student numbers and potentially a higher PE multiple as investors recognise it for a nice, boring but stable business with growth in line with inflation (once current capacity have been filled) and a decent dividend. Given the strong cash flow generation, the $150MM bond should be easy to repay which will free up $8.1MM in annual cash (pre-tax) compared with net income in 2014 of $22MM

One potential negative point is whether the annual maintenance costs of the new school will be substantially higher than the old one. I suspect so but hopefully higher school fees and an increase in student numbers will more than offset that.

Vested in the shares and the bonds

RHB Securities has published a report with a sell recommendation and a target price of 70 cents a share. Stock fell today from around 84 cents to around 77 cents. Presumably as a result of this report. The report is well written and the analyst has tried to do good research on the market. Whilst I don't disagree with many of the potential risks, I do think that the analyst is too bearish.

The report is here :

https://sites.google.com/site/researchre...072015.pdf

The main points that she makes are :

1. The new campus is in Pasir Ris which is far less attractive than Orchard Road and most expats live in districts 9 and 10 and many of those work in the financial district so Pasir Ris is far away.

No one can argue that Pasir Ris is less attractive than Orchard Road but I would point out that UWC has its second campus 4 KM away and that is full. Singapore American School is in Woodlands - hardly an expat ghetto, Canadian International School is in Jurong (as is Dulwich) and Stamford American School and Australian School are both in Serangoon. Whilst many expats would like to live in prime districts, many also live on the East Coast and given school busses, the location is probably less critical than the analyst argues. Her other point is that UWC is a stronger brand than Overseas Family School [the brand under which OEL operates] (I agree) and that hence UWC will soak up most of the demand from the East. I disagree with that as both UWC campuses are full, so even if parents want their kids to enrol, it is difficult to get a spot.

2. There has been a 32% drop in registration fees and the biggest loss in students appears to have been in the junior school as parents don't want their young kids to have such a long commute (assuming that the parents all live in Orchard). The analyst is concerned that this will impact future enrolment in higher grades as the lower grades move onto higher grades.

I think this is the biggest concern and one that needs close monitoring. However, I think we need to bear in mind that for kindergarten, there are plenty of good local alternatives that many expats use (Eton House, Pats school house etc) and I can see the logic in some parents switching from OFS to a local kindergarten. However, most expat parents then send their kids to international school for primary one. The only other international school in Orchard is International School of Singapore and Chatsworth and I don't think they have much extra capacity, hence, the kids will still have to commute whether to Jurong, Woodlands, Serangoon...or Pasir Ris. The other point to bear in mind is that most expats stay here for 3 - 5 years. As a result most international schools have a 20%+ turnover in students every year. So it is just not a case of catching them in Kindergarten and then they move up through he grades for the next 12 years.

3. Tight immigration policy will limit the # of expats on Employment Pass (and the statistics shown, show these numbers as stable rather than growing).

My own view is that the government is likely to relax this post the election but even if they don't, the target expats for the international schools are the high earners (after all, if you have 2 kids and have to pay $60,000 a year in total school fees, you will only relocate to Singapore if your company pays you well) and these high earners have high positions in foreign companies that the govt will want to support. Where I think the govt is likely to clamp down is on PMEs directly competing with many Singaporeans.

4. Higher supply of new schools (Dulwich and GEMS last year plus the govt is seeking tenders for additional schools - if successful, these schools are likely to emerge after 3 years given that campuses have to be built).

I agree there is higher supply and that the high capacity utilisation and increases in fees cannot continue indefinitely. However, I do think that the analyst has overlooked the fact that (1) certain schools cater to specific markets (eg Singapore American School is very focused on US citizens with a US curriculum as opposed to IB and hence competes less directly with other schools, Australian school ditto and Dulwich and Tanglin are very focused on the English market) and (2) there are also smaller schools with poorer facilities (eg Nexus, Chinese International, Chatsworth, International Community School....) where parents typically move their kids onto bigger schools once they reach P3 - . Hence, some market share will be taken from these smaller schools.

5. Expats have smaller packages these days and hence there is pressure on them to seek cheaper alternatives (local schools or international schools in Johor).

I agree with this but there are still plenty of more well paid expats, that can afford the top international schools and wouldn't consider anything else.

6. OFS has now raised its fees to similar levels as other top schools (most of which only raised fees by 3% this year whereas OFS raised them by 10%), so future fee growth is likely to only be in the 2-3% range.

I agree with this assessment. As I have stated in previous posts, the key here is to get the capacity utilisation up from probably around 3,300ish (down from 3,700 - 3,800 at their Orchard campus) to the maximum capacity of 4,800. That is what will cause the big jump in revenues. If that doesn't happen, then growth closer to inflation rates is likely.

7. Earnings are likely to be flattish with a stable dividend due to increased depreciation charges as well as interest charges (upon completion of the campus, interest is no longer capitalised but will be expensed) although cash flow will grow nicely.

If you subscribe to the analyst's view that OFS is unlikely to be able to grow student numbers significantly, then this makes sense but if you see room for growth, then she is being too negative. The analyst's view is that cash flow will grow nicely but is likely to be conserved to pay off the $150MM bond maturing in 2019 and hence an increase in dividends is unlikely in the near future. I guess this all depends whether the company wants to end up debt free or is happy to have a bit of debt outstanding, in which case it could increase the dividend.

Valuation wise, if the company is throwing off a lot of cash with small capex requirements, it also begs the question whether the market will use earnings or EBITDA multiples to value the stock.....


So, in conclusion, I think the analyst has done a good job highlighting the various things that could go wrong. I just don't agree with her that they will . The key points for this stock is really whether you believe (1) that there is still sufficient overall demand in the market to fill up these schools (given new capacity from Dulwich, GEMs and OFS) and (2) that Pasir Ris is not so off the beaten track that OFS (which has a long track record as a school in Singapore) can still increase enrolment to 4,800.

Vested in bonds and shares.

Isn't value investing boils down to this? Demanding a margin of safety because we assume certain things will go wrong.

(27-07-2015, 10:59 PM)GreedandFear Wrote: So, in conclusion, I think the analyst has done a good job highlighting the various things that could go wrong. I just don't agree with her that they will . The key points for this stock is really whether you believe (1) that there is still sufficient overall demand in the market to fill up these schools (given new capacity from Dulwich, GEMs and OFS) and (2) that Pasir Ris is not so off the beaten track that OFS (which has a long track record as a school in Singapore) can still increase enrolment to 4,800.

Vested in bonds and shares.

A great reminder that operating leverage works BOTH ways. Alot of time, our confirmation bias and over optimism trends to exaggerate the upside of operating leverage, while conveniently leaving its downside unaccounted for in our evaluation.

greengiraffe' Wrote:On a big picture front, should there be a major external shock - we can expect expats to return in droves and hence with a substantially higher fixed costs to cover, one can expect operational leverage of OE to be much higher.

(28-07-2015, 02:09 PM)weijian Wrote: Isn't value investing boils down to this? Demanding a margin of safety because we assume certain things will go wrong.

(27-07-2015, 10:59 PM)GreedandFear Wrote: So, in conclusion, I think the analyst has done a good job highlighting the various things that could go wrong. I just don't agree with her that they will . The key points for this stock is really whether you believe (1) that there is still sufficient overall demand in the market to fill up these schools (given new capacity from Dulwich, GEMs and OFS) and (2) that Pasir Ris is not so off the beaten track that OFS (which has a long track record as a school in Singapore) can still increase enrolment to 4,800.

Vested in bonds and shares.

A great reminder that operating leverage works BOTH ways. Alot of time, our confirmation bias and over optimism trends to exaggerate the upside of operating leverage, while conveniently leaving its downside unaccounted for in our evaluation.

greengiraffe' Wrote:On a big picture front, should there be a major external shock - we can expect expats to return in droves and hence with a substantially higher fixed costs to cover, one can expect operational leverage of OE to be much higher.

All good points but I think we always have to strike a balance between margin of safety and what is a good business. There are plenty of stocks that trade at 40-50% discount to NAV but that doesn't necessarily mean that they are great investments. Their businesses may not be doing that well and / or there is no incentive for the majority shareholder to unlock the discount to NAV which means that minority shareholders can get stuck for years on end without realising any upside (and potentially seeing further downside in the share price).

Yes, operational leverage cuts both ways and one should not be blinded by the upside but operational leverage is inherent in business (although its degree varies by industry). WRT to GG's point on expats leaving in droves post the Asian crisis, that is correct but they all returned again. Same thing for SARS. My point is that long term, Singapore will always have a significant population of highly paid expats who can afford to pay for (and demand) quality international schools. To me that is the attraction of the industry. Now whether Mr Market will make the shares cheaper or more expensive is anyone's guess but I think the industry is good and OFS is a proven player.

Vested

I agree with GreedandFear (some of my points might overlap) that the author's points are not all that convincing. In fact, I found some to be inconsistent.

1) The author stipulates that the government's tight immigration policy is limiting the number of expats/foreigners, yet we see active government (EDB) involvement in FSS in Singapore through 2010's RFI which resulted in the opening of Dulwich and GEMS. On top of that, EDB conducted another RFI in Apr 2015. This hardly paints a picture of dwindling demand and lack of expat community in Singapore. This is somewhat contradictory in my opinion.

2) The author then suggests that GEMS and Dulwich are competitors with strong take-up. If point (1) is valid, this would not be the case. GEMS/Dulwich would also not jump into a 30year land parcel if the schools have such bearish outlook on FSS in Singapore. Being seasoned operators, I would assume that they did their due diligence and have a bullish long term view on FSS in Singapore.

3) The author claims that moving OFS to Pasir Ris was a bad move because of the awkward location. In my view, GEMS at Yishun and Dulwich at Bukit Batok and UWC at Pasir Ris are strong indicators that schools need not be centrally located to attract students. This is of course dependent on a robust "school-bus" and "transport" system employed by the school. From the website of OFS Pasir Ris, you can see how this is anticipated and actively handled by management.
OFS being in Pasir Ris cannot be viewed in isolation and leading to its "demise" if other schools are also adopting out-of-city locations.

4) In addition to point (3), the industries of Singapore are now vastly spread out across the island. The aerospace industry in Seletar/Changi, the build up of business parks in Expo area are just a few to be named. Quite a large number of expats live in the East Coast area as well.

In any case, the risks presented in the article are not new and shocking to me. They are valid and real, but have been that way since 1-2 years ago. Management has had time to predict and plan their moves accordingly. Only time will tell how the story will play out.

-vested and adding on the recent price weakness at 0.775-

While Overseas Education Limited ("OEL") has a stable business, I have reservations on the growth story portrayed by brokers such as Maybank KimEng who have a target price of approximately $1.30.

Here is my personal analysis:

1. EBITDA Margins
If we were to be generous, an optimistic scenario for OEL's future would be 27.0%. However, larger and more diversified industry peers such as G8 Education Limited and Nord Anglia Education have EBITDA margins around 22.0%. While we could argue that the cost bases in these countries are different, a look at Asian peers in Japan and Hong Kong suggest much lower EBITDA margins.

In recent periods, OEL's EBITDA margins have declined from 30.0% to 28.0%. This has been attributable mainly to staff salaries that have increased to 56.0% of revenue in 2014 from 50.0% in 2011. I believe EBITDA margins will continue to decrease as teachers in the public sector are expected to have wage increments between the range of 4.0% and 9.0%, and this should have a follow on effect in private schools.

2. Return on capital employed and revenue growth
OEL's return on capital employed decreased from 30.0% in 2011 to 7.0% in 2014. This is below the industry's average of approximately 8.0%. In addition, revenue growth in the last year was negative.

As mentioned by a few others in previous posts, the disposable income of expatriate households has an effect on OEL's business. Having worked with a few expatriates, it feels as if expatriates are thriftier these days and are considering cheaper alternatives such as our local schools which are viewed as having higher standards. If this is representative of the wider community, what then is OEL's point of differentiation?

While OEL should be able to increase its student numbers and fees, I'm not sure whether this would be enough to cover their rising cost base. 

3.  EBITDA multiple
While OEL's PE multiple seems cheap at around 12.0x compared to the industry average of 29.0x, I prefer to consider the EBITDA multiple.  OEL's EBITDA multiple is approximately 12.7x, compared to the industry's range of 5.0x to 22.4x, or an average of 10.0x. Definitely not expensive, but not cheap either.

4. Valuation 
Despite all these factors, I have considered an optimistic scenario where OEL will have 4,000 students by the end of FY15 and average fees increase by approximately 10.0% to $29,000 per student. Revenue for the year would be $115.0 million. I have also assumed that registration fees, school bookshop fees and enrichment programme revenues would be approximately 2.0%, 1.0% and 1.0% of tuition fees based on historical trends. This gives us total revenue of $120.0 million.

I have considered two different scenarios where EBITDA margins are 27.0% and 30.0%, which gives us a range of $32.0 million and $34.0 million. To derive the equity value, I subtracted net debt of $26.0 million from the enterprise value (calculated using a capitalization rate of 10.0%). My derived value falls in the range of $0.72 and  $0.80. Using the midpoint of $0.76, my margin of safety would only be 20.0%. As a value investor, I would keep away from OEL unless its share price dips any further from its last traded price of $0.63.

http://infopub.sgx.com/Apps?A=COW_CorpAnnouncement_Content&B=AnnouncementToday&F=T51TSQUNSCPW1FD7&H=0a5f439d48089da1473251562a003e679f2eb41eba8eeeafb38c069b41513346&fileId=Announcement_Q3_2015_Financial_Results.pdf

[url=http://infopub.sgx.com/Apps?A=COW_CorpAnnouncement_Content&B=AnnouncementToday&F=T51TSQUNSCPW1FD7&H=0a5f439d48089da1473251562a003e679f2eb41eba8eeeafb38c069b41513346&fileId=Announcement_Q3_2015_Financial_Results.pdf][/url]


Overseas Education oso mati



falling rev and rising fixed costs - recipe for immediate failure

No 40c no look,I don't buy the notion ang mo are willing to pay for anything that come with a high price,more and more ang mo are not on expat pay,I also think the company make a mistake
.they should have kept the Patterson campus and buy a smaller site at pasir ris,by doing these students will have choice with two location which wouldn't lead to a big drop in student numbers,bad business planning, couple with rising costs,it is a recipe for destruction in earning

Enrolment of students did not increase as expected. The interest expense and depreciation of PPE definitely will drag down the P&L in the upcoming Quarter.