Tree House Education - Shaping young minds - ElaraCapital

Preschool industry on robust growth trajectory

Rapid urbanization, rising aspirations for a quality education, improved affordability and more women joining the workforce are driving strong growth in the preschools segment. The organized preschool market is expected to grow at a 26% CAGR over FY13-18E to INR 42.8bn. To meet this demand, 8,400 new preschools would need to be added to the existing base of 4,300 preschools.

Tree House is on an expansion spree; thrives on asset-light model

Tree House (THEAL IN) management has been on an aggressive expansion spree, adding 80 schools every year over the past four years, at a CAGR of 60%. We have factored in an addition of 230 selfoperated schools and 120 franchisees over FY13-16E at less than 70% of the company's target of 513 preschool additions. Consequently, THEAL should register a revenue CAGR of 32% over the same period. Usually, it takes two years to reach stable capacity utilization of 50%, which offers return ratios of 50%. As a higher proportion of centers reach healthy capacity utilization, the preschool ROC should improve from the current 30% to 50%. Further, INR 5mn capex per school offers low investment/earnings ratio, allowing high growth potential.

Asset sale to lighten balance sheet, improve CF and return ratios

Tree House owns K-12 assets worth INR 2.4bn, nearly 50% of the asset base, which has dented return ratios. In line with its asset-light model, the company plans to sell its properties, which should reduce asset size by INR 960mn and recover advances worth INR 1.1bn from trusts. This would lower the asset base by about 50%. Further, 1.5x property value of book assets would raise incremental cash flow of INR 1.45bn, reducing overall K-12 book value to just INR 300mn, which will be amortized over 30 years. The company has completed its K-12 investment, and we are optimistic about its strong annuity business, with potential to make 100%-plus ROC.

Valuation

Our two-stage DCF valuation estimates a robust operating profit CAGR of 34% over FY13-16E and marginally tapered EBIT growth of 20% over FY16-20E, deriving a target price of INR 370. We assume a 14.5% WACC and a 4% terminal growth rate.

Our target price gives an implied EV/EBITDA and P/E of 12x and 7x, respectively, on FY16E numbers. This looks reasonable considering the strong growth opportunity, low earnings risk and FCF positive in the current fiscal. We initiate coverage of Tree House with a Buy recommendation and a DCF-based target price of INR 370, implying potential upside of 51% from the current levels.

Source : Equity Bulls

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