RAFFLES EDUCATION - Low EPS growth and high capital requirements make RLS a SELL

When comparing Raffles Education to Educomp and Megastudy, two other major listed education providers in India and South Korea Korea, Raffles Education fails to stand out due to a lack of growth drivers. The company’s cashflow issues are apparent relative to its peers. Raffles has the lowest expected ROE and ROIC among the three. Moreover, it is expensive trading at the highest FY10CL PE, while we expect it to post the slowest EPS growth. SELL Raffles Education. BUY Educomp and Megastudy.

Slow earnings growth. We expect Raffles Education (RLS SP - S$0.48 - SELL) to post slower earnings growth than both Educomp (EDSL IB - Rs2423.2 - BUY) and Megastudy (072870 KQ - 206,600 won - BUY) over the next two years. This is a result of Raffles Education focusing on high-fee tertiary education programs, while Educomp and Megastudy focus on low-fee K-12 programs, where demand will be more robust. Moreover, Raffles Education’s growth strategy, which is very capital intensive unlike Educomp’s and Megastudy’s due to a high number of acquisitions and high set-up costs of new schools, slowed down significantly due to a lack of access to new capital.

Margin pressure. Educomp and Megastudy are expected to benefit from operating leverage in the next few years that will see their margins improve. Both companies have a number of sunken fixed costs, so adding new students only comes at an incremental cost. Raffles Education on the other hand, decided to set up six new schools, on top of the 28 schools it currently owns. As these schools take two-to-three years to reach breakeven, they will be a drag on margins in the coming years.

Cashflows under pressure. Raffles Education has the highest gearing among the three companies at 42%. The company had historically never been geared but needed to take on loans to finance its Oriental University City (OUC) acquisition. If we include the OUC obligations, Raffles Education’s gearing is 123%. Cashflow generation will decelerate as a result of lower earnings growth, making it harder for the company to pay off its obligations. Hence, we expect Raffles Education to stop paying dividends.

Valuations remain unattractive. Raffles Education is the most expensive education stock that we cover at 17.5x FY10CL PE and has the lowest expected earnings growth. The company shows the lowest expected FY09 ROE and ROIC due to the high capital intensity of its business and the near zero expected earnings growth.

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