Raffles Education Corporation: Muddied waters; downgrade to HOLD

Difficult year. Raffles Education (RLS) posted FY09 revenue of S$202m (+6.3% YoY) and bottomline of S$51.1m (-48% YoY). The poor showing was primarily impacted by weak student growth numbers coupled with the full S$33m impairment of Oriental Century and higher bad debt provision. Higher taxes were recorded due to tax incurred from its disposal of land as well as withholding taxes as it mobilised cashflows from overseas subsidiaries. RLS did not declare any final dividends in a bid to conserve cash.

Addressing concerns. With the market concerned about its ability to pay its short term loans and meet its Oriental University City (OUC) deferred payment obligations, RLS recently embarked to raise capital of S$131.3m via two tranches of fresh equity offerings. RLS has also restructured its outstanding RMB1.2b debt with OUC with 75% repayable only after Dec 2012 with an intended public listing. Post listing, the provincial government will likely own a significant part of OUC. We think that it would still keep a stake seeing that it can be a cash producing asset that has been turned around by Raffles. As education is largely driven by regulators, the government's stake in the listed entity will be seen as an advantage for Raffles.

Muddied organic growth. Although it has addressed debt concerns, RLS will not experience the growth of prior years. Management has guided for revenue to grow 15-20% and hopes to achieve net profit margin of 40-45% by FY12F. Student enrolment growth will also be stifled by a weakening Chinese market for private education as students put off longer and more expensive courses for shorter ones. Uncertain and haphazard regulatory changes to the education system have also introduced a murky outlook for organic growth. RLS will be setting up eight new colleges this year with breakeven timelines of 2-3 years each, depending on its locality.

Wait for clearer earnings drivers. We have adjusted our estimates to cater for a smaller topline coupled with higher operating costs and taxes. This offsets the absence of negative exceptional items for FY10F. With its funding issues addressed, we have bumped up our peg to 18x FY10F (prev 12x). Our fair value is tweaked to S$0.60 (prev. S$0.57). With the limited upside, we downgrade the stock to a HOLD.

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