Raffles Education Corporation: Seeding the clouds. Initiate with BUY

30% growth in FY09F. We are forecasting Raffles Education Corporation (Raffles) to grow its bottomline at a clip of 28% in FY09F. While long-time investors have been used to higher growth trajectories, we think that Raffles will be using this year to refine its operations in its schools. The difficult credit and equity situation will not present them cheap financing opportunities as it had in the past. As such, we think Raffles is unlikely to undergo another bout of major acquisitions that will boost its financials. On a quarterly basis for FY09F, Raffles could face resistance to growth due to slower student recruitment and very minor fee hikes (in the light of the difficult economic situation).

Prime asset overlooked. While the market looks at Oriental University City (OUC) as an outsized investment, we are of the view that it is Raffles' prime asset that will drive growth in the next few years, if run properly. The land bank and its possible plot sales, set up of more private colleges on campus and ready pool of current students to recruit into its own programs hold tremendous potential.

Reduce dividends? We think more investors may opt out of the scrip dividend scheme. Although Raffles has not indicated so, we anticipate that Raffles could reduce its dividends to 0.75 S cents/quarter (vs current 1 S cent/quarter) to preserve more cash. We are assuming that the scrip program will continue indefinitely with a 50% subscription rate. This will translate to about 4-5% dilution every year.

Attractive valuation, initiate with BUY. We are using a PER-type valuation for Raffles as we think that earnings growth will drive its share price. Raffles has traded in a wide spectrum, ranging from ~34-78x in 2007 to its recent 52-week low of ~8x PER during the Oriental Century scandal. Concomitant with the volatile equity market conditions, we think recent lows have primarily factored in the funding needs for its expansion (especially OUC's RMB2b price tag), cloudy sentiments of S-chips, its slowing growth in student numbers and ability to operationally execute well with an enlarged geographical footprint. As such, we peg our valuation to a blended 12x FY09/10F PER, closer to its lower trading band. Our fair value is S$0.60 (46% upside). Initiate with BUY. Dividend yield for FY09F is attractive at ~8% despite our 0.75 S cent/quarter assumptions. Sustained margins that trump our estimates and continued ability to grow student population beyond our forecasts will incentivise us to edge our valuation upwards.

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