Raffles Education - Exposure to China’s new liberal youth

Headline growth isn’t the story: Education motivation is We initiate coverage on Raffles Education (RLS), an education provider that aims to “nurture creative talents and design management expertise for the arts, design and lifestyle industries and expertise for business management” with a BUY and target price of SGD0.78. RLS runs private and national schools across Asia. Analyses on RLS usually include growth trend charts in China (Appendix 2). Invariably, they do not explain why growth will continue; just that RLS has been growing. In our view, RLS offers exposure to China’s social liberalization, specifically, the desire by young China to express itself in artistic fields, rather than on the assembly line. We believe this gives RLS unique market exposure.

RLS has displayed phenomenal growth since listing in 2002. Of specific concern is its penchant for equity financing to fuel growth. We often hear about management’s aggressive appetite for growth but the conservative streak in preferring equity over debt (to fuel it) is unappreciated just as often. RLS has been net-cash positive from the time of its listing until FY08. A track record of prudence allowed it to dip into debt when made a large opportunistic acquisition in FY08. We believe this will be pared down quickly. Although equity dilution was 71% from FY02 until FY08, net profit grew 28x over the same period.

RLS’ latest acquisition of Oriental University City (OUC) gives it the potential for double enrolment. Budding exposure in India is also exciting. We believe that RLS’ growth will be limited only by the amount of capital it can find. As such, we have predicated our base-case growth assumptions on existing schools.

Our TP implies a FY10 P/E of 19.1x compared with a historical average of 22x. We have included a DCF sensitivity analysis in the report. Returns have retreated from astronomical levels in its early years, but look to mature on a stable profile. Nonetheless, forward ROE, estimated to be around 19.1%, is commendable on low leverage. RLS’ growth potential is more than commensurate to its risks. Sustained profit growth should validate its investment concept and catalyze the stock.

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