Weekly Update: Stock To Watch G8 Education (GEM)

G8 Education (GEM) is an Australian child care operator, managing 134 centres throughout the country.

The Australian child care centres are concentrated mostly in Queensland and NSW, while in Singapore the group owns or operates 20 child care centres. GEM is the only listed child care operator on the ASX, following the much publicised collapse of ABC Learning in 2008.

Acquisition success

A key plank of GEM’s strategy is buying up independent childcare operators, and extracting synergies from the businesses.

During the half, GEM acquired two child care centres and divested an underperforming centre. This followed a busy FY11 in which the group purchased 54 centres. Importantly, the integration of the acquisitions into the current group structure has been well executed.

Demonstrating this point, GEM’s Kindy Patch acquisition (settled March 14, 2011) helped lift 1H11 revenue 14.4% and EBIT margin 21.5%. In 2H11, revenue was boosted by 16.4% and EBIT margin by 24.4%.

GEM has produced similar outcomes with its other acquisitions because a) it doesn’t overpay for the businesses (its acquisition multiple is only 4x the target’s one-year forward EBIT), b) the businesses are profitable, and c) the centres are in ideal locations, which increases scale.

Yesterday, the group announced that it had acquired 7 more premium childcare and education centres in NSW for $9.2 million (representing 4x EBIT and funded from existing cash and debt).

In addition to expanding GEM’s presence in NSW, the acquisitions were expected to contribute to EBIT immediately post-settlement.

Healthy balance sheet and history of growth

Prior to 2H09, GEM was a loss making entity, but since then the rate of profit growth has been impressive.

Since 2H09, half-year revenue has risen at a 35% compound rate of growth, with the rate of profit growth an even more robust 65.4%.

The balance sheet was in healthy shape, with a net debt to equity ratio of just 19.2% at the end of 1H12.

GEM had a $50 million debt facility which, when combined with existing cash, gives it the flexibility to make acquisitions without undertaking a dilutive capital raising.

With the group now generating positive free cash flow, we are confident in its ability to grow dividend payments. The latest quarterly dividend was 1.5 cents.

Favourable industry dynamics

GEM’s Australian operations receive a crucial level of support from the government with the child care rebate.

The increase in the rebate has significantly outpaced the rate of inflation over the past seven years, and the higher the rebate, the greater the incentive for parents to put their children in day care centres.

The longer term demographic trends are also supportive of GEM’s business. The group noted that since 2006, the percentage of 0-5 year olds attending childcare has risen to 38%, from 33% in 2006.

Moreover, the 0-5 year old population since 2006 has grown at 6 times the rate of the prior 20 years. What these trends tell us is that GEM’s target market is experiencing strong growth, and the child care rebate is increasing the incentive for parents to use the company’s centres.

Outlook

Since turning in a profit in 2H09, GEM has been on a strong revenue and earnings growth path.

The group’s strategy is to grow by acquisitions, and on this front it has succeeded. In addition to increasing market share and boosting scale efficiencies, the acquisitions have been earnings accretive.

Going forward, the government’s child care rebate will continue to offer incentives for parents to place their children in care centres. We believe the market is recognising GEM’s potential, and as such we think GEM is defiantly a stock to watch in the near-to-medium term.

Kathmandu Holdings Limited (KMD) Report Net Profit Decline

Kathmandu Holdings Limited (KMD) is a provider of clothing and equipment for the travel and adventure market.

Retail locations are spread across Australia and New Zealand offering a range of products with technical specifications for different conditions. The company listed on the Australian Stock Exchange in the latter half of 2010.

Kathmandu Holdings has reported an FY12 net profit of NZ$34.85 million, a 10.8% fall on the prior corresponding period.

Revenue over the period was up 13.4% to $347.1 million. Same store sales growth was 5.7% in the year to July.

Despite the sale growth, profit was hurt by lower margins and store refurbishment costs. The group will pay a final dividend of seven NZ cents, fully franked, taking its total dividend for the year to 10 cents.

Fortescue Metals Group Out Of Trading Halt

Fortescue Metals Group Ltd. explores for and produces iron ore. The company conducts business worldwide and is listed on the Australian Stock Exchange.

Fortescue came out of trading halt after it announced that it had  struck a deal to refinance all of its existing bank facilities in order to provide it with additional liquidity and stave off looming debts.

Specifically the group said "this new facility removes these covenants and extends the Company’s debt maturity profile. The earliest repayment date for any of the company’s debt is now November 2015.”

Fortescue said it had received strong interest from a range of parties over potential partnerships on several of its assets, but will only undertake them if they add shareholder value.

Weekly Update: Stock To Watch Oil Search (OSH)

Oil Search (OSH) explores, develops and produces oil and gas in Papua New Guinea (PNG) and Australia.

OSH's major producing operations are the Kutubu and Gobe oil fields and the Moran development.

However, much of OSH's perceived value is in its substantial PNG gas resources, which have been given a boost by partners such as Exxon Mobil investing huge amounts of money in the project.

The company is poised to enter a major new growth phase, driven by its 29% interest in PNG LNG. The gas will be sourced from the Hides, Angore and Juha gas fields, as well as the Kutubu, Agogo, Moran and Gobe Main oil fields.

1H12 results

Although OSH’s 1H12 results showed a 6% fall in net profit to US$107.5 million, much of the fall was attributable to a jump in exploration costs. An interim dividend of US$0.02 a share was declared.

The increase in exploration costs came as OSH seeks more natural gas to underpin an expansion of PNG LNG.

Whilst an increase in costs is generally not desirable, in OSH’s case, the payoff from finding more gas is worth it if this leads to a third LNG train (plant) at PNG.

A positive takeout from the result was a 7% lift in revenue, which occurred amid stronger sales prices and production volumes.

Nearing first PNG LNG production

The PNG LNG project is the big driver of OSH’s share price, as it has the potential to transform the company into a major energy producer.

The project has an expected life of 30 years, a resource estimated at over nine trillion cubic feet of gas and over 200 million barrels of associated liquids.

The project’s two trains will produce close to 6.6 million tons per annum (mtpa), with OSH’s 29% stake yielding approximately 2 mtpa.

There is also the possibility that a third train could operate in the field, which may increase the project’s production to over 8 mtpa.  OSH is currently looking for the gas needed to support the third train, and we are confident of exploration success.

There is around 20 trillion cubic feet of gas in Gulf of Papua and OSH holds significant acreage in the area.

Demonstrating how significant the step change in production will be, OSH’s output is expected to increase to over 16 mmboe in FY14, with that figure then jumping again to just below 25 mmboe in FY15.

This compares to FY12’s production estimate of 6.2-6.7 mmboe, thus implying a significant boost to earnings and cash flow in coming years.

Outlook

With second half production expected to remain strong, OSH stuck to its previous guidance for FY12 production to be within a range of 6.2 - 6.7 million barrels of oil equivalent (mmboe).

Complementing its output, OSH is also likely to benefit from the price of oil, which has risen around 15% since the latter part of June. The key value driver, however, remains PNG LNG.

As we head closer to first output in 2014, and barring no unexpected cost overruns with the project, we expect PNG LNG to become a bigger factor behind OSH’s share price strength.

We anticipate these factors will continue to underpin OSH share price and as such think it’s a stock to watch in the near-to-medium term.

Weekly Update: Cochlear (COH) Stock To Watch

COH clear for gains

Cochlear (COH) researches, develops and markets cochlear implant systems for hearing impaired individuals.

The company currently occupies a ~70% share of the world market for the profoundly hearing impaired (PHI).

COH hearing implant systems include Nucleus and Baha, and are sold in over 100 countries, with direct operations in over 20 countries.

With well over 80% of the group’s earnings not denominated in Australian dollars, the company’s bottom line is sensitive to currency translation.

FY12 Results

COH’s FY12 results don’t look that impressive at first glance.

Net profit was $56.8 million, down 68% on the prior year’s result.

However, this did include a $101.3 million (post-tax) charge relating to the voluntary product recall of its implanted Nucleus CI500 range after an increase in failures in its Nucleus CI512 implants.

Total revenue over the period was down 4% to $779 million.

However if we look at sales on a constant currency terms they were actually up 1%.

Implant sales for the full year were 23,087 units, which was down 6% on the prior year.

Whilst the fall in implant sales would normally give us some cause for concern, especially given the recall issues, the second half sales showed a 15% improvement on the first half.

Aussie dollar

As previously mentioned, COH’s earnings are very sensitive to Australian dollar movements given that over 80% of its earnings are sourced overseas.

Over the last month the Australian dollar has fallen against most currencies, and against the US dollar it has fallen from a little over $1.06 to $1.02.

Against the euro, the Aussie has fallen from about $0.86 to $0.81.

It is well known that there is a strong positive correlation between the Australian dollar and the country’s mining industry.

As such, the recent weakness in the sector is likely to see continued weakness in the Aussie dollar.

Outlook

The recall appears not to have affected COH’s revenue, at least on a constant currency terms.

The company’s long-term position still remains strong, with an aging population likely to support growth for many years to come.

COH’s earnings have always been defensive in nature and we don’t see this changing in the future.

As such we believe that the short-term weakness in the Aussie dollar will continue to see COH’s share price to appreciate in the near-term.

Fortescue Metals (FMG) Announce Power Station Sale

Fortescue Metals Group Ltd. explores for and produces iron ore. The company conducts business worldwide and is listed on the Australian Stock Exchange.

Fortescue Metals announced the sale of the power station at its Solomon iron ore mine in the Pilbara region of Western Australia to TransAlta Corporation for net proceeds of US$300 million.

The company has concurrently entered into a long term Power Purchase Agreement with TransAlta for 100% of the power station’s capacity over the current life of the Solomon mine.

Fortescue CEO Nev Power said the agreement provides for long-term security of power supply to the 60 million tonne per annum Solomon mine, which is currently under construction.

Weekly Update: Res Med (RMD) Stock To Watch

ResMed (RMD) is a leading developer, manufacturer and distributor of medical equipment for treating, diagnosing, and managing sleep-disordered breathing and other respiratory disorders such as sleep apnoea.

RMD operates in over 65 countries through 16 direct offices and a network of distributors, including Australia, France, Germany, New Zealand, Singapore, the UK and the United States.

Latest results

RMD delivered an outstanding FY12 result that came in ahead of market expectations.  Revenue for the June 2012 quarter totalled $3.6 million, a 9% increase on June 2011’s result (constant-currency terms.).

Net income was up an impressive 31% in the same period to $76.8 million. For the full year, revenue grew 10% to $1.4 billion, whilst net profit rose 12% to $254.9 million.

The strong fourth quarter came on the back of healthy flow generator and mask sales in RMD’s core America’s division.

Flow generator sales growth came despite a slowing US economy, highlighting the success RMD is experiencing in penetrating the American sleep-disordered breathing market.

RMD achieved the profit result whilst benefiting from a lower Australian dollar, which helped contain general and R&D expense growth. Quarterly general and R&D expenses were up 3% on-year.

Importantly, the strong result allowed the group to declare a maiden quarterly dividend of 1.7 cents per Australian share.

Strong financials

The strong FY12 result bolster’s our confidence in RMD’s ability to maintain its high profit margins.

FY12 gross margin was 60%, with EBIT margin a similarly robust 21.5%. The numbers were similar to FY11, where gross margin was 59.6% and EBIT margin was 21.5%.

The strong margins came as the group benefited from favourable exchange rate movements and cost control measures such as supply chain efficiencies and expanding manufacturing in Malaysia.

Continued growth in flow generator sales combined with cost control measures and are likely to support margins going forward.

The balance sheet was also in healthy shape, with the group having a net cash position of $558,706 at the end of FY12.

Outlook

RMD’s FY12 results show a company growing its share of the lucrative US sleep-disordered breathing market.

American flow generator sales were healthy despite concerns over the economy, and RMD demonstrated operational efficiency through good cost control.

RMD’s balance sheet was in pristine shape, and in our view, the company’s already robust margins will benefit from continued flow generator and mask sales growth.

As such we think RMD is a stock to watch in the coming months.