Educomp Solutions’ (Educomp) Q4FY12 EBIT at Rs1.2bn and PAT at Rs0.6bn were
in line with our expectations, though lower than the management’s guidance which
was sharply cut a quarter ago. The management has guided for 25-30% revenue
growth in FY13 and EBITDA margin improvement of 150-250bps YoY. However, it
refrained from providing PAT guidance. We expect FY13 recurring PAT to be flat
YoY mainly due to expected surge in interest cost by 53% YoY owing to likely
refinancing of US$110mn FCCB maturing in July 2012 including premium which
was not getting charged off earlier. While the volume growth momentum in the
core business of Smart Class remains strong, pricing and hence margins are likely
to remain under pressure because of intense competition. Other businesses like K-
12 schools and supplemental education are in nascent stage and in investment
mode. Educomp is unlikely to turn FCF positive over the next two years. The stock
has corrected 40% since our downgrade last quarter and is down 70% YoY, and
with valuations at FY13E P/E of 8.6x and EV/E of 6x, we believe that the downside
is limited. Hence, we upgrade the stock to REDUCE from SELL with a revised
target price of Rs148 (6x average FY13-14E EV/E), however, it is still not the time to
accumulate the stock. Higher-than-expected Smart Class additions and any stake
sale of assets are the key risks to our negative stance.
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FY13 – a year of consolidation – unlikely to regain investor’s confidence. We cut
our FY13E EBITDA by ~8% due to lower than expected margins in Smart Class and
PAT by 25% owing to likely higher interest costs. We now factor in revenue and
EBITDA CAGR of 20% and recurring PAT CAGR of 10% over FY12-14E.
Educomp unlikely to turn FCF positive over next two years: In spite of full
securitisation of Smart Class receivables in FY12, DSO days remained high at 252
days and the same is unlikely to reduce significantly in the medium term. While
absolute capex in K-12 schools is likely to come down, 43 new schools (21 greenfield
schools and 22 schools under asset-light JVs) are likely to be constructed and the
existing 69 schools would require upgradation and maintenance.
Pricing revives in Smart Class, but margins declined: Smart Class pricing went up
10% QoQ in Q4FY12 to Rs0.37mn per classroom after a 17% QoQ fall in the prior
quarter. Average classrooms per school also went up to 6.8 vs 5.3 in Q3FY12. In
spite of this, the EBIT margin declined 60bps QoQ to 39% owing to higher marketing
expenses. The company added a massive 17,815 classrooms in Q4FY12 and
~40,000 classrooms (guidance of 40,000-45,000) in FY12 vs ~27,000 classrooms in
FY11. The company securitised all its FY12 Smart Class receivables amounting to
Rs6.9bn under the reduced guarantee model and received Rs6.33bn till March 2012.
• New product launches to complement Smart Class product. Educomp has
planned for multiple product launches in FY13 including a tablet (with Educomp’s
content) and assessment product. Since these new products can be cross-sold to
the existing schools, the company has refrained from guiding for classroom
addition for FY13. The pricing is likely to be in the range of 0.34mn to 0.37mn per
classroom. We factor in ~50,000 classroom additions in FY13E.
• K-12 segment promising but has long gestation period: Currently, just 8% of
the schools are in the fourth year of operation and generating a healthy EBITDA
(~49%). Around 40% of the schools are in the first/zero year of operations, which
will take another three years to add meaningfully to EBITDA. The company has
moved towards asset-light model in K-12 segment, which led to a 40% drop in
capex in FY12 vs FY11.
Valuation methodology and key risks
We upgrade Educomp to REDUCE from Sell with a revised target price of Rs148
based on 6x EV/E of average FY13-14E. The key risks to our call are higher-thanexpected
classroom additions or better margins in SmartClass and any stake sale in
subsidiaries.
Valuation based on average of FY13-14E EV/E
Valuation
EV/E (x) 6.0
EBITDA (Rs mn) 6,114
EV (Rs mn) 36,685
Net Debt (Rs mn) 21,568
Market Cap (Rs mn) 15,118
Diluted Shares (mn) 102
Target Price (Rs) 148
Source: I-Sec research
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