Overseas Education - UOB Kay Hian 2016-01-14: Valuation Does Not Justify Weak Earnings Outlook.

OVERSEAS EDUCATION LIMITED RQ1.SI

Overseas Education (OEL SP) - Valuation Does Not Justify Weak Earnings Outlook. Downgrade To HOLD

We had highlighted OEL’s challenges previously as a softer economy coupled with the restructuring of MNCs will cause international student enrolments to decline.
As the school has to operate regardless of enrolment numbers, we see depressed earnings in 2015 and 2016.
We lower our target price by 41% to S$0.52, to account for the reduction in earnings forecasts for 2015/16 and downgrade our recommendation to HOLD.

We cut our 2015-16 net profit forecasts, taking into account the structural challenges.
Overseas Education (OEL) will report its full-year financials in mid-Feb 16.
With the downbeat earnings for 3Q15, which is its first quarter operating in the Pasir Ris Campus, we expect the depressed profits to continue into 2016.

The World Bank had slashed growth forecast of the global economy for 2016 by 0.4% to 2.9%, citing weaknesses in major emerging markets such as China, Brazil and Russia. As a result, we have also seen many MNCs announcing major job cuts across the globe from Barclays, Standard Chartered, HSBC Holdings, Yahoo! Inc to Microsoft Corp, just to name a few.

The expatriates’ employment environment in Singapore has also changed over the last few years as they are no longer offered on a generous expatriate package but are now on a comparable local package instead. This had deterred many expatriates from relocating their family to Singapore, in our view.

Fixed operating costs of the new campus have risen due to higher finance costs and depreciation and amortisation, as previously expected. However, with the shrinking international student pool, OEL has seen a drop in total revenue from reduced enrolment numbers despite increasing their school fees. Accordingly, we saw the school reporting a 66.9% yoy slump in 3Q15 earnings from S$5.3m to S$1.8m.
The challenging environment is unlikely to change in the medium term and thus we believe that the weak earnings will persist into 2H16

As the school’s operating cash flow will be affected, investors may now be concerned about the S$150m bullet bond redemption in 2019. The company currently has no bank borrowings on its balance sheet, with its operating new school worth approximately S$250m, bank financing should not be an issue. Upon the repayment, OEL will be generating free cash flow at a rate of more than S$25m every year for the next 24 years’ lease of the school, as compared with its current market capitalisation of S$208m.
To recall, the school collects school fees upfront for the term (6 months ahead) before disbursing the expenses on a monthly basis and these fees are only refundable on a case-by-case basis.

We have trimmed our earnings in the previous report citing lower enrolment and higher utilities.
As we have seen the operating environment deteriorating further, we reduce our estimate and expect OEL to generate a net profit of S$14.5m in 2015 and S$8.9m in 2016, a further reduction of 30% and 58% respectively.

Downgrade to HOLD with a lower target price of S$0.52, based on a two-stage DCF valuation (cost of equity: 9%, terminal growth: 1%), which implies 24.4x 2016F PE.
This is mainly a result of the reduction in the student enrolment numbers for school term starting Aug 15 and 16. Entry price is S$0.45.

Brandon Ng CFA UOB Kay Hian | http://research.uobkayhian.com/ 2016-01-14

UOB Kay Hian SGX Stock Analyst Report HOLD Downgrade BUY 0.52 Down 0.89