Overseas Education Limited (OEL) - UOB Kay Hian 2019-04-22: An Education Gem Backed By A Sustainable 8.2% Yield

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OVERSEAS EDUCATION LIMITED (SGX:RQ1)

Overseas Education Limited (OEL) - An Education Gem Backed By A Sustainable 8.2% Yield

• OVERSEAS EDUCATION LIMITED (SGX:RQ1) has done a good job in managing costs, maintaining dividends and paring down debts to cope with declining student numbers after its campus relocation in 3Q15.
• We expect 2019 to be the third consecutive year of recovery with net profit growth of 11.2% y-o-y, as the rate of decline in student numbers continues to narrow while significant cost savings from loan refinancing kick in.
• Initiate coverage with BUY and EV/EBITDA-based target price of S$0.46. Valuation is attractive at a current 8.3x 2019F EV/EBITDA and a sustainable 8.2% dividend yield.

Company Background

Reputable name with over 25 years of operations.

• OVERSEAS EDUCATION LIMITED (OEL, SGX:RQ1) is the holding company of wholly-owned subsidiaries Overseas Family School Limited (OFSL) which operates OFS and Overseas Family School (Hong Kong) with the main operating subsidiary being OFSL.
• OFSL was founded by Executive Chairman and CEO David Perry and Executive Director Irene Wong, starting with 12 classrooms and an enrolment of 130 students in 1991. The school is now a leading private multi-national FSS in Singapore supported by 400 staff from over 30 countries and has about 2,500 students of over 70 nationalities.
• OVERSEAS EDUCATION LIMITED (OEL) was listed in 2013 to raise funds for the new campus in Pasir Ris to overcome capacity constraints at its old campus and due to lease expiration of its rented building. The new campus, which has a land area of 110,000sqm, is fully equipped with facilities such as a swimming pool, basketball courts, a running track and a multi-purpose studio.
• To date, OEL is the only SGX-listed international school.

Industry Overview

• Due to the regulations of the Singapore government, local students are restricted from attending international schools except with the approval of the Ministry of Education under special circumstances. Therefore, the international school industry in Singapore relies heavily on enrolment from expatriate families. According to International School Consultancy Research (ISC Research), Singapore’s international school enrolment grew at a CAGR of 11% from 2012 up to early-18 while international school capacity rocketed with a 32% jump in the number of international schools over 2012-16 as demand increased. Currently, there are over a hundred international schools in Singapore.
• In recent years, the Singapore government has tightened foreign hiring rules and has increased the minimum salary required to qualify for the Employment Pass (EP) multiple times. This led to a decline in the number of EP holders in 2018 (1.0% y-o-y) and 2017 (2.4% y-o-y). With that said, we believe skilled foreign professionals who hold the P1 Employment Pass (qualifying salary of S$8,000/month) are less impacted as the restrictions target lower-pay Q1 EP holders who may be shifted to the S pass. The number of Permanent Residents (PR) in Singapore dipped by 0.8% in 2018. However, it has been stable in the past couple of years. As Singapore citizens are typically prioritised in local school placements during the balloting process, PRs and foreigners who are unable to register in local schools would most likely turn to international schools.
• In addition, the Singapore population has remained largely stagnant with an annual growth rate of 0.5-1.3% in the past five years. As of Jun 18, the Singapore population stood at 5.64m with a higher median age of 40.8 (2017: 40.5) and a 13.7% increase in resident population aged 65+ (2017: 13%).
• Given an ageing population and low fertility rate (2017: 1.16, 2016: 1.20), foreign talent is required to sustain the Singapore population and mitigate the effects of an ageing profile. This includes highly-paid, quality skilled workers who are able to enrol their children in international schools.

OFS tuition fees slightly lower than market median rate.

• Apart from the high school fees which are 2% higher than peers’, tuition fees charged by OFS are slightly lower than the median market rate (kindergarten: 4%, elementary: 2%, middle school: 9%) while the S$2,000 one-off fees charged to new students by OFS are significantly lower than the median market rate of S$5,245.
• In addition, some of the other international schools charge additional fees for language classes whereas OFS provides mother tongue lessons at no extra cost. Therefore, OFS provides a wider curriculum at slightly lower fees than the market median rate.

Investment Highlights

Excellent track record in coping with challenging times.

• OVERSEAS EDUCATION LIMITED (OEL) has taken a proactive approach to managing cost after its campus relocation. In the face of declining student numbers due to the new campus’ poorer accessibility, OEL has carried out right-sizing measures to boost profitability. EBIT margin improved from 17.1% in 2016 to 19.8% in 2018, underpinned by a reduction in personnel cost from S$56.0m in 2016 to S$47.4m in 2018.
• The short-term employment contract of two years and ample supply of teachers give OEL the flexibility to make adjustments based on changes in student numbers. OEL typically has a 10:1 student teacher ratio. We expect further reduction in operating costs, in line with declining tuition fee revenue.
• In order to facilitate the redemption of the balance of S$117.5m bonds due in Apr 19, OEL entered into a facility agreement for a term loan facility of up to S$120m for a tenure of 120 months. We estimate finance cost savings at S$1.8m in 2019 from the refinancing of its borrowings which will flow through to the bottom line.
• In our estimates of borrowings and finance costs, we assume:
  1. 4% interest rate p.a., and
  2. 50% of the term loan will be refinanced at the end of the 120-month period.

11.2% net profit growth in 2019 from major cost savings and narrowing rate of decline in student numbers.

• In terms of student enrolment, we see shreds of positive development as the decline has been narrowing. Moreover, Overseas Family School (OFS) is able to accommodate many new students within their 100,000-sqm campus with a capacity for 4,800 students, which is well over the present student count of about 2,500.
• We expect net profit growth to be driven by the narrowing decline in revenue, as well as the reduction in operating costs which has outpaced the drop in revenue growth over the past two years. We expect this trend to continue with cost savings of about S$3.3m in 2019.

Expect improvement over time from paring down of debt and better brand name.

• OEL has pared down debt over the past three years through a series of bond repurchases. At the end of Jan 19, OEL entered into a facility agreement for a term loan facility of up to S$120m, which has been utilised to fully redeem the balance of S$117.5m bonds.
• Moving forward, with the refinanced loan, net debt will continue to fall over time, improving balance sheet strength. We also do not see any significant increase in capital expenditure in the near term as no major renovation will be required for the new campus. Annual capital expenditure levels are at S$1m-2m.
• In addition, OEL has consistently made annual dividend payment of 2.75 S cents per share since 2013 with a dividend payout ratio of more than 100% since 2015 despite the fall in net profit after the campus relocation. This is backed by a stable operating cash flow in recent years with an improvement from S$18.1m in 2016 to S$25.1m in 2018.
• We expect cash flow to remain at around this level, sustaining a DPS of 2.75 S cents. This translates to an attractive dividend yield of 8.2% for 2019.
• See attached 22 pages PDF report for complete analysis on OVERSEAS EDUCATION LIMITED (OEL, SGX:RQ1)

Financials

Strong turnaround in net profit driven by cost savings and narrowing decline in revenue.

• We expect core net profit to grow 11.2%/6.4%/5.7% for 2019/20/21. This will largely be driven by the narrowing decline in revenue as OVERSEAS EDUCATION LIMITED (OEL) starts to establish its brand name at its new campus and student enrolment numbers stabilise. The revenue decline narrowed from 5.4% in 2016 to 4.5% in 2018 and can be expected to narrow to 3.1% in 2019.
• On the other hand, we expect cost savings of around S$3.3m from the refinancing of borrowings and further reduction of operating costs.

Paring down of debt.

• OEL reduced its borrowings from S$150.0m in 2015 to S$117.5m in 2018. In order to facilitate the redemption of the balance of S$117.5m bonds due in Apr 19, OEL entered into a facility agreement for a term loan facility of up to S$120m. Net debt level declined from S$89.1m in 2016 to S$76.1m in 2018. With the refinance loan, net debt level will continue to fall.
• In our estimates of borrowings and finance costs, we assume:
  1. 4% interest rate p.a., and
  2. 50% of the term loan will be refinanced at the end of the 120-month period.

Improving operating cash flow levels back 8.2% dividend yield.

• Operating cash flow improved from S$18.1m in 2016 to S$25.1m 2018. Going forward, OEL’s strong cash position should be sufficient to continue funding a DPS of 2.75 S cents. This translates to an attractive dividend yield of 8.2%.

Valuation

We initiate coverage with a BUY recommendation and target price of S$0.46.

• We initiate coverage on OVERSEAS EDUCATION LIMITED (OEL) with a BUY recommendation and target price of S$0.46, implying a 37.3% upside from the current Overseas Education Limited share price.
• We derive our target price based on 10.4x EV/EBITDA, a discount of 15.4% to global peers’ 2019 average. OEL offers an attractive dividend yield of 8.2% for 2018 and we expect it to remain at this level.
• Since 2013, OEL has consistently paid a DPS of 2.75 S cents, even in challenging times. This translates to a dividend payout ratio of over 100% since 2015. We believe the high dividend yield will be supported by a narrowing decline in revenue as student enrolment stabilises, continued cost savings and lower finance cost from the refinancing of borrowings.
• Our target price of S$0.46 implies a 2019F ex-cash PE of 19.3x and dividend yield of 6%.
• We have also modelled a discounting cash flow method based on projections over a span of 25 years, up to the expiry of the school lease in 2043. The share value derived based on this method is S$0.52, 12.3% higher than our target price.

John Cheong UOB Kay Hian Research | Joohijit Kaur UOB Kay Hian | https://research.uobkayhian.com/ 2019-04-22

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