If Labor wins the federal election, pencilled in for around May 18, the childcare sector may become a lot more interesting for investors than it was last year.

Federal Labor is proposing to guarantee 15 hours a week of free childcare at state kindergartens for three and four year olds, and subsidised at private centres.

And pressure is mounting from a coalition of 27 early childhood research, profit and not-for-profit, and parenting organisations on both parties to relax the activity test in the childcare subsidy.

Royal Bank of Canada (RBC) analyst Garry Sherrif says about 80 per cent of families are better off under changes made to the childcare subsidy last year, and the extra from Labor should be “incrementally positive” for listed companies. A balancing out of a childcare centre glut in 2019 as well will help to lift occupancy levels.

Directly affected are the ASX’s two childcare operators, $1.4b behemoth G8 Education (ASX:GEM) and $82m minnow Think Childcare (ASX:TNK).

Mr Sherriff expects G8’s earnings in calendar 2020 to moderate by 8 per cent, but occupancy is trending upwards.

Ronan Barrett at Moelis is picking Think over G8, saying in a research note at the start of March that it’s cheap in comparison with more room to grow organically.

Run, and don’t look back

Childcare has been seen as a sector in which companies can print money: privately operated yet with some government funding which doesn’t come with as many strings attached as, say, the aged care sector, and which is heavily in demand.

But last year the sector was hit by what Think CEO Mathew Edwards called a “perfect storm”.

At the start of 2018 parents were pulling children out of childcare as they hit government caps under the old subsidy system. At the same time the last of the ‘baby bonus’ children began filtering out of the pre-school sector.

Mr Edwards says that in NSW 101,000 children went off to school, and were replaced by about 91,000 kids who’d been born after the birth-rate-hiking baby bonus was cancelled in 2014.

The bigger operators like G8 stopped buying centres “en masse” which led to banks pulling back from lending to developments.

Finally, Chinese investors were behind a number of deals, such as the $18.75m raised by Moelis to buy centres from G8 in 2016. But in 2017 it became more difficult to get money out of China and that source of funding dried up.

MHOR Asset management founder James Spenceley told Stockhead in November last year investors had to get their timing right when investing in childcare, as he eyed G8.

According to RBC, that sentiment appears to be panning out for this year as the policy winds begin to blow favourably and the market begins to tighten slightly.

This year is different

Promises of more government cash, the impact of the childcare subsidy changes, and a balancing out of the number of new centres coming into the market is making 2019 look a whole lot calmer.

Mr Edwards says the new childcare subsidy is starting to positively hit their bottom line and creating extra demand.

The government’s subsidy changes that came in during July 2018 dropped the cap on payments and introduced a means test and a work activity test.

Mr Edwards says in the past people would start pulling their kids out as they hit the government’s cap on rebates and revenue noticeably dropped off in the second half of the financial year. From January this year, that hasn’t happened.

 

Furthermore, the supply of new childcare centres into the market, which had created a glut in suburbs like Brunswick in western Melbourne and Rosebury in eastern Sydney, has moderated.

Charter Hall, which owns the once-listed childcare centre investor Folkestone Education Trust, said data for calendar 2018 shows the “supply of new centres exceeded child demand growth for most of 2018 by an estimated 75 centres or 1 per cent. The growth in new centres reduced in the last few months [to December].”

“Supply is expected to moderate in 2019 and beyond with higher barriers to entry becoming increasingly more difficult: bank lending criteria has tightened further; councils approval processes are becoming more challenging; operators continue to remain cautious in regards to location and centre selection and have decreased funding capacity.”

Anecdotally they’re hearing that in the first few months of the year, a period when children were pulled from centres, long day care enrolments are up 2-3 per cent.

And if there is a recession this year, as a number of bears are forecasting?

The childcare sector may be able to tough it out.

“When times are tough there’s probably a greater need for childcare, and you’re probably compromising the income you’re prepared to earn in order to put children through childcare,” Mr Edwards says.

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