Buy Educomp Solutions Target 2400

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Buy Educomp Solutions Target 2400

  1. 1. FAIRWEALTH SECURITIES PVT. LTD. Educomp Solutions (EDSO.BO) January 22, 2009 India CMP: Rs.1715 Target: Rs.2750 Computers- Education Target price of Rs 2,750 based on 35x FY09E EPS — we are initiating coverage on Educomp with Buy. Share prices of Educomp have corrected by 40% from its one month high of 2775. A lot of this fall has been due to various market rumors regarding EDSO.BO Reuters allegations about company’s high debtor days, high working capital, profitability, EDSL IB Bloomberg company’s assets and promoters pledging their shares among others. 532696 BSE Code Company has given detailed clarifications on these allegations and same can be found on the company website. Priced on January 22, 2009 We consider that markets have oversold this stock and recommend buy at every dip. EDUCOMP.BO @ Rs 1715 Currently the share is trading at 22x FY09E EPS. From the operations point Educomp has continued to deliver strong earnings and Rs 4799/1,375 12M hi/lo exponential growth, 50% CAGR in both revenues and Net income, is estimated for next four years. Rs 2750 12M price target Industry Potential +80% ±% potential 22 Jan 09 Target set on India has emerged as one of the world’s largest consumer of education services with 17.3m a target population of more than 445 millions, with public and private spending on Shares in issue educational services in India aggregating approximately $100 billion per annum. 45.0% Free float (est.) Spending on Education in private sector has grown by CAGR of 10.4% since 1994, 1.4 Beta double the 5.11% CAGR on total spending. Government spending on education has reached 4% of GDP and is expected to rise further as India focuses on reducing its literacy rates. Market cap, INR Millions: 26532.7 Major shareholders Company description 55.0% Promoters Educomp Solutions Ltd, formerly Educomp Datamatics Limited, was incorporated in 35.6% FIIs 1994 and is based in New Delhi, India. It is India's largest market-listed educational service provider mainly focused on the K-12 space. Educomp group serves over 19,000 schools and 9.4 million learners and educators Sovid Gupta across the world. Company operates private schools across various cities and also Equity Analyst: Fairwealth Securities Pvt. ltd partners with various state governments. It has 27 offices worldwide. In addition, the Company operates through its various subsidiaries including authorGEN, Threebrix eServices, Learning.com, USA, AsknLearn Pte Ltd, Singapore and via its associates such as Savvica in Canada. Fairwealth Securities Page 1
  2. 2. Educomp Solutions - Buy The company has three primary business segments : Meanwhile, the use of smartclass has grown 1. Licensing of tools that help existing education system to from 90 private schools in 2006 to 1,200 now, Move to a higher standard of delivery. and Educomp expects it to touch 1,800 by 2. Direct Intervention – running schools, pre-schools and tutoring classes, online March delivery etc. 3. Post K-12 initiatives such as vocational and professional education. Educomp's main business is developing and licensing digital lessons, which are uploaded onto servers and provided to schools. It also trains teachers (75,000 in the last quarter), provides vocational training to students with courses such as accounting and marketing, and offers online and in-person tutoring. It runs eight K-12 schools. It has joined up in January with New Delhi real estate developer Ansal Properties & Infrastructure to start 25 private schools in new townships. It aims to start 150 schools over the next three years. Smartclass provides 49% of revenues for Educomp with 60% EBITDA margins Educomp's big money-maker is Smartclass, a range of interactive digital lessons with animation and graphics that's marketed mainly to private schools as they have deeper pockets than public schools. The multimedia lessons-- 16,000 so far--are based on the different curricula in place across the country and use 12 of the country's languages. Figure 1: Description Segment Segmental Revenues Product/ Service FY06 FY07 FY08 Smart Class 38% 44% 49% Smart- Highly animated Instructor-led content for schools Private Schools TM ICT Solutions 30% 28% 35% delivered inside the classroom as a quot;teachers aidquot; Class Professional Government Educational Infrastructure and digital content to Development 24% 17% 10% Schools ICT Solutions bridge the digital divide in government Schools Retail and Consulting 8.00% 11% 6% Private and Technology aided learning Pedagogy & Cognitive Professional Government K-12 0% 0% 0% learning workshops for teachers Development Schools Source: Company Reports Grades 6 to 12 eTutoring Online portal for students of Mathematics (NCERT Books) TM Mathguru Revenue share from Smart Class business has Retail online eTutoring on all curricular subjects US/ India / been continuously increasing and is likely to Learning Hour and test prep Middle East stay in between 47%-50% range. Roots to Neighborhood schools for Kindergarten-aged Kindergarten - TM children aged children Wings Millennium Brick and Mortar Kindergarten to Grade 12 Schools K-12 TM Schools Fairwealth Securities Page 2
  3. 3. Educomp Solutions - Buy Key Developments during 1HFY2009 Smart Class: This is the multimedia education business of Educomp catering to Private schools. Company charges upwards of 3000 Rs. Per student per month from each school. Company keeps infrastructure (multimedia content) on its books and Smart Class: Company has covered 27 cities transfers the content at the end of the contract. Company added 231 schools in Smart with total plan of 80 cities. EBIT margins for Class in 2Q09 taking cumulative number of schools to 334 in 1H09 versus 172 last year. Cumulative number of students under smart class has increased to 1.43 million. this business more than 50% Company doesn’t have any major competitors and we expect strong revenue growth of 80%+ for next three years and margins to stay above 55% for this business. This segment will continue to remain main driver of business for the Company. ICT Solutions: This is computer literacy initiative funded by Union/ State Governments. Company manages and installs labs in public schools and bills to government. Highlight of this business is long term contracts (5-year). However, it results to high debtor days of around 180 days. Margins for ICT improved to 35% from 27% Company added 1626 schools in 2Q09 at contract value of 110 crores taking earlier, however such margins are cumulative number of schools to 8900+. Margins for ICT have improved to 35% from 27% earlier. unsustainable in the long run, and are likely to settle around 20%. Number of states covered till now is 14. This business is likely to face major competition from several regional and national players forcing the margins down. This segment will remain a low growth segment for the business with revenues growing at more than 70% for period FY09-FY11 but margins are expected to decline further to around 20% post FY11. Higher revenue share of this business would hinder company in reducing its working capital requirements down to below 120 days. When company attains steady state (post FY15) this business will constitute less than 15% EBITDA share of the company. Professional Development: Company trained 81000+ teachers in 2Q09 which is less than 7% of its total 1.2 million teachers. Revenues for the segment for 2Q09 increased by 4.3% (YoY) while number of teachers trained increased 51% for the quarter (YoY). Margins for this business shall continue to remain high (abover65%). Revenue growth for this business will remain around 20-25%. Retail and Consulting: Company is putting a lot of stress on its retail business Educomp achieved growth rate of 700% on its growth by focusing on both organic and inorganic channels. Company’s online education portal Mathguru.com on paying education portal MathGuru has witnessed ~700% growth rate. Company is growing customers. its Preschool portfolio (Root to Wings) by expanding through franchisee. Company bought 50% stake in Euro kids taking preschool number under its umbrella to 500. This business will continue to see lot of inorganic growth as company explores new Margins for retail business improved from 41% ways to enter retail markets. to 71%. Company might find some difficulty in raising money under tight credit conditions. However, this business will help company by lowering its debtor days, providing brand value and goodwill to the company. Fairwealth Securities Page 3
  4. 4. Educomp Solutions - Buy K-12 Initiatives: Under this company will operate and manage entire schools and provide access to all its intellectual property. Total of 11 schools with 14000+ students have been established in 9 cities. Company targets 24 schools under K-12 initiatives this year. Company has already received financial closure for Rs 725 cr of debt Received financial closure for Rs 725cr of debt including - Non-Convertible Debentures (Rs 100cr), out of which 250 crore has for its K-12 business. already been utilized. Company has planned 140 million of capital expenditure per school and expects EBIT of Rs. 45 million (at 60% margins) per year per school. This segment will see around 100% growth rate over FY09-FY12 and margins will remain above 60%. In steady state (FY14) this business will constitute more than 15% of the revenues and with Debtor days for company have come down negative debtor days of the company. from 179 days to 145 days. Financials Good 2QFY09 results: %age share of revenue among various segments has changed significantly. Figure; Q2 FY08 Q2 FY09 Figure Source: Company Reports nd 2 quarter saw huge increase in contribution from SmartClass and Retail line of business, going forward SmartClass, will continue to remain main driver for growth for next three financial years. Fairwealth Securities Page 4
  5. 5. Educomp Solutions - Buy Figure : Ratios: Figure: EBIT Margins Profitability Ratios % Mar-08 Mar-07 Mar-06 48.2 48.12 50.58 Operating Profit Margin 35.87 39.31 40.44 Gross Profit Margin 25.51 25.54 25.89 Net Profit Margin Turnover Ratios 185.88 32.75 30.1 Inventory Turnover Ratio 2.29 2.16 2.08 Debtor Turnover Ratio Fixed Asset Turnover 1.27 1.67 2.76 Ratio Solvency Ratio 5.41 4.5 5.33 Current Ratio 1.28 1.09 0 .11 Debt Equity Ratio 21.69 25.81 37.13 Interest Covering Ratio Professional Development segment margins remain high and will continue to remain highest Valuation Ratio however revenue contribution from this 35 110 na P/E adjusted business will remain small. 18 24 31 P/BV Company closed 2Q FY09 with 60% margins Source: Company Reports, Fairwealth Research without considering forex losses. Analysis of Ratios: Company’s Debt Equity Ratio has increased significantly from 0.11 in 2006 to 1.27 in 2008. Company has already made financial closure of secured debt for capital expenditure requirement for K-12 business up to the year 2011. Company’ Interest coverage ratio remains comfortable as most of the debt of the company is in the form of FCCB maturing in 2012. Company had high inventory turnover ratio as company has built up inventory of installing computers for its SmartClass and ICT business. Future Outlook Future Outlook FY09E FY10E FY11E Year 5722 11100 16400 Revenues Company is poised to continue perform exceeding well with more than 70% revenue 148 60 60 Other Income growth for period FY09-FY11 and margins 2977 6125 9050 Oper. Expenses staying above 45%. 2745 5235 7510 EBITDA(Mn) 48% 47% 46% EBITDA(%) Net Profits are expected to rise 5 fold from Rs.700 million in 2008 to 3566 million in 718 1154 1614 Depreciation FY11giving a CAGR of 70%. 2027 4081 5896 EBIT 217 498 634 Finance Charges 1958 3644 5322 PBT Company’s P/E to growth ratio is highly 646 1202 1756 Tax discounted for FY10 and FY11, as company is expected to continue its growth trajectory of 1312 2441 3566 Net 30% for several more years. 77 140 205 EPS 22 12.25 8.4 P/E@1715 Source: Fairwealth Securities Analyst Estimates Fairwealth Securities Page 5
  6. 6. Educomp Solutions - Buy Figure : Revenue & EBIDTA mar. Estimates Growth Outlook Company is likely to post very high growth rate for a long time. Revenue figures are expected to show a CAGR of 70% for the period 2009-2011, 35% for the period 2011- 2014 and 20% for the period 2014-2016. We forecast strong 65% CAGR in Net Profits over FY09-FY11E and see limited risks to estimates given. EBITDA margins are likely to improve as revenue share of high margin retail and online business is likely to improve considerably. We expect ROE to double and settle Source: Fairwealth Securities Analyst Estimates in the range between 30-35%. Company has forward P/E of 7.5 for FY-2011 on constant prices while growth rate is Segmental Revenues expected to be upwards of 30% for year FY11-FY14. Company will continue to shine even in downturn as spending on Education and price levels are highly resilient to FY09E FY10E FY11E economic downturns. Smart Class 45% 48% 45% ICT Solutions 26% 29% 24% Another positive for this company is its short payback period on its investment as Professional significant business comes from long term contracts of 5 years. Development 7% 5% 6% Retail and Company understands its strengths and challenges ahead to deal with these Consulting 18% 12% 16% challenges. Company has recognized four areas of opportunities/ strengths as under: K-12 4% 6% 9% Source: Fairwealth Securities Analyst Estimates 1. Large market opportunity(scale) Revenues will start coming for K-12 business 2. Create barriers of entry for other players through strong IP and from 2009 and should contribute more than 10 product differentiation. percent in 3 years. All other segments might see dilution in share to adjust for K-12 3. High operating margins (50%+) business. 4. Experience and ability to execute On segmental basis ICT business will see margin dilution, while new business K-12 and Retail will deliver high margins and growth. Risks: Due to high margins and nature of business, company might face competition from new entrants. • Company is in high growth phase; PEG (P/E to Growth) ratio will be an important consideration for the stock. Any disappointment • on Earnings Growth numbers will see a downward price movement. Free cash flows to remain negative for a while; if credit market tightens or company fails to deliver on expectation, raising fresh • funds will be a problem. If government reduces spending on education, earnings and growth potential are likely to taper down. • Company faces huge execution risks in its Edu-Infra business. Also company has been very aggressive in its growth plans, both • Organic and Inorganic, and it would be very difficult to manage such growth plans under unforeseen circumstances (E.g.-Key Man Risk, Death of MD/Promoter) Fairwealth Securities Page 6
  7. 7. Educomp Solutions - Buy Appendix1: Previous year Financials Statements(Balance Sheet, Income Statement and Cash Flow Statement) Figure Balance sheet(All figures in millions) FY06 FY07 FY08 Shareholders’ funds Share capital 160 160 172 Reserves and surplus 736 988 2629 Figure3: One year stock price movement: Net worth 895 1148 2884 Minority interests 2 128 194 Loan funds Secured loans 109 183 622 Unsecured Loans 1071 3150 Deffered Tax Liab 0 60 210 1021 2590 7061 Total source of funds Fixed assets Gross block 375 949 2890 Net Block 185 723 2342 Capital work in progress 67 108 372 Total 252 831 2714 Price fall 21 102 36 Investments 30% 1m 1 138 282 Goodwill 10% 3m Current assets, loans and advances 60% 1y Inventories 17 33 18 Sundry Debtors 260 496 1157 Price fall in last one month has been due to Cash 609 1106 2912 various rumors in the markets, company has Loans and Advances 49 110 490 responded immediately by giving just 1761 4639 Total Current assets, loans and advances 935 explanations. Less current liabilities and provisions 187 242 610 748 1519 4029 Net current assets 1021 2590 7061 Total Applications Income Statement Company Debtor days are high, as both FY06 FY07 FY08 Rs million ICT and Smart class segment revenue 555 1065 2620 Sales collection starts post 90 days. It is around 14 59 150 Other Income 120 days for Smart Class and more than 569 1124 2770 Total 150 days for ICT. These will take time to 95 304 798 Cost of goods sold reduce as K-12 and retail business are 91 105 338 Personnel Expenses just beginning to pick up. Post FY15, we 100 155 238 Admin & Other Expenses expect debtor days to come to around 100 286 564 1374 Total Expenditure days from 150 days presently. 269 501 1246 EBITDA 57 93 322 Depreciation 212 408 924 EBIT 6 14 42 Finance Charges 220 453 1032 PBT 79 170 330 Total Taxes 141 283 702 Profit after tax and before prior period items 115.2 229 455 Balance bought from previous year 254 512 1157 Amount Available for App 220 455 1035 Balance Carried to Reserves 11 18 41 EPS Fairwealth Securities Page 7
  8. 8. Educomp Solutions - Buy Cash Flow Statement(All figures in millions) Key Cash Flow Statement Data FY06 FY07 FY08 Net Income (Reported) 141 284 711 Company has negative free cash flows Depreciation & Amortization 56 96 331 which are likely to turn positive by Change in Working Capital -60 (225) (730) Deferred Taxation Charge NA NA FY13. Other Adjustments, Net 0 10 193 Cash Flow from Operations 137 165 505 Purchase of Fixed Assets -162 (675) (2,224) Purchase of investments -50 -389 -16 Net Cash used in Investing activities -212 -719 -2102 Shares Issue / (Repurchase) 557 0 0 Proceeds/ repayment of long term borrowing 53 71 334 FCCB Raised 1094 3109 Temporary Overdraft facility against fixed deposits 75 3 106 Net cash from financing activities 615 1088 3393 Source: Company reports Why Buy: Valuations at 22x FY09E, 12.25x FY2010E and 8.5x FY2011E, on the lower side look cheap. More over company is expected to post CAGR of 50%+ in revenues for next four years. EBITDA margins for 2QFY09 excluding extraordinary forex losses were around 60%. Earnings have been forecasted keeping EBITDA on the lower side at 45-50%.Higher EBITDA will lead to further revision in Earnings Estimate. Continue recessionary conditions will make this stock more attractive relatively as Education segment remains recession proof. Downside Risks: 1. Short Term Market sentiments (High beta of 1.4) 2. Lower Earnings than market expectations 3. Execution/Regulatory/Key Man Risks 4. Tight credit conditions will pose difficulty for company to raise more cash at cheaper interest rates. Disclaimer: This publication has been prepared solely for information purpose and does not constitute a solicitation to any person to buy or sell a security. While the information contained therein has been obtained from sources believed to be reliable, investors are advised to satisfy themselves before making any investments. Fairwealth Sec Pvt Ltd., does not bear any responsibility for the authentication of the information contained in the reports and consequently, is not liable for any decisions taken based on the same. Further, Fairwealth Research Reports only provide information updates and analysis. All opinion for buying and selling are available to investors when they are registered clients of Fairwealth Investment Advisory Services. As a matter of practice, Fairwealth refrains from publishing any individual names with its reports. As per SEBI requirements it is stated that, Fairwealth Sec Pvt Ltd., and/or individuals thereof may have positions in securities referred herein and may make purchases or sale Thereof while this report is in circulation. Fairwealth Securities Page 8

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