The Investor - Moneyweb's monthly investment magazine Issue 6 | Page 20

schools division. After years of an overly conservative approach, its management seems to have realised that it needs to step up. It made a bold statement of intent with an initial R1.7bn capital outlay. Over and above that the group is now parading a R3bn war chest. About R1.5bn of this five-year investment plan has already been authorised for expenditure by the board. This investment programme will not only help Advtech catch up with its closest rival, Curro, but will also result in a quantum leap in its scale as well as in earnings. The first phase of the investment plan has already bolstered the group’s capacity by 75% to 35,000 students. The second phase is projected to add capacity for 24,000 students in the schools division, bringing the total capacity close to 60,000 students. While this falls short of Curro’s target of 90 000 students, we find Advtech’s story more attractive and sustainable. About two thirds of the planned additional capacity in the schools division is going to come from expansion of existing campuses. This reduces the risk of overpaying for acquisitions of new schools while ensuring management retains reasonable control of the expansion programme. What the market also seems to be overlooking is the “baked in” growth potential that Advtech offers. Through organic investments made over the past few years the group is now sitting on 31% (about 11 000 students) unutilised capacity at its schools. Margins are bound to expand significantly when the group start reaping the benefits of scale as pupils fill up this expanded capacity. Early indications are that this will 20 ISSUE 6 – SEPTEMBER 2015 be achieved because schools are already reaching capacity in the lower grades. The benefits are already materialising with the recently released results showing that all of the 29% growth in earnings was organic. The schools division also has the support of the tertiary division, whose profits are also on the rise. Operating profit almost grew 51% and the operating margin has also expanded nicely. Management attributes the growth to the restructuring exercise and strong growth in enrolment. RISKS Despite the attractiveness of Advtech‘s growth ambition, it is not without pitfalls. Implementing a strategy of this magnitude will require the allocation of significant funds. With the group’s shares looking undervalued it is more likely that management will opt for debt financing rather than share issues. If it goes that route it will put more pressure on its balance sheet, which is already highly geared with a debt to equity ratio of 132%. Interest charges will also rise, which will offset the earnings contribution from the new investments. If the group raises funds through share issues it will have dilutive effects. So whichever financing option it takes, there will be pressure on earnings. Largely because of that we expect short- to mediumterm earnings growth to be organically driven. Overall, we think the group’s growth targets are achievable. It is a profitable, mature business with excellent cash-generating abilities. We strongly believe the market is underestimating its future earnings growth potential and as such it might be highly rewarding to buy its shares. Bull factors Established brands backed by the perception of a quality education offering give significant pricing power in the private education arena. Strong cash-generative business model to support investment p