Slowing Childcare Demand Will Test Profitability Yet Inspire Efficiency

Key Takeaways

• Government support and operational improvements are offset by declining birth rates and families opting for informal care, which may restrict long-term revenue growth.
  
• Persistent sector-wide staffing challenges, regulatory pressures, and alternative care models threaten to compress margins and limit future scalability.
  
• Falling occupancy, ongoing affordability pressures, rising sector supply, reliance on divestments, and potential labor cost hikes threaten revenue growth, margins, and long-term competitiveness.

Catalysts

Provides early childhood education and care services in Australia.

• While recent government initiatives, such as increased funding, the removal of the activity test, and higher subsidies, are expected to bolster demand for childcare services and improve revenue growth for G8 Education, demographic headwinds such as slowing population growth and declining birth rates in Australia may restrict the pool of new enrollments, limiting the company's ability to deliver sustained top-line growth in the long term.
  
• Although rising female workforce participation and ongoing industry recognition of the importance of early childhood education provide structural tailwinds for occupancy and pricing, increasing cost-of-living pressures and stagnant wage growth are driving more families toward informal care or reducing paid childcare usage, which could cap occupancy rates and present downside risks to future revenues.
  
• Even as the company has successfully driven operational efficiencies and improved team retention-translating to lower agency costs and expanding margins-challenges in attracting and retaining qualified educators, especially amid sector-wide wage inflation, may put persistent upward pressure on operating expenses and compress net margins over time.
  
• While G8 has benefited from enhanced regulatory support and a strengthened capital position, the sector faces the risk that growing adoption of flexible work arrangements and automation may permanently lower the need for center-based childcare services, shrinking the addressable market and potentially stalling long-term earnings growth.
  
• Despite recent network optimization and improved center performance, the group's exposure to greater regulatory scrutiny, rising compliance costs, and the entry of alternative childcare models may continue to weigh on profitability and limit the scalability of future earnings.

G8 Education Future Earnings and Revenue Growth

Assumptions

• This narrative explores a more pessimistic perspective on G8 Education compared to the consensus, based on a Fair Value that aligns with the bearish cohort of analysts.
• The bearish analysts are assuming G8 Education's revenue will grow by 2.8% annually over the next 3 years.
• The bearish analysts assume that profit margins will increase from 6.7% today to 8.4% in 3 years time.
• The bearish analysts expect earnings to reach A$92.6 million (and earnings per share of A$0.12) by about July 2028, up from A$67.7 million today. The analysts are largely in agreement about this estimate.
• In order for the above numbers to justify the price target of the more bearish analyst cohort, the company would need to trade at a PE ratio of 11.6x on those 2028 earnings, up from 10.4x today. This future PE is lower than the current PE for the AU Consumer Services industry at 15.8x.
• Analysts expect the number of shares outstanding to decline by 1.67% per year for the next 3 years.
• To value all of this in today's terms, we will use a discount rate of 8.38%, as per the Simply Wall St company report.

G8 Education Future Earnings Per Share Growth

Risks

• Slowing occupancy and a weaker start to 2025, with spot occupancy 3.5 percentage points below the prior comparative period and year-to-date 1.9 percentage points lower, suggest potential for revenue and earnings softness if these trends persist and fail to rebound as anticipated.
  
• Cost of living pressures and affordability issues continue to impact family decisions, heightening the risk that rising inflation or stagnant wage growth will lead more families to opt out of paid childcare, directly impacting future revenues.
  
• Ongoing supply growth in the sector, especially with recently reaccelerated supply in certain regions, increases the risk of oversupply, which could pressure occupancy rates and erode G8 Education's ability to maintain revenue growth and stable margins.
  
• Persistent operational reliance on portfolio optimization, including divestment of underperforming centers, may reflect a need to address structural challenges in the portfolio; continual divestitures could limit long-term top-line growth and indicate underlying occupancy or profitability weaknesses relative to competitors.
  
• Future labor cost risks remain, as while recent government-funded wage increases are covered, further increases through the Fair Work Commission or sector-wide labor shortages could drive staff costs higher, squeezing net margins and challenging long-term earnings expansion.

Valuation

• The assumed bearish price target for G8 Education is A$1.15, which represents the lowest price target estimate amongst analysts. This valuation is based on what can be assumed as the expectations of G8 Education's future earnings growth, profit margins and other risk factors from analysts on the more bearish end of the spectrum.
• However, there is a degree of disagreement amongst analysts, with the most bullish reporting a price target of A$1.7, and the most bearish reporting a price target of just A$1.15.
• In order for you to agree with the bearish analysts, you'd need to believe that by 2028, revenues will be A$1.1 billion, earnings will come to A$92.6 million, and it would be trading on a PE ratio of 11.6x, assuming you use a discount rate of 8.4%.
• Given the current share price of A$0.91, the bearish analyst price target of A$1.15 is 20.4% higher.
• We always encourage you to reach your own conclusions though. So sense check these analyst numbers against your own assumptions and expectations based on your understanding of the business and what you believe is probable.