Earnings from learnings

• South Africa
• AdvTech, Curro, Stadio
• August 26, 2020

I feel that I must apologise up-front for the annoyance of a company name in capital letters. For an education group, one might think that STADIO (see?) would know that only one capital letter is necessary.

Nevertheless, that’s their brand, so STADIO it is. Perhaps they want to shout the name from the rooftops and it’s hard to blame them with the trajectory they find themselves on.

At first blush, the results for the first semester of this year look awful. Headline Earnings collapsed into a net loss. As ever, one needs to look closer. STADIO’s share price closed 5.76% up today and there are good reasons why.

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Education is big business

The JSE boasts three important education groups in the form of Curro, Stadio and AdvTech. Curro and Stadio were both incubated in the PSG stable.

Curro is a primary and high school play. STADIO used to be part of the group as the tertiary education offering but was spun out to allow shareholders to take a pure-play view on tertiary education.

This is a great example of where an unbundling will make sense over the long-term, because I have no desire to own Curro shares but I find myself quite interested in STADIO.

Top-line growth: rare in this economy

Most companies are struggling to achieve positive revenue growth, but STADIO has 30,000 students and has set a target of 56,000 by 2026. That’s a growth rate of around 10% per year which will do wonders for revenue growth, as there will be inflationary increases in the fees as well.

This is a great example of splitting revenue growth into volume (student numbers) and price (inflation) growth. STADIO will enjoy both, although inflationary gains may be subdued as STADIO may elect to go after market share instead and price as competitively as possible.

What will the expense line do?

Likely revenue growth of 10% – 15% per year becomes incredibly juicy provided the cost structure doesn’t grow at a similar rate.

This is a question around operating margin. In the spirit of STADIO and teaching, I give a quick example of this below using simple numbers:

If revenue grows by 15% but operating expenses only grow 10%, then the growth in operating profit magically jumps to 27%. This is how JSE-listed companies can report earnings growth above 20% when revenue only beats inflation by a few percentage points.

Also note that operating margin, a key measure, increases by 300bps (3%) in the above example. This is known as margin expansion.

It all comes down to two things:

• Extent of fixed vs. variable costs in the company
• Cost management across the board

Companies with a higher proportion of fixed costs are said to have higher operating leverage. When times are good (like in this example), the fixed costs only grow by inflation even though revenue grows at a much higher rate. Variable costs, on the other hand, would grow along with revenue.

With high fixed costs, expense growth is often far lower than revenue growth. However, in tough times, these companies struggle to remain profitable if revenue collapses. Examples would be hospital groups and property companies.

STADIO’s ability to drive operating profit over the next 5 years will likely depend on the split between distance and on-campus learning. Distance learning can be scaled into a powerful source of profits because revenue growth can far exceed cost growth. On-campus learning, on the other hand, requires investment in property.

Distance learning has had a great semester

STADIO’s latest report gives great insight into the student base:

• 80% of students are distance learning
• Over the past 3 years, annual growth in student numbers have been similar in on-campus and distance learning
• But, in the past year, distance students grew 12% and on-campus only grew 3%

That bodes well for profitability going forward because I personally believe the trend is here to stay. People are terrified of being retrenched and have suddenly woken up to a need to invest in themselves to stay relevant.

Impressive acquisitions

STADIO is a highly acquisitive business. The group has bought a number of businesses like LISOF, Milpark Business School and AFDA. Following a similar model to Bidvest, STADIO has elected to move away from the individual brands towards a single STADIO brand.

This resulted in an unpleasant accounting outcome where an impairment of R60m was recognised for these trademarks that won’t be used going forward. I wouldn’t worry too much about that: it’s a non-cash accounting entry and isn’t at all a reflection of how the underlying businesses are performing.

Speaking of accounting entries, there’s a R74m adjustment that is worth touching on.

STADIO bought CA Connect, an institution that offers final year accounting courses to prepare students for their CA(SA) qualifying exams. As is often the case, the price for the acquisition of this business was based on an earn-out structure where the sellers make more money if the business does better than expected for a few years after the deal.

The business is performing so well that the purchase price is expected to be R74m higher, so STADIO has had to recognise this as an expense. It’s another long and complicated accounting issue.

If we look through all this noise, what does it actually mean? Well, two things:

• STADIO’s EBITDA (Earnings Before Interest, Taxes, Depreciation and Amortisation) was skewed by the R74m adjustment, so EBITDA grew 14% after adjusting for this once-off issue (vs. declining by 55% if you don’t make the adjustment)
• STADIO seems to buy great companies

This is all positive in my books.

Last but certainly not least: is there cash flow?

Cash profit, calculated in note 9 of the results by simply removing all the non-cash items from the net loss, grew from R108m in the comparable period to R124m in this period.

Yes, there is certainly cash sitting behind these earnings. Lots of it.

Earnings from learnings

STADIO is a small business with a market cap of just over R1.1bn. The group is still finding its feet and figuring things out, but it feels like one of the few opportunities on the JSE to buy into a company that has strong top-line growth prospects and a sensible business model.

The share price has come off hard since the unbundling and separate listing (over 60% down) but does look interesting at the moment. If management can manage costs and deliver the communicated student growth numbers, STADIO will pass with flying colours.