Curro Holdings. A company that once promised so much (with an obscene valuation multiple to match) now finds itself in a loss-making position.
You read that correctly – net of impairments (write-downs of school property values), Curro is going to report a loss for the 12 months to December 2020.
Right idea, wrong time
Curro’s investment thesis was to position itself slightly above government schools. This is a mid-LSM consumer approach where Curro hoped to bring private school quality to the masses. A noble cause indeed and it looked good on paper, until the South African consumer slowly crumbled under the pressure of low economic growth.
With nearly 60,000 pupils in the group at the end of June 2020, Curro is so big that it is highly susceptible to macroeconomic challenges faced by middle class consumers.
Lockdown simply accelerated a trend that was already there. Mass job losses have hit the Curro customer base the hardest. People who are trying to pay off houses and cars, while supporting their elderly parents and juggling credit cards, simply couldn’t afford to lose their jobs.
On average, Curro had 4.1% fewer learners in the second half of the year than the first half. Where did all these kids go? The most likely answer is that their parents lost their income and had to find cheaper schools.
The ones who did everything possible to keep their kids at Curro now find themselves as part of Curro’s debtors’ book. The company has confirmed an increase in outstanding school fees and a deterioration in debtors aging. Quite simply, many of the parents can’t afford to have their kids there.
Financial results in detention
There really aren’t any positives here. After Curro’s management told the market in early lockdown that everything would be ok, they ended up doing a rights offer in September 2020 to raise money.
At the time, Curro said that the cash would be used for opportunistic acquisitions and paying down debt.
In January, Curro bought St George’s Preparatory School, a private school in the bustling metropolis of Port Elizabeth. That’s very cute and all, but at best it is a distraction from the real issue: money was raised so that the company could repay R1.1bn in debt.
The impact of lockdown on the existing school portfolio is where investors should be focusing. When a school is built or acquired, the value is recognised as an asset because it will generate future cash flows. When something goes wrong and the prospects for those cash flows aren’t as promising as was initially hoped, the company may need to recognise a write-down in the value of the assets (in this case the schools).
This is known as an impairment. Curro has recognised R202m in impairment losses based on a decrease in the value of its schools. It’s painful, but Curro is a R6.5bn company, so we’ve certainly seen bigger horror stories in the past year (like Sasol).
Final report: Headline Earnings Per Share
Headline Earnings Per Share (HEPS) is a measure of profitability that tries to strip out once-offs and non-recurring issues. In a school context, it would be your final mark assuming the teacher gave you the benefit of the doubt for the time the dog ate your homework.
Earnings Per Share (EPS) is tougher, with no allowance made for badly behaved pets.
HEPS will only drop between 18% and 30% vs. the prior year because the R202m impairment is ignored in this number. EPS on the other hand takes Curro into an overall loss-making position, expected to drop between 110% and nearly 119%.
Based on forecast HEPS of between 34c and 39c, the closing share price today of R10.32 suggests that the company trades on an earnings multiple of over 26x. This feels very expensive for a business that relies on South African consumer health and limited disruption from online learning.
That last point is critical
I’ve written previously about education megatrends. In short, I believe that traditional schools face significant risk of disintermediation. Technology can connect teachers directly with students, which changes the role of a school considerably.
Instead of just offering classrooms and sports fields, along with secret smoking areas, high schools in particular will need to offer flexible and interactive learning areas. They could become more like a shared workspace environment rather than an old-fashioned classroom environment.
I’m afraid that a demanding valuation of 26 years’ worth of earnings in a traditional school business just doesn’t appeal to me. Over 5 years, the Curro share price is down over 75%, which shows how wide the gap has become between the dream and its execution.
This business model is a dinosaur. You won’t find Curro in my portfolio. If you want to see a good example of the future of schools, check out Rallim Preparatory School in Cape Town.