Net profits came in below consensus on account of a fall in margins; revenues came in line at Rs 2.3 b. The management attributed Ebitda (earnings before interest, taxes, depreciation and amortisation) decline to: (a) timing mismatch between revenues and costs; (b) more sales people; and (c) increased losses in some subs. Net profit, at Rs 365 m, was up 7% YoY (year-on-year)?aided by lower tax rate (10% against 37% for FY10). While the stock has corrected 13% YTD (year-to-date), we still remain concerned about margin pressures and high expectations. We lower our target price to Rs 565 based on 15x Sep 2011 EPS (earnings per share) in line with market multiples with slowing growth and deterioration in balance sheet.
SmartClass continues to do well with good growth in Tier-II and III cities. We expect Educomp to add 30k/41k classrooms in FY11/12E. Revenue per school was Rs 3.1 m in Q1; we model Rs 2.8 m in FY11/12E. Revenue per school assumptions have been meaningfully reset over the last few quarters and look more reasonable now.
Other businesses (ex-ICT) still in the early stage: ICT contribution is coming down; we expect it to contribute 9% in FY12. New businesses are in the investment phase?K12 have become profitable. K12 is going to be an important segment in two-three years? timeframe?in FY12, we expect 12% of revenues to come from this segment.
Revising estimates: We raise our FY11 estimates by 30% (due to recognition of Rs 2.9 b, deferred content revenue) and lower tax rates. We lower FY12E EPS by 16%, mainly on the lower-than-earlier-expected revenue/school and lower K-12 assumptions. We are 18% below the Street on FY12 EPS?we believe consensus is high?a large part of FY11 profits are non-recurring.
Valuations are not compelling enough, given high expectations, moderating growth and balancesheet deterioration. Upside risks are: (a) better growth/profitability in SmartClass, and (b) improvement in balancesheet quality in the coming quarters.
Q1 results, key highlights: Educomp?s consolidated topline at Rs 2.3 b (+18% YoY) was in line with consensus expectations. However, Ebitda margins fell 1,200 bps YoY to 30.4%. Ebitda fell 16% YoY in absolute terms. The management attributed this to: (a) rise in COGS due to timing mismatch between revenues and costs; (b) the rise in salary costs due to 160 new sales and marketing personnel; and (c) increased losses in some subs. Net profit, at Rs 365 m, was up 7% YoY, aided by lower tax rate (10% against 37% for FY10).
Debtor days, net of fixed assets, which were converted into debtors due to transfer of schools, were at 183 at the end of Q1. Net debt went up to Rs 5.5 b as against Rs 2.7 b at the end of the prior quarter. K-12 business had a good quarter?37% YoY rise in revenues. ICT revenues declined 43% YoY to Rs 205 m; Ebit margins of 21.4%.
We rate Educomp Sell/Medium Risk (3M) as we believe earnings growth will be challenged in FY12 despite valuations becoming reasonable. We forecast a strong topline CAGR (compound annual growth rate) of 24% and 16% EPS CAGR over FY10-12E as the company penetrates beyond Tier-I and II cities. We are concerned about the company?s high capex needs in organic business and expansion plans in the capital intensive K-12 business.
Valuation: We value Educomp at Rs 565 based on 15x Sep 2011E EPS. Due to a change in the business model of SmartClass, we think that the historical price-to-earnings are no longer relevant in valuing Educomp and use the 15x Sep 2011 estimates, which are in line to the current Sensex Sep 2011 trading multiples. Due to the favourable education dynamics in India and the fact that Educomp remains the only large liquid option to play it, we think this is justified.