This report was prepared by Maheswar Reddy, as part of the Safal Niveshak Value Investing Contest. None of the facts herein have been validated by Safal Niveshak. Also, please DO NOT treat this report as a “recommendation” from either the author or Safal Niveshak. Do your own homework.
Tree House Education & Accessories Ltd. (Tree House) is the largest self-operated preschool education provider in India. After establishing itself as one of the top brands in pre-school education, Tree House has also entered the K-12 school segment.
Rapid growth – From one center in 2003 to more than 400 in 2014:
- 2003 – Incorporated first Tree House pre-school in Mumbai
- 2006 – Established 6 more pre-schools
- 2007 – Converted to private limited company and launched first franchise
- 2008 – INR 35 crores investment from Matrix Partners India
- 2009 – Entered K-12 and day care segments
- 2010 – INR 15 crores investment from Matrix Partners India
- 2011 – Converted to public limited company; Successfully completed IPO of INR 112 crores; INR 9 crores investment from Matrix Partners; INR 31crores investment from FC VI India Venture
- 2012 – Acquired pre-school business “Global Champs”; INR 41 crores investment from ON Mauritius & Aditya Birla Company
- 2013 – Acquired pre-school business “Brainworks”
1. Low entry barrier – Unorganized sector has a high share
- Achieved tremendous growth in the pre-school segment so far
- Management seems to have fine-tuned the process of setting up new centers and quickly turn them profitable
- What needs to be watched out for in the next couple of years is how well the “Global Champs” and “Brainworks” acquisitions add value.
- Heavy investment – almost INR 200 crores – has been made in the K-12 segment in land, buildings and for school management rights. A big portion of this amount – about 100 crores – is given as deposit to trusts that run the schools. This deposit will be refunded to Tree House over a period of time. Tree House will also get school management fees for about 30 years.
- The fact that 4 of the school buildings have been put up for sale seems to indicate a reversal of plans although Tree House will retain school management rights even after selling the buildings.
- How well the K-12 investment pays off for Tree House is something that investors need to watch out for in the coming years.
- Geographical risk: As of end March 2013, 50% (191 out of 379) of Tree House pre-schools are located in one state – Maharashtra. Any negatives that may impact Tree House brand or if competitors take away market share in this state could have significant impact on revenues.
- Low entry barrier: Pre-schools require low capital. Also PE funding seems to be available (Tree House has received PE funding multiple times). Competitors could scale up quickly and capture market share.
- Govt regulations: As of now there is no govt intervention in the running of pre-schools in the country. Any change in policy that may impact pre-schools could affect Tree House’s business.
Setting up a preschool requires low investment due to which the Indian preschool market is largely unorganized. Organized sector consists of 6 – 8 big brands and some smaller brands. Due to rapid urbanization and increasing awareness among parents about the importance of quality learning during the early formative years there is a gradual shift happening from unorganized sector to the organized sector.
2. Huge growth potential for organized sector
According to Crisil research, the preschool market in India is expected to grow at a CAGR of 20.6% from Rs 4,300 crores in FY10 to Rs 13,300 crores in FY15. The share of organized sector is expected to increase from 11% in FY10 to 34% in FY16 which suggests there is enough space for many players in the organized sector.
3. Tree House’s advantage over competition
Tree House is the only major pre-school chain which is primarily based on self-operated model as compared to the other big players who run primarily on a franchise model. Being self-operated gives Tree House advantages in terms of lower operating costs and at the same time maintains quality of education. Tree House also runs teacher training courses which helps the company in meeting its need for qualified teachers to support its rapid expansion and to maintain centralized approach to curriculum and quality of pre-school education.
1. Low Debt: Tree House has a total debt of INR 66 crores which is not high for a company with market cap of about INR 830 crores (Mar’14) and estimated FY 14 PAT of INR 48 crores.
2. Nearing the end of capex cycle: The major capex for Tree House so far has been in the K-12 segment where they have invested around 200 crores for school management rights, land, building etc. No major capex expected going forward.
3. Estimated to be FCF positive from FY14: Tree House is now at the end of its capex cycle. Tree House has also put 4 of its school buildings for sale in Dec 2013 so as to become asset light. Income from sale of buildings and earnings from operations should help the company become cash flow positive and possibly debt free from FY14 onwards.
4. Strong growth in net profit
Tree House has three streams of revenue – pre-school, K-12 and teacher training.
Of these three, pre-school contributes close to 85% of revenues. This could change in future as K-12 returns start increasing. Teacher training revenues are insignificant in the big scheme of things but this is a key aspect of Tree House as it builds a pool of trained teachers which would help in rapid expansion of its pre-schools.
Focus of the valuation for now is on the pre-school segment.
Pre-schools turn profitable for Tree House in about 1-2 years from the time they are set up. Profits for a pre-school continue to rise over time as capacity utilization increases.
Effectively, the average revenue per center continues to rise each year as more and more schools from earlier years become more profitable due to increasing capacity utilization. This can be seen from data below:
Average revenue per center has gone up from Rs 15 lac in FY10 to Rs 28 lacs in FY13. This number is expected to rise as more and more pre-schools turn profitable.
About 27-30% of this revenue ends up as PAT. The PAT margins could increase in the future as Tree House achieves cost efficiency through scale.
For the purpose of valuation, 27% of revenue ending up as PAT is assumed. Tree House is adding on an average 75 new centers every year. Below is the forecasted model based on these factors –
At the current market price of Rs 220 (as of 7th March 2014), Tree House is trading at FY16E PE of 9.8 and FY17E PE of 7.5. This is based on estimated earnings from pre-school segment only. Any earnings from K-12 segment will be an upside. Based on this, I believe the stock is undervalued.
Disclosure: I, Maheswar Reddy, own shares in the company.