Leading Independent Investment Research, Morningstar, Inc.

Morningstar

Leading Independent Investment Research

Morningstar, Inc.

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Thematic (Sector/Industry)

Australia Consumer discretionary / Thematic (Sector/Industry)

<div class="content-highlight"><p style="text-align: center;"><strong>New government funding package will benefit child care providers</strong></p></div><hr><h2>Executive Summary</h2><p>The Australian early childhood education and care, or ECEC, sector will soon receive a boost from higher federal government funding via the introduction of the child care subsidy under the Jobs for Families Child Care legislation. From July 2, the new funding system will increase subsidies for most families, and government forecasts project a 16% increase in subsidies in fiscal 2019 alone. In aggregate, the government expects annual funding to increase by around 40%, or AUD 3 billion, over the next three years. As around 60% of child care fees are funded by government subsidies, we expect this to materially benefit ECEC providers. Although we don't explicitly forecast government subsidies, our analysis suggests government forecasts could be conservative, considering subsidy growth averaged 15% between fiscal 2011 and fiscal 2016. Higher subsidy growth is unlikely to impact our REIT EPS forecasts but would improve the credit quality of their tenants. Operators, such as <a href="https://www.smartkarma.com/entities/581" target="_blank" data-smartkarma-citation="entities:581:1">G8 Education Ltd (GEM AU)</a>, would benefit from higher earnings, akin to our bull-case forecasts but we are reluctant to adopt a more bullish stance until the CCS begins in fiscal 2019 and we have more information about its impact. Investors can gain exposure to this funding boost via ASX-listed equities we cover including ECEC centre operator G8 Education, and ECEC real estate investment trusts, or REITs, including <a href="https://www.smartkarma.com/entities/8288" target="_blank" data-smartkarma-citation="entities:8288:1">Folkestone Education Trust (FET AU)</a> and <a href="https://www.smartkarma.com/entities/12209" target="_blank" data-smartkarma-citation="entities:12209:1">Arena REIT (ARF AU)</a>. Our preferred exposure is via Arena REIT, which offers an attractive discount to our fair value estimate, an internalised management structure, and a high-quality diversified portfolio with relatively long triple-net leases.</p><hr><h2>Key Takeaways</h2><ul><li>We expect the federal government's Jobs for Families Child Care Package, which will be introduced in July, to drive an increase in ECEC industry revenue of around 40% over the next three years which will benefit ECEC providers.</li><li>ECEC demand is also supported by population growth, a rising proportion of children using child care, and growing female workforce participation.</li><li>Child care centre REITs offer low-risk exposure to the ECEC sector and benefit from relatively long triple net leases. ECEC centre operators provide higher-risk exposure due to their relatively high earnings volatility. However, operators also have attractive characteristics, such as capital-light business models, which should enable strong cash flows albeit with higher volatility.</li></ul>

New government funding package will benefit child care providersExecutive SummaryThe Australian early childhood education and care, or ECEC, sector will soon receive a boost from higher federal government funding via the introduction of the child care subsidy under the Jobs for Families Child Care legislation. From July 2, the new funding system will increase subsidies for most families, and government forecasts project a 16% increase in subsidies in fiscal 2019 alone. In aggregate, the government expects annual funding to increase by around 40%, or AUD 3 billion, over the next three years. As around 60% of child care fees are funded by government subsidies, we expect this to materially benefit ECEC providers. Although we don't explicitly forecast government subsidies, our analysis suggests government forecasts could be conservative, considering subsidy growth averaged 15% between fiscal 2011 and fiscal 2016. Higher subsidy growth is unlikely to impact our REIT EPS forecasts but would improve the credit quality of their tenants. Operators, such as G8 Education Ltd (GEM AU), would benefit from higher earnings, akin to our bull-case forecasts but we are reluctant to adopt a more bullish stance until the CCS begins in fiscal 2019 and we have more information about its impact. Investors can gain exposure to this funding boost via ASX-listed equities we cover including ECEC centre operator G8 Education, and ECEC real estate investment trusts, or REITs, including Folkestone Education Trust (FET AU) and Arena REIT (ARF AU). Our preferred exposure is via Arena REIT, which offers an attractive discount to our fair value estimate, an internalised management structure, and a high-quality diversified portfolio with relatively long triple-net leases.Key TakeawaysWe expect the federal government's Jobs for Families Child Care Package, which will be introduced in July, to drive an increase in ECEC industry revenue of around 40% over the next three years which will benefit ECEC providers.ECEC demand is also supported by population growth, a rising proportion of children using child care, and growing female workforce participation.Child care centre REITs offer low-risk exposure to the ECEC sector and benefit from relatively long triple net leases. ECEC centre operators provide higher-risk exposure due to their relatively high earnings volatility. However, operators also have attractive characteristics, such as capital-light business models, which should enable strong cash flows albeit with higher volatility.

Charter Hall Social Infrastructure REIT (CQE AU)

How to Play the Australian Child Care Bonanza