Raffles Education Corp - FY11 results boosted by exceptional items (OCBC)

Dropping Coverage

Current Price: S$0.435

FY11 results boosted by exceptional items. Raffles Education Corp (REC) ended FY11 on a muted note, with revenue retracting 16.2% to S$157.6m, representing its second consecutive year of top-line decline. This was 4.7% lower than our forecast of S$165.4m. Net profit dipped 20.2% to S$41.9m. Excluding forex effects and exceptional items, we estimate that adjusted earnings would have decreased 29.5% to S$18.7m. This was 4.3% above our projection of S$17.9m. The slump in revenue was attributed to a decline in student enrolment numbers for all its business segments (-22.0%), coupled with currency translation losses due to the strengthening of the SGD against the RMB. The former was due largely to fewer students taking the 'Gao Kao' in China. A final cash dividend of 0.45 S cents was declared.

Near term pressures likely to persist. We believe that near term pressures are likely to persist for REC, on the back of declining revenue and rising cost pressures stemming largely from a rise in personnel expenses. This formed 38.4% of revenue in FY11, versus 25.2% and 30.0% in FY09 and FY10, respectively. Hence the group is seeking to ramp up operations for its new colleges outside of China, which typically have a gestation period of two to three years. Recent initiatives to operate a university at Iskandar, Malaysia are also likely to incur higher start-up costs. This would be followed by another new university in Greater Noida, India. Universities typically take a longer time than colleges to breakeven. Hence while the longer term outlook could augur well if REC executes effectively, margins and profitability could be impacted in the near term as REC makes the transition to a higher education provider.

Dropping coverage on lack of positive catalysts for the medium term. To maintain the sustainability of its core education business, REC is seeking to monetise its assets. This would initially involve the engagement of a property developer to jointly develop part of its OUC land (approval for 260, 000 sqm) into residential property. Nevertheless, we believe that execution risks exist, as it is of paramount importance for REC to find a reliable developer with strong financials for this partnership to bear fruition. Moreover, persistently high inflationary pressures in China could see the government introduce more cooling measures which would increase uncertainty and possibly stymie the projected levels of income that the group is looking at. In light of the aforementioned factors, coupled with increasing macroeconomic uncertainty, we see a lack of positive catalysts for the group in the foreseeable future. As such, we are DROPPING COVERAGE on REC.