G8 Education (GEM) is an Australian child care operator, managing 134 centres throughout the country.

The Australian child care centres are concentrated mostly in Queensland and NSW, while in Singapore the group owns or operates 20 child care centres. GEM is the only listed child care operator on the ASX, following the much publicised collapse of ABC Learning in 2008.

Acquisition success

A key plank of GEM's strategy is buying up independent childcare operators, and extracting synergies from the businesses.

During the half, GEM acquired two child care centres and divested an underperforming centre. This followed a busy FY11 in which the group purchased 54 centres. Importantly, the integration of the acquisitions into the current group structure has been well executed.

Demonstrating this point, GEM's Kindy Patch acquisition (settled March 14, 2011) helped lift 1H11 revenue 14.4% and EBIT margin 21.5%. In 2H11, revenue was boosted by 16.4% and EBIT margin by 24.4%.

GEM has produced similar outcomes with its other acquisitions because a) it doesn't overpay for the businesses (its acquisition multiple is only 4x the target's one-year forward EBIT), b) the businesses are profitable, and c) the centres are in ideal locations, which increases scale.

Yesterday, the group announced that it had acquired 7 more premium childcare and education centres in NSW for $9.2 million (representing 4x EBIT and funded from existing cash and debt).

In addition to expanding GEM's presence in NSW, the acquisitions were expected to contribute to EBIT immediately post-settlement.

Healthy balance sheet and history of growth

Prior to 2H09, GEM was a loss making entity, but since then the rate of profit growth has been impressive.

Since 2H09, half-year revenue has risen at a 35% compound rate of growth, with the rate of profit growth an even more robust 65.4%.

The balance sheet was in healthy shape, with a net debt to equity ratio of just 19.2% at the end of 1H12.

GEM had a $50 million debt facility which, when combined with existing cash, gives it the flexibility to make acquisitions without undertaking a dilutive capital raising.

With the group now generating positive free cash flow, we are confident in its ability to grow dividend payments. The latest quarterly dividend was 1.5 cents.

Favourable industry dynamics

GEM's Australian operations receive a crucial level of support from the government with the child care rebate.

The increase in the rebate has significantly outpaced the rate of inflation over the past seven years, and the higher the rebate, the greater the incentive for parents to put their children in day care centres.

The longer term demographic trends are also supportive of GEM's business. The group noted that since 2006, the percentage of 0-5 year olds attending childcare has risen to 38%, from 33% in 2006.

Moreover, the 0-5 year old population since 2006 has grown at 6 times the rate of the prior 20 years. What these trends tell us is that GEM's target market is experiencing strong growth, and the child care rebate is increasing the incentive for parents to use the company's centres.

Outlook

Since turning in a profit in 2H09, GEM has been on a strong revenue and earnings growth path.

The group's strategy is to grow by acquisitions, and on this front it has succeeded. In addition to increasing market share and boosting scale efficiencies, the acquisitions have been earnings accretive.

Going forward, the government's child care rebate will continue to offer incentives for parents to place their children in care centres. We believe the market is recognising GEM's potential, and as such we think GEM is defiantly a stock to watch in the near-to-medium term.

Weekly Update: Stock To Watch G8 Education (GEM) is a post from: Australian Stock Report Share Tips

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