Kip McGrath: The Strategy Shifts Are Paying Off

School children in Australia and across the globe have been suffering from the effects of up to two years of missed schooling due to the pandemic. With governments pledging extra funding to bridge the learning gap, one company is in a prime position to ride this tailwind. Kip McGrath Education Centres Limited (KME: ASX), was founded in Maitland NSW in 1976. They have been providing out of school tutoring services for over 40 years. The company is currently run by Kip McGrath’s son, Storm, and between the two they own 23% of the company. The company reported a drop in lessons during the height of lockdowns and the pandemic, however, was able to maintain revenue growth with higher online and corporate lessons.

Delivering strong results

Kip McGrath has several key factors that have placed the company in a position to deliver strong results over the next two financial years. These key factors are:

• Prior to the pandemic the business had commenced a strategic shift in their business model with a renewed focus on technology and corporate centres. The pandemic has seen the rapid uptake of online lessons and hybrid learning has become the norm at Kip. Corporate centre revenue also increased by 115% in FY22, and this strategy is discussed in detail later in this blog.
• Kip McGrath purchased Tutorfly in the US. Tutorfly is a marketplace matching tutors with students. This business has performed above expectations since its purchase and offers free upside in our valuation.
• The company is set to benefit from governments allocating funding to tutoring companies to bridge the learning gap. In Australia Kip McGrath won a tender for an NSW Government contract and is bidding for further tenders. The Biden administration also pledged $120bn to bridge the learning gap created by the pandemic and Tutorfly has been successful in winning part of this funding.
• A new learning management system (LMS) is being rolled out this half and will be exclusive to gold partner franchisees. It is expected that silver partners will transfer to gold partners to access the new LMS.

Source: Kip McGrath FY22 Results Presentation

McGrath Invests in Technology

The company has invested heavily in technology over the past few years and lockdowns may have been a blessing in disguise for Kip McGrath. Prior to COVID, online lessons had failed to gain real traction, but adoption has now accelerated. Being able to offer parents and students a hybrid choice of face-to-face or online lessons on a class-by-class basis is proving to be a success as they enjoy the flexibility this provides around their busy weekly schedules. Part of the technology investment being implemented by the company is the rolling out of their new learning management system (LMS). The new system was released in June and will be rolled out exclusively to gold partner franchisees this half. The CEO, Storm McGrath, believes this new system will see silver partners upgrade to the gold model as the system provides many benefits to the franchisees business. Gold partners are charged a 20% franchise fee by the company, compared to 10% for silver partners.

Corporate Centre Strategy

The corporate centre strategy continues to grow with 24 centres now operated by Kip McGrath and revenue doubling for the year. Their strategy involves buying back franchises in cities or metropolitan areas and running the centres through corporate management. Storm has recognised that these areas are more profitable when run under the corporate structure. These corporate centres are where he believes a lot of the future value creation for shareholders will come. As the company increases their corporate lessons as a percentage of total lessons, we will see the top line grow substantially. This is because the company receives the full amount of revenue for each corporate lesson rather than a percentage from a franchisee. As these centres reach full scale the margin will improve significantly as the cost base for the corporate centres is mostly fixed.

Tutorfly

The acquisition of Tutorfly provides expansion into the new geography of the United States, the largest tutoring market in the world. Tutorfly performed above expectations this year, bringing in $1.6m of revenue. The company has been able to secure several contracts in schools across the state of Arizona and there is more upside to be had here with the US Government pledging $120bn in assisting students to catch up on learning post-COVID. This acquisition also provides an opportunity for the company to open corporate centres in the US.

Kip McGrath Outlook

Kip McGrath has now halved from its peak share price in 2020 and as of writing is trading under 80 cents. The company reported strong growth across all metrics in FY22 with revenue up 28%, Earnings Before Interest, Taxes, Depreciation, and Amortization (EBITDA) up 21% and net income up 8%. These numbers were achieved despite being impacted by COVID lockdowns. The UK market has now recovered to pre-COVID levels, and the Australian market is expected to break above pre-COVID lessons in the second half of 2022. Net margins have contracted significantly from pre-COVID with the company reporting margins of 7.6% in FY22 compared to 16.3% in FY19. We are forecasting the margin to improve to 13% in FY23 as they have been kept artificially low over the past few years due to strong investments in technology and the corporate centres. The graph below outlines the Earnings per share (EPS) of Kip McGrath over the past five years and Oracle Advisory Group's forecast Earnings per share (EPS) for the next two years. Our model is forecasting the company to deliver earnings per share (EPS) of 7.9 cents in FY23. This places the company on a forward Price-to-earnings (P/E) ratio of 10x. The company can double Earnings per share (EPS) this year, as we are forecasting, so a price-to-earnings of 10x looks cheap.

Source: KME Annual Reports & Oracle Advisory Group Forecast

If Kip McGrath continues to trade on its current Price-to-earnings (P/E) of 24x with next year’s earnings, then the share price will trade at $1.90, a 120% upside. This reasonable valuation also provides a good risk/reward ratio, protecting the downside in the current volatile market. Kip McGrath has several tailwinds that it can leverage over the next few years, and we believe the current share price provides a great risk/reward opportunity for shareholders willing to be patient.  

Get in touch with us today for complimentary consultation to discuss your financial position and we can provide you advice tailored to your unique situation.      

Written by Jack Magann
Portfolio Manager
Emerging Companies

Important information – Oracle Advisory Group makes no representation or warranties as to the accuracy or completeness of any statement in it including, without limitation, any forecasts. The information in this document is general information only and is not based on the objectives, financial situation or needs of any particular investor. An investor should, before making any investment decisions, consider the appropriateness of the information in this document, and seek their own professional advice. Past performance is not a reliable indicator of future performance. The information provided in the document is current as the time of publication.