UPDATE: G8 teaches lesson in upgrade

G8 education has hit a record high following its half-year earnings guidance upgrade this morning, surprising analysts and setting itself up for a stellar 2013.

Those who doubt that children can be a rewarding experience should look away. Child care services provider G8 Education has extended its stellar gain to reach a fresh record high this morning after it issued a profit upgrade.

Analysts were already predicting a stellar 69% surge in G8’s earnings before interest and tax (EBIT) for the six months to June to $17.1 million (G8’s financial year is the same as the calendar year), but management said that’s underestimating its earnings potential.

Unfortunately, management didn’t say how much it expected to exceed the forecast by, but I suspect analysts will be fairly aggressive in upgrading their price targets as we could be looking at a further 20% to 30% upside to G8’s first half EBIT when it reports its half-year results next month.

G8 is the most acquisitive small cap stock on the market and has bought no fewer than 37 child care centres since the start of the year.

Each deal follows a set formula – G8 pays four times the annualised EBIT and each centre contributes to EBIT immediately on settlement.

Looking at all the centres it bought since June 30 last year and calculating their contribution since settlement, I’ve worked out that the recent acquisitions alone would add close to $12 million to G8’s EBIT for the first half of the current year.

G8 posted an EBIT of $10.1 million for the first half of last year, and if one assumed a flat result from its existing operations for simplicity, we should see the company deliver an EBIT of around $22 million.

G8 typically delivers a far stronger second half result due to the transitioning of children from day care to primary school, which happens early in the year. The EBIT split is roughly 30/70 to 40/60.

Further, news that G8 is going to issue $30 million in unsecured fixed-rate notes to professional and sophisticated investors will also be welcomed by investors. The debt issue will help diversify G8's funding base and give management additional flexibility in pursuing its aggressive acquisition program. The interest rate payable on the six-year note won't be set until after the book build.

G8 is part of the Uncapped 100. The stock jumped 1.9% to $2.65 in lunch time trade.

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