Navitas: Result 2018

On the surface, education provider Navitas's result seemed a little better than expected. The company reported a scary-looking loss of $55m due to the $124m of writedowns flagged last month, mainly related to the SAE creative media business.

But underlying earnings before interest, tax, depreciation and amortisation (EBITDA) were $142m, down 8% – somewhat better than we feared. Adding back various one-offs, underlying net profit was $71m, although the messy result makes the numbers rubbery.

Curiously, the final dividend was cut 21% to 8.0 cents. While that sometimes flags a difficult period ahead, perhaps it's just Navitas's new management preferring to be conservative. The 2018 dividend payout represents 87% of free cash flow, after all.

Management gave no explicit profit guidance for 2019. That's not unusual for companies that have missed guidance in the past, as Navitas has.

What was interesting, however, was that new managing director David Buckingham reaffirmed the 2020 targets outlined by his predecessor Rod Jones last year. The main target is a group EBITDA margin of 18.0% by 2020, up from 15.3% in 2018.

But there's some sleight of hand here. When the targets were released, market revenue expectations implied 2020 EBITDA of close to $190m. Since then about $100m in potential revenue has evaporated and, by implication, so has $18m in potential EBITDA. As last month's announcement involved the closure or divestment of SAE in the US, Navitas's 2020 revenue will now be significantly lower than expected.

Shifting goalposts

This in turn implies EBITDA of close to $170m in 2020. If Navitas meets this target it will only be because the goalposts have been moved. The reality is that the company will be much less profitable in two years than management implied last year.

Even $170m in EBITDA could prove a stretch, as it suggests a lift in earnings of close to 20% over the next two years. Management is apparently basing this on the expectation that earnings from the University Partnerships division have now bottomed.

On the face of it, there was some evidence for that in the result. After several years of decline due to the loss of the Macquarie and Curtin Sydney contracts, the University Partnerships division saw EBITDA grow by 8% in the second half of 2018.

But, as we've said, the University Partnerships division is facing headwinds in most territories. Much will depend on how enrolments pan out over the next year or two.

So far they're holding up. Navitas released its second semester enrolment figures with its 2018 results. Australasian enrolments grew 4%, although this is much weaker than it should be given the flood of international students entering Australia.

Various government rule changes mean Navitas is failing to get its ‘fair share' of international student enrolments.  First, the federal government's Simplified Student Visa Framework has caused students to prefer the Group of Eight universities rather than those with which Navitas partners.

Second, the Western Australian state government has reduced migration incentives since taking power, causing international student enrolments to weaken at important Navitas partners like Edith Cowan and Curtin universities. Government rules being what they are, they could change in Navitas's favour at any time but for now they're a drag on domestic enrolments.

O Canada

The big surprise in the second semester enrolment numbers was North America, where enrolments grew 13%. This was again due to strong growth in Canada offsetting the US, but Navitas will run up against capacity constraints in Canada at some point.

Navitas's management cautions against reading anything into one semester's enrolments and we think that's sensible advice. A reasonable second semester does not imply enrolments will hold up over the next year or two.

Navitas presents a conundrum. If you believe management, then the stock doesn't look expensive. If earnings bottomed in 2018, then the stock will rally once there's evidence.

But we remain worried that enrolments will face headwinds for some time yet. It's also unusual for management to cut a dividend by 20% if earnings are expected to resume growing immediately, as the 2020 targets imply.

Our recent Sell recommendation was based on a lack of confidence that the company can generate sufficient earnings growth to produce decent returns from the stock. With management giving out mixed signals, we see no reason to change our view. SELL.