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Sunday, May 28, 2006

Raffles Education @ 2.44 ( Education / Singapore ) 0 comments

Final Poll Results: 6:6

(P.S: Sorry for any disturbances the advertisements above may have caused you)

Main issues

1.Quarter-on-quarter performance stable rather than strong

2.Huge downside given high valuation

I have to resist two temptations for this writeup. The first temptation is that of doing my half-year assessment of my hotstocksnot predictions over the the last few months; I think >90% of my calls would probably be "good" by comparison of stock price alone given the recent drastic Singapore stock market correction. However, what it just shows is the power of the stock market tide in lifting or sinking all stocks; as much as the rising tide made many of my hotstocksnot calls "bad" earlier this year, so the falling tide has made them "good" calls. I cannot overly attribute it to good "stockpicking" skills. The second temptation is to pick the losers of the Marina IR bid (particularly the Singapore government-linked companies) as hotstocksnot; well I have covered Capitaland and Genting before already, so I have to resist the tempation to pick Keppel Land here.

I pick Raffles Education (formerly Raffles Lasalle) on a top-level assessment of valuation risk alone. I do not believe that there is any problem with its business; this Singapore company operates a total of 21 colleges under three brands (14 Raffles Design Institutes, 6 Hartford business colleges, 1 KvB Institute), where its 8 design institutes in China, the biggest potential market in the world, form its crown jewel and a base for expansion throughout the Asia-Pacific. Yet, any company with trailing PE 70X and forward PE 40X (estimated based on annualising 9M05 results), with NTA of merely 7 cents, faces little margin for error.

I had written something on Raffles Education in my StockTalesLot blog (article link) where I noted the share's meteoric rise was predicated on a PE expansion on top of a margin expansion on top of a revenue expansion. Rather than compare year-on-year performance, one should note that revenue and profit over the last three quarters of FY06 have remained relatively stable at ~S$20M revenue and S$7-8M net profit every quarter. Might this be the end of the margin expansion? Although I believe in investing with the trend (and so far Raffles Education's profit trend has been great), I also believe in reversion to the mean --- extremes always correct (as many investors/traders on the SGX found to their dismay recently), competition ensures that. Note that I am arguing on the basis of a perceived law of nature (or rule of thumb, for that matter), without any knowledge of the market dynamics of the Chinese education market for example; those who might know better please advise me.

Some might point out that quarter-on-quarter comparisons seem rather harsh, yet I would argue that it might be appropriate in this case for two reasons: firstly, the business exhibits a non-seasonal nature, and secondly and more importantly, its high valuation demands such an analysis. One comparison I find most appropriate is search giant Google, which, although not an industry peer, shares the kind of high growth expectations priced into its stock, at 67X trailing PE and 30X consensus forward PE. The stock has been trading at lofty valuations ever since its IPO last year, and it largely met market expectations with doubling (at least) of annual revenue and net profit over 2003 to 2005 (in fact, it tripled net profit over 2004-05). Yet when profits disappointed in the quarter ending Dec 05 (stagnant quarter-on-quarter net income on 20% quarter-on-quarter revenue growth), the stock price corrected 20% from US$450 to US$350 in a then buoyant US market. The point is that the market doesn't care about "intrinsic/long-term value" (and Google has plenty of that) at such lofty valuations, but rather focuses on near-term performance ie. it looks for reasons/excuses to de-rate the stock to lower multiples. This is the very real risk facing a stock like Raffles Education.

The catalyst for me making a call on Raffles Education is the correcting Singapore market. In a falling market, growth stocks suffer the brunt of the damage, and high PEs come in for special attention. It has surprised me that Raffles Education has survived things rather well compared to other Singapore stocks. Perhaps it is the quarterly dividends it issues, although it probably amounts to only 2% dividend yield for FY06 (based on 1.25 cts/quarter). Or perhaps it is its linkage to 2G Capital, although one should note that Tommie Goh cashed out his direct holdings to below the 5% threshold in March 06.

For all likelihood the company should report a sterling set of full-year FY06 results three months later, on the basis of its 9M06 results. Yet how does one decide whether a stock's growth rate justifies a 40X PE? Re-rate to 30X and it still looks expensive to a jittery market, re-rate it to 20X and it still looks fully-valued for whatever growth the company is projected to deliver in the medium-term. In comparison, a stock previously trading at 15X PE will look cheap at 8X PE; it forms a base.

Again, I could have egg on my face on this call, but given a more sober market mood coupled with quarterly pressures to perform, this is as good a time as any to call a hot-stock-not on Raffles Education.

(1) Yahoo Finance's data on Google Inc.'s quarterly results




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