BFAM - Bright Horizons: Attractive Valuation Trumps Near-Term Risks Upgrade To Buy

2023-11-02 18:15:01 ET

Summary

• Bright Horizons Family Solutions reported robust Q3 results with revenues growing 20% YoY, driven by growth in backup care and full service segments.
• Enrollments in the US grew 12% YoY, but enrollment outside the US remained challenging.
• BFAM expects mid-single digit growth in full service enrollment and gross margin expansion in 2024, but the industry continues to face challenges with rising childcare costs and remote work.
• We upgrade our rating to Buy as a result of a significant valuation discount and stable operating profile.

Investment Thesis

In continuing with our previous coverage for Bright Horizons Family Solutions Inc. ( BFAM ), we had ascribed a Neutral rating as a result of significant near-term headwinds impacting the recovery of its core segment leading to pronounced downside risks. The share price declined by a fifth since the publication significantly underperforming the broader indices. The company reported solid growth in Q3 underpinned by growth in both its full service and backup care segments with its full service business turning operationally profitable compared to the previous year. We believe the current valuation discount to its long-term averages offers a favorable risk-reward and upgrade our rating to a Buy and ascribe a target price of $90 (at 19x forward EV/EBITDA)

Robust Q3 Results

BFAM reported robust Q3 with revenues growing 20% YoY to $645 mn comfortably beating estimates pegged at ~$620 mn. The strong beat was driven by Backup care revenues which jumped 32% YoY along with full service revenue increasing by 17% YoY. Backup care segment growth was driven by strong consumer usage over the summer months (July-August) along with BFAM's expansion of its use case offerings. The strength in the full service segment was driven by an increase in enrollment along with the benefits of its pricing actions.

Enrollments in the US grew 12% YoY which is also a sequential acceleration of 10% growth it reported in Q2 in an otherwise slow quarter which is affected by seasonal enrollment dips as older children age up and move to elementary schools. However, enrollment outside the US remained challenging, although growing in low single digits with UK continuing to be the worst affected driven by macro headwinds and the staffing environment. Netherlands and Australia continue to report higher occupancies averaging more than 70% as well as improving sequentially. Overall occupancy levels came in at 58-60%, down sequentially in an otherwise seasonally weak quarter.

Gross margins came in at 23.4%, up 60 bps YoY and 80 bps sequentially primarily as a result of pricing actions and enrollment growth in the US leading to higher occupancies along with higher utilization in backup care partially offset by ending of ARPA benefits and weakness in the UK market. Adj. EBITDA margin improved by ~70 bps YoY to 15.6% primarily due to gross margin expansion and slight operational leverage. This led the company to report EPS of $0.88, ahead of the consensus estimates of $0.82.

The balance sheet position remained stable with the company ending up with a $41 mn cash balance and an additional ~$351 mn in undrawn RCF facilities. Total debt outstanding inched up marginally to under a $1bn compared to ~$970 mn in previous quarter with Debt to EBITDA continuing to ease, now under 3.0x driven by strong operating growth.

BFAM tightened its revenue guidance and expects full year revenue of $2.375 bn to $2.4 bn (vs $2.35 - $2.4 bn previously) reflecting continued momentum. It also tightened its EPS guide and now anticipates full year EPS of $2.73 - $2.78, which implies a lower Q4 EPS guide of $0.72 - $0.77 (assuming flat to mid-single digit declines in EPS compared to last year).

2024 Expectations

The company was cryptic in providing a guidance for the next year, however, it provided some directional commentary and expects mid-single-digit growth in full service enrollment, 4-5% tuition growth, and +3-4% wage inflation. Pricing could have a 100 - 200 bps spread compared to cost hikes implying a potential for gross margin expansion. We expect 2024 revenues to grow in high single digits to low double digits assuming a 6% enrollment growth and a 4-5% pricing impact with gross margins expected to be up 100 - 200 bps. We expect Adj. EBITDA margins to expand by 150 - 250 bps as a result of gross margin expansion and higher utilization partially offset by wage hikes. We expect the company to report an EPS of $3.25, slightly below estimates primarily on account of higher interest expense which kicked in this quarter.

Industry Remains Challenged

Childcare costs have continued to spiral higher with average childcare costs climbing above the $700 a month mark, up 32% compared to 2019 with the largest increase for families with income ranges of $100k - $250k. This also comes in even before the end of ARPA benefits which represents continued challenges. In addition, there have been lower dual-income households with an average 1.34 payrolls a month versus 1.39 in 2019 implying some workers dropped out or got laid off which further weakens the ability to sustain rising childcare costs.

In addition, there is the continuing remote/hybrid working arrangement which is becoming the general norm with a total of 2 in 10 people working fully remotely and 5 in 10 people working in hybrid conditions. Parents often opt to take care of the children by themselves in the wake of rising childcare and inflationary headwinds. We continue to believe the full service segment would be impacted and its recovery to pre-COVID levels would be thwarted by persisting headwinds.

Valuation

BFAM does not have a direct peer, hence, we compare BFAM with Cintas Corporation ( CTAS ) which is focused on industrial service. In addition, we compare it with other homecare players such as UnitedHealth Group Incorporated ( UNH ) which is also acquiring Amedisys, Inc. ( AMED ), Addus HomeCare Corporation ( ADUS ) and Option Care Health, Inc. ( OPCH ). BFAM is trading at a discount to Cintas while and largely in line with the other peer set.

The company is also trading at a discount to its historical averages, even after factoring in a sharp decline during COVID as its centers were shut off. However, compared to pre-pandemic averages as well, the company trades at a discount compared to its long-term averages on a forward basis. The multiples have de-rated significantly since my last publication, however, we believe the company's fair value is likely at 19x forward EV/EBITDA, at a discount to its long-term historical averages given the current challenging macro environment. Given the valuation discount from the last coverage, we upgrade the rating to a Buy and ascribe a target price of $90 (at 19x forward EV/EBITDA).

Risks to Rating

Risks to rating include:

1) Remote working can continue impacting the recovery in its full service segment.

2) Rising childcare costs can further pressure consumer wallets which are squeezed due to current inflationary headwinds and may lead to parents finding alternatives.

3) Macroeconomic headwinds can dampen consumer sentiment and affect spending.

Final Thoughts

BFAM has been faced with multiple headwinds over the past several years with COVID jolting its operations to a halt, rising childcare costs and remote/hybrid work operations. However, the company has reported consistent and sustained growth in its backup care segment which remains a silver lining. Given the relative undervaluation and strong operational beat, we believe there is adequate margin of safety and upgrade our rating to a Buy rating and ascribe a target price of $90 (at 19x EV/forward EBITDA).

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