Educomp Solutions Ltd: Avoid

Educomp Solution Ltd, an educational service and support provider, has been one of the most beaten down stocks in the last one year. The scrip has fallen by almost 70 per cent to Rs 136 over a period of last 12 months. We at DSIJ in our magazine issue dated February 26, 2012 had asked investors to avoid the scrip at the price of Rs 236. The major reasons for giving an ‘avoid’ rating were the company’s weak performance during the September 2011and December quarter, increasing competition impacting the pricing of the smart class revenues leading to lower margins, lower incremental growth opportunity due to high base, burgeoning debtors, swollen balance-sheet, FCCB redemption obligation by July 2012 at a premium to the principal value and the depreciating rupee value that has led to huge forex loss impacting the bottomline of the company.

The scrip at one time used to be the investors’ favorite because of its strong performance and the growth potential in the education space. The opportunity is still there in the education space but Educomp has been on the radar due to various company specific issues. The company has been facing serious allegations related to corporate governance. As per a media report, the equities research arm of a Portuguese investment bank has raised doubts about its corporate practices. Espirito Santo recently has raised an alarm about auditor independence and flagged the resignation of four company secretaries at EduSmart (third party vendor for Smart Class), an entity which contributes nearly 60-65 per cent of the company’s revenue and profits. Moreover, the research firm also questioned the accounting practice of the company as regards some expenses incurred by EduSmart reflected in the books of Educomp.

Not only has the company been on the radar for such corporate governance issues but it also has a swollen balance-sheet and weak financial performance in the last one year. The company had a debt equity ratio of 1.26 as on March 31, 2012 which forced the company to reduce its capex spending from Rs 800 crore in FY11 to Rs 479 crore in  FY12 to maintain a healthy cash flow. The debtor receivables are high at 255 days for FY12. Further, the company has an FCCB redemption obligation due in July 2012.  Further the Rupee is still hovering around 56 levels which will continue to impact the bottomline in the June quarter 2012.  

In conclusion, we believe that due to the emergence of new entrants in the sector, the company’s incremental growth will not be sustainable and the margins will see some erosion due to competition. Further, any slowdown in the Smart Class additions can result in slower revenue growth for the company going forward.  

On the valuation front Educomp is currently trading at PE of 6.91 its TTM EPS of Rs 19.68 which looks decent as the counter has been beaten down heavily over the past year.  In view of the above concerns we continue to ask the investor to avoid the scrip.