Kip McGrath Education Centres (ASX: KME) AGM Update

During the week, remedial tutoring company Kip McGrath Education Centres (ASX:KME) held its AGM, and gave a short update of the year to date. I won’t rehash the annual result, which I already covered here.

However, it is worth noting that KME gave an update on FY 2022 so far. They said that “Business now seeing a strong uplift in UK and Australian markets, with 8% lesson growth rates compared to last year,” and “Revenue is tracking 21% higher than prior year, driven significantly by Corporate Centre transitions.”

Now importantly, we must remember that corporate centres need to grow to become profitable, since the company first needs to replace the franchisee with an employee, and then grow revenue from there to make profits. In the last year, this strategy has been depressing profits, as the company has rapidly grown its corporate centres. And it says it is planning to grow its corporate centres by at least 5, to 22, in FY 2022.

Unfortunately, KME did not hold a virtual AGM, but I was able to catch up with the CEO Storm McGrath for a phone call afterwards.

Kip McGrath Shares (ASX:KME) versus Cluey Shares (ASX: CLU)

One question I had was whether the company is suffering from the (in my view) irrational competition from Cluey (ASX:CLU), the, at least presently, cash furnace online tutoring company that is also listed on the ASX. Storm McGrath said they had indeed suffered an increase in cost per lead, from around $50, to as high as $100, though they had since gotten it back down to around $75. In this scenario, it will definitely be more expensive for KME to grow, however, Cluey can only keep burning investor cash for as long as there are people willing to fund it, so KME should find things easier if and when Cluey runs out of money to burn.

Cluey burnt through about $3.5 million last quarter, but has around $36m in the bank, so KME will likely have to endure their marketing spend for many years to come. Fortunately, KME is consistently profitable and cashflow positive, so there is no time limit to how long it can keep competing and my expectation would be that Cluey investors will eventually realise that an online tutoring business is not a software business, but a services business.

If you’d like to hear more about Cluey (in particular) and how it compares to Kip McGrath, then check out episode 3 of the Baby Giants podcast, below from around the 33 minutes mark.

Kip McGrath (ASX:KME) Shares In a Post-Lockdown World

I also asked Storm McGrath what the tutoring mix between online and in person looked like post lockdown and he said words along the lines of that “the UK is out of lockdown for four months, and online has settled at around 30%, [partly] because of this factor where parents don’t want to take a risk or because they are used to blended learning.” This is important going forward because it actually suggests that in coming years the blended model that KME is able to offer will probably be resonating with the market, and may indeed have some advantages over pure online learning, especially for younger kids.

And importantly, about 70% of KME’s lessons are primary school students, whereas online only competitors like Cluey tend to have a higher proportion of high school kids.

In terms of operational advances, KME is still beta testing its software upgrade which allows tutors to run a lesson that has a mixture of online and in person students. This has been slower than I hoped, partly because the company has been focussed on scaling the administrative side of the corporate business. Specifically, the company is implementing salesforce so that it can have a centralised call centre that allows call centre operators to have full visibility of the history of interactions between a student’s parents and the company. This is a sensible customer service initiative and it will also allow KME to offer long hour call centre services to all franchisees, which should generally improve the health of the network and brand overall.

From our conversation, I got the sense we won’t really see much profit (if any) from corporate centres in the first half of FY 2022 numbers, though we might get a little uplift in the second half. As the centre number growth slows down as a proportion of the total corporate centres, we should see those profits coming through, and I’ll be miffed if we don’t see an uplift by FY 2023 at the latest.

In term of the dividend, which was cut in the pandemic, going forward Storm McGrath flagged a potential possibility that the board may choose to drop the payout ratio to around 50% from around 70%, in order to leave more cash available for investment. This may see some churn in the shareholder base as previously KME was a solid dividend stock. On top of that, he mentioned that one institutional holder was selling down. We can’t know why sellers sell, but if that’s true we might see a stronger share price once that selling is exhausted.

Finally, it is early days, but the tutoring marketplace Tutorfly, which is 50% owned by KME, seems to be on track to run at breakeven so it shouldn’t be a much of a drag on company resources (while offering plenty of higher growth upside).

Going forward, the company says “We expect the business to continue to focus on growth opportunities worldwide to increase our lesson numbers.”

Overall I remain confident that KME is a decent quality business run by honest, competent and aligned leaders and I am more than happy to remain a shareholder, as the business rebounds from covid and battles a competitor funded on hype and promises of growth, rather than profits or dividends.

These are incomplete personal reflections about a stock by the author, who owns shares in KME, and will not sell any for at least 2 days after the publication date of this article. This article should not form the basis of an investment decision. It is an investment diary valuable only for the cognitive process it demonstrates. We do not provide financial advice, and any commentary is general in nature. Please read our disclaimer.

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