This Company Brightens up the Day for Working Parents

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Due to concerns over the safety of domestic baby care products, many mothers in China have been going to Hong Kong to purchase baby milk powder for their children. This is just one of many examples of how much parents value quality when it comes to the well-being of their children. Bright Horizons Family Solutions (NYSE: BFAM) is the largest provider of for-profit employer-sponsored child care services in the U.S., benefiting from the increased demand for high quality child care.

Company benefits from an emphasis on quality

Bright Horizons has a 97% client retention rate for its employer-sponsored child care centers.

Firstly, similar to how well-known universities and companies attract the best applicants every year, the size and quality of Bright Horizons’ customer base is a testament to the quality of its services. Bright Horizons boasts of having over 130 Fortune 500 companies and 75 of the 2012 100 Best Companies for Working Mothers ranked by Working Mother magazine among its more than 800 clients. This becomes a self-fulfilling prophecy, as more high caliber companies engage Bright Horizons’ services in view of the strength of its current customer base.

Secondly, most people prefer some form of endorsement or certification by independent parties when making choices. In the U.S., the National Association for the Education of Young Children (NAEYC) offers accreditation for early childhood education programs. 70% of Bright Horizon’s eligible centers are NAEYC accredited, which provides further assurance to the quality of Bright Horizons’ services.

Unique operating model leads to high returns on investment

Bright Horizons operates its child care centers under three different business models: the cost plus model, the single sponsor model and the consortium lease model, which accounted for 30%, 30% and 40% of its total number of centers as at the end of 2012.

Under the cost plus model, Bright Horizons is compensated with a management fee, on top of operating subsidies to cover costs. It has limited earnings risk with this model, with enrollment having no effect on profitability. No specific employer is linked with an individual center and Bright Horizons has to market its services to potential clients in the vicinity and be responsible for most of the capital investment under the consortium lease model.

For both the cost plus and the single sponsor models, employers are responsible for funding the bulk of the development and maintenance capital expenditures. As a result, Bright Horizon delivers Returns on Investment (ROIs) above 70% for centers run under these two models, compared with a more modest ROI of around 25% for the consortium lease model.

Growth drivers

On the back of a 9% and 17% year-on-year growth in revenue and adjusted EBITDA respectively for the first quarter of 2013, Bright Horizons revised its full year 2013 revenue growth forecasts upwards from 8%-10% to 10%-13%.

In terms of organic growth, the employer-sponsored child care market will likely grow with the perceived importance of family friendly employee benefits in staff retention and the increase in dual income families. In addition, with more than three quarters of its centers located in North America, Bright Horizon has room for further growth in its foreign markets such as Europe and India.

With respect to M&A, Bright Horizons has a solid track record, having acquired an average of 24 centers every year since 2001, which contributed to slightly less than half of total new center openings annually. In April 2013, it added another 64 centers with the acquisition of Kidsunlimited, a U.K. based operator of nurseries.

Peer comparison

Bright Horizons’ peers incude Children's Place (NASDAQ: PLCE) and Carter’s (NYSE: CRI).

Children’s Place is the U.S.’s largest children's specialty apparel retailer with 1,111 local stores and 20 franchise stores in the Middle East as of May 2013. It is expanding both in terms of sales channel and geographical presence. Its e-commerce business Childrensplace.com, which carries higher margins than its brick and mortar business, grew its revenue contribution almost tenfold from $27 million in 2005 to $215 million in 2012. In terms of international expansion, following its successful expansion into the Middle East in 2012, it recently announced plans to open franchise stores in Israel by the first quarter of fiscal 2014.

Notwithstanding the fact that net sales and gross profit for the first quarter of fiscal 2013 fell by 3.5% and 8.6% year-on-year respectively, Children’s Place surpassed its quarterly forecasts and raised the lower end of its adjusted earnings per diluted share guidance from $2.90 to $3.05.

Carter’s markets its branded children’s apparel under its two brands Carter’s and OshKosh. Similar to Children’s Place, international expansion is a key growth driver going forward for Carter’s. Given that countries outside the U.S. contributed less than 10% of  total revenues in 2012, Carter’s has plans to open 20 new stores in Canada every year until 2016 and capture more international customers through its e-commerce website.

It delivered a good set of results for the first quarter of 2013, with quarterly net sales and operating income increasing 7.1% and 24.4% year-on-year to $591.0 million and $66.9 million respectively. Carter’s maintained its full year 2013 guidance of a 8-10% growth in net sales and a 15% rise in adjusted diluted earnings per share. It also announced in May 2013 that it initiated a quarterly dividend and a new $300 million share repurchase authorization. 

I am negative on Children’s Place and Carter’s, given the fickle nature of children apparel customers and the volatility of cotton prices.

Conclusion

Bright Horizons impresses me with its market-leading position, quality and unique operating model. However, I view current valuations at 23.8 times forward P/E and 1.2 times PEG as expensive. A share price pullback leading to a valuation below 1.0 times PEG will pull the buy trigger for me.

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