Tree House tweaks strategy to perk up returns

add_main_imageTree House Education and Accessories Ltd is looking to sell some assets, a departure from the typical strategy of rivals in the education business. It is planning to sell the land and buildings of four schools out of the 24 it operates. The company will, however, continue to manage the schools, said managing director Rajesh Bhatia.

The asset sale can give a fillip to the company’s returns ratios. Close to half of the company’s asset base is locked up in the relatively low yielding K-12 (kindergarten to 12th grade) business, according to Elara Securities (India) Pvt. Ltd. Compared with 21% from pre-schools, the K-12 assets (some still being built) generate a 5% return on capital.NextMAds

Taking note of the huge returns gap, the management has decided to sell the physical assets. This can help it raise about ₹ 100 crore, Elara Securities said in a note. The proceeds can also be put to better use. At the end of March this year, Tree House had debt worth ₹ 66 crore. It can also use the funds to expand the pre-school business.

The management, meanwhile, is expecting the company to turn free cash flow positive in the second half of the current year. The investment phase in the K-12 business is coming to an end. Although the firm continues to expand aggressively in the pre-school business, it expects to generate sufficient funds from the existing business, which has attained sizeable scale. The asset-light strategy and the completion of the investment phase in the K-12 business can improve Tree House Education’s return ratios in the coming quarters. The stock is weathering the stock market downturn better than the benchmark index.

What investors need to be wary about though is the sustainability of margins. As pointed out earlier in this space, the firm is planning to increase its presence in non-western parts of the country. That requires it to increase its dependency on franchisees, which can weigh on margins.

The management is confident about sustaining operating margin at 50%. While that should not be a problem in the medium term, it will become a huge challenge as the company grows in size.