Tree House Education and Accessories Ltd is an outlier among education stocks. As shares of other educational services firms have tumbled on depleting cash flows, Tree House Education has delivered an enviable return of 38% over the past one year.

Among the reasons for this outperformance is the continuing traction of the company’s mainstay preschool business. Revenue from such centres that were open for at least one year and are operated by the company, rather than franchises, increased 33% last fiscal. New preschool additions remain strong; thus revenue and operating profit jumped by half in the last year.

Second, Tree House’s growth is not as debt-fuelled as other education services firms. It depends on internal accruals and cash flows from its existing preschools for expansion of new centres. That said, total debt increased 29% in the last fiscal, although the management maintains that most of the funding for preschools comes from existing centres.

Third, unlike its peers, Tree House largely prefers to run its own preschools. Of the 379 centres, 300 (79%) preschools are operated by the company itself. Not only does that allow Tree House to maintain quality and service levels, it also provides leeway for revenue generation after school hours through teacher-training programmes and activity classes on dance, music and art, leading to greater asset utilization. It has also signed an agreement with an organization to let out the school facilities for birthday parties.

According to PhillipCapital (India) Pvt. Ltd, Tree House can boost revenue by about 4% from these activities in the current fiscal. With preschools already having strong cash flows (and no receivables problem), revenue from post-school activities are boosting operating margins, which stood at 56% last fiscal.

But the challenge for the company is the profitable scale-up of the preschool business, mostly focused in Mumbai and western India currently. As it expands in northern India and smaller cities, the sustainability of return ratios and utilization levels will be a challenge.

Tree House is aiming to add 70-80 new preschools in the current fiscal. Depending on the location, a new centre used to break even in 4-18 months till now. Yes, rentals in smaller cities are low, but such locations have their challenges.

While pricing power can be limited due to relatively low income levels, the generation of revenue from extra-curricular activities can be a challenge. Also, the company would have to rely more on the franchise model to expand in smaller towns, which could lead to lower returns.

Overall, a low base and greater expansion in large cities have helped Tree House deliver robust growth till now. While a profitable scale-up from here will be a challenge, the management is estimating a sustainable growth rate of 25-30%.