Tree House Education and Accessories Ltd’s March quarter results show the necessity of its planned asset sale. Its revenues rose by 21% and a decline in other expenses caused a 33% jump in earnings before interest, taxes, depreciation and amortization (Ebitda or operating profit). But that did not percolate down to profit growth and net profit grew by a tepid 9%, the slowest in more than two years.

A substantial chunk of its operating earnings were eaten up by interest costs. Finance charges doubled from a year ago period. Capital expenditure incurred in the K-12 schools segment led to a spurt in finance charges. It had invested about 100 crore in the last fiscal year. The company completed the construction of two educational complexes and opened 111 preschool centres, which resulted in higher borrowings and interest costs.

Interest coverage ratio is down from 10 times in March 2013 and is relatively comfortable at 5.8 times. But high interest costs and rising depreciation are putting pressure on the company’s profitability. Net profit margin of 22.5% is lowest in two years. The growth in earnings per share also slowed to 2.8%.

The slowing earnings growth is a departure from the past when, despite rapid expansion, it delivered strong growth in profits. The company has decided to cut debt and is in talks to sell some of its K-12 schools. A sale of two schools will make the company debt free, according to the management. The asset sale will free up capital and boost return ratios—return on equity and return on capital employed.

The company plans to sweat its assets to improve returns and is starting day care facilities in its preschools. It will tie up with large employers to provide day care services to their employees. The initiative should help improve returns, if it is successful. But the biggest trigger remains the asset sale.

“We feel the stock has the potential to rerate once its K-12 asset-light approach is executed, which should improve liquidity and return ratios significantly," Elara Securities (India) Pvt. Ltd said in a recent note.

The asset sale will bring down debt and help the company turn free cash flow positive. But a delay can affect stock valuations as many analysts have factored it in their current valuations.

“Delay in monetizing the K-12 asset poses a serious threat to the return ratio and valuation," Cholamandalam Securities Ltd said while pointing out the risks.