Correction: Fitch Affirms Bright Scholar at 'BB-'; Outlook Stable
(The following statement was released by the rating agency)Fitch Ratings-Hong Kong-07 February 2021:
This is a correction of a press release published on 2 February 2021. It includes the Corporate Rating Criteria and Country-Specific Treatment of Recovery Ratings Criteria that were omitted in the original release.
Fitch Ratings has affirmed Bright Scholar Education Holdings Limited's Long-Term Issuer Default Rating (IDR) and senior unsecured rating at 'BB-'. The Outlook on the Long-Term IDR is Stable. The 'BB-' rating on the company's USD300 million 7.45% senior notes due 2022 has also been affirmed.
The affirmation and Stable Outlook reflect our expectation that Bright Scholar will maintain a solid financial profile as the resilient domestic K-12 business provides buffer against deterioration in overseas operations caused by the coronavirus pandemic. However, rating headroom has reduced following its overseas expansion, which increased leverage and weakened cash flow generation.
We believe Bright Scholar's business will be able to recover to pre-Covid-19 levels given the strength of its brand, close relationship with Chinese homebuilder Country Garden Holdings Company Limited (BBB-/Stable) and positive industry dynamics.
The ratings on Bright Scholar reflects the company's solid market position as the largest operator of international and bilingual schools that cover kindergarten to 12th grade in China by enrolment. The ratings also incorporate the education industry's positive growth prospects and stable cash flow generation, the company's synergistic relationship with Country Garden. The ratings are constrained by the company's relatively small operating scale and lower cash flow generation.
Key Rating Drivers
Resilience on K-12 Education: Fitch believes steady growth in Bright Scholar's domestic K-12 education business will support its cash flow and make its credit profile more resilient against disruptions in its overseas operations due to the pandemic. Its unutilised capacity of around 25% as of September 2020 and additional capacity from new schools will provide ample room for growth.
Increase in Enrolments Domestically: Bright Scholar's close strategic relationship with Country Garden and operation of most of its K-12 schools on Country Garden properties supply the education company with new students. Student enrolment in its K-12 schools continued to grow over the past few years. The number of students in its international schools rose by 10.5% in the first quarter of the financial year ending August 2021 (FY21), in its bilingual schools by 8.4% and in its kindergartens by 16.3%.
Covid-19 Impact: The coronavirus pandemic in the UK has a large impact on Bright Scholar's overseas school operations as seven of its eight overseas schools are in the UK. We expect revenue from overseas schools to drop sharply in FY21 as a result of a 30% decrease in student enrolment and loss of the majority of boarding and meal fees due to the closure of campuses.
In contrast, Bright Scholar's school operations in China returned to normal in June 2020. We expect revenue to grow by the low single digits in FY21, driven by stable growth in the domestic K-12 business and complementary education services.
Positive FCF: Fitch expects Bright Scholar to generate positive free cash flow (FCF) despite the impact of the coronavirus. This is supported by stable and recurring cash flow from its domestic K-12 schools, growth in its complementary education services and moderate expansion of schools under an asset-light model, which limits capex. The company has a clear deleveraging path after the pandemic, with FFO adjusted net leverage trending towards 2x along with the recovery in its overseas operations.
Profitability Under Pressure: Fitch expects weakness in the overseas operations to weigh on Bright Scholar's overall profitability, with EBITDA margin narrowing by 3pp to 14.3% in FY21 by our estimate. The increasing number of low-profit kindergartens in the portfolio will pressure profitability in the medium term. The company has taken steps to reduce costs and improve operational efficiencies, while utilization increased with the ramp-up of new schools. These will partly offset the impact of lower margins from its overseas schools and kindergartens.
Slower Acquisitions: Fitch expects Bright Scholar to be financially conservative and reduce acquisitions in the next year or two due to uncertainty related to the coronavirus. The company's recently acquired businesses overseas have diversified its portfolio, but weighed on its financial profile given deteriorating performance amid the Covid-19 pandemic. In the medium term, we expect the company to seek growth opportunities in complementary education and overseas schools to complement its K-12 education services.
Regulatory Uncertainty: The private education sector in China is highly regulated and subject to stringent scrutiny. Fitch expects current regulations to have limited impact on Bright Scholar's existing school operations, but regulatory risk exists as the rules are evolving rapidly.
Proposed regulations will limit Bright Scholar's ability to acquire kindergartens and schools providing compulsory education as it is a listed company. In addition, tightened restrictions over kindergartens' pursuit of profits and the government's goal of increasing the number of low-profit kindergartens to 80% of the total will negatively affect the margin of Bright Scholar's kindergarten business.
Bright Scholar has slightly smaller EBITDAR scale and weaker profitability than Chinese private-school operator Wisdom Education International Holdings Company Limited (BB-/Stable). Bright Scholar is more diversified than Wisdom Education in terms of school locations and education formats, but its overseas operation has been disrupted by the coronavirus and weighs on Bright Scholar's cash flow generation.
Bright Scholar has stronger FCF generation due to its asset-light model, supporting its deleveraging path after the pandemic, while Wisdom Education's leverage is likely to stay high due to negative FCF.
Fitch's Key Assumptions Within Our Rating Case for the Issuer:
- Single-digit revenue growth in FY21, improving to low-teens in FY22, driven by organic growth and recovery in overseas operations
- EBITDA margin of 14% in FY21 due to the impact of the coronavirus pandemic, and gradually improve to 19% by FY24 (FY20: 17.1%)
- CNY300 million in capex in FY21 and CNY500 million-600 million per year in FY22-FY24 (FY20: CNY150 million)
- Acquisition payment of CNY50million in FY21
- No dividend payment
Factors that could, individually or collectively, lead to positive rating action/upgrade:
- Positive rating action is not expected in the medium term until Bright Scholar achieves a substantially larger operating scale without material deterioration in its financial profile
Factors that could, individually or collectively, lead to negative rating action/downgrade:
- Significant deterioration in operating performance
- FFO adjusted net leverage sustained above 3.0x (FY20: 2.3x)
- FFO fixed-charge coverage sustained below 2.0x (FY20: 2.2x)
- Evidence of greater government, regulatory or legal intervention leading to an adverse change in the company's operating and business profile
Best/Worst Case Rating Scenario
International scale credit ratings of Non-Financial Corporate issuers have a best-case rating upgrade scenario (defined as the 99th percentile of rating transitions, measured in a positive direction) of three notches over a three-year rating horizon; and a worst-case rating downgrade scenario (defined as the 99th percentile of rating transitions, measured in a negative direction) of four notches over three years. The complete span of best- and worst-case scenario credit ratings for all rating categories ranges from 'AAA' to 'D'. Best- and worst-case scenario credit ratings are based on historical performance. For more information about the methodology used to determine sector-specific best- and worst-case scenario credit ratings, visit https://www.fitchratings.com/site/re/10111579.
Liquidity and Debt Structure
Strong Liquidity: Bright Scholar had CNY3.8 billion of cash and short-term investments as of November 2020, which is more than sufficient to cover its short-term bank borrowings of CNY945 million. Bright Scholar has demonstrated access to offshore capital markets. It completed an equity placement in 2018 and issued a USD300 million bond in 2019.
Summary of Financial Adjustments
Fitch has chosen to use the multiple approach to capitalise leases for Bright Scholar and assess leverage on an adjusted leverage basis. We think the multiple approach is more appropriate for education services companies under the Generic Navigator, like Bright Scholar, as leasing school and facility premises form a core element of its operations. A multiple of 8x was used as the company is based in China.
Bright Scholar typically collects tuition and fees at the beginning of the semester and there is usually a large "contract liabilities" on its balance sheet. We have classified part of cash that is not expected to generate EBITDA (i.e. contract liabilities * (1-EBITDA margin)) as "not readily available", and this amount is excluded from net debt calculations.
REFERENCES FOR SUBSTANTIALLY MATERIAL SOURCE CITED AS KEY DRIVER OF RATING The principal sources of information used in the analysis are described in the Applicable Criteria.
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Bright Scholar Education Holdings Limited; Long Term Issuer Default Rating; Affirmed; BB-; Rating Outlook Stable
----senior unsecured; Long Term Rating; Affirmed
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