Kip McGrath Education Centres (ASX:KME) sells franchises and provides services to more than 550 franchises globally in the afterschool tuition sector. On the face of it, Kip McGrath’s 2016 financial year result was underwhelming. Revenue was down 2.2 per cent, to $14.6 million, and earnings before interest, tax, depreciation and amortisation (EBITDA) was up a mere 4 per cent to $2.1 million. The headline numbers, however, hide some important facts. In the full article below, we explain why the Kip McGrath share price doesn’t add up.

Revenue was suppressed because of the change from reporting gross to net lesson fees in Australia, an accounting change which had no effect on profits. Operationally, ongoing franchise fees increased 21 percent on the previous corresponding period, as Kip McGrath continued to transition franchises from a fixed fee to a percentage-of-revenue model. EBITDA was suppressed due to a number of one-off costs ($400,00 on licencing, $200,000 on legal fees and other expenses) which won’t be repeated in the 2017 financial year.

At the same time, Kip McGrath is confident that a national marketing campaign and a relaunch of its online effort will produce higher revenues in the coming year. Taking a conservative approach to adding back costs and assuming a small amount of growth (with nothing for online), we believe Kip McGrath could deliver +20 percent earnings per share growth in the 2017 financial year. At present, Kip McGrath is trading on less than 10x P/E 2017 financial year, with a dividend yield of 6 per cent. We believe that KME is worth +45c. If the British pound weakens or online starts to deliver, then KME’s valuation could be much higher. The maths is simple: sooner or later the market will realise that Kip McGrath’s current share price doesn’t add up.

Article contributed by Pie Funds:  (VIEW LINK)