Shares in IDP Education (ASX:IEL) have weakened from a recent high of around $27. This was following recent market weakness that impacted high P/E stocks and technology-based stocks such as IEL. Prior to the recent weakness, we had reviewed the Company and concluded that the fundamentals were strong enough to warrant a positive view. We just needed to see some support get established on the share price chart. Have the recent events changed our view and is the current weakness an opportunity to enter a quality high-growth stock?
About IDP Education
IDP Education operates English testing as a co-owner of the largest global English proficiency test, International English Language Testing System (IELTS). The IELTS agreement runs under a co-ownership agreement between IEL, the British Council, and Cambridge Assessment, in equal shares. IEL and the British Council are responsible for operating and distributing the test, while Cambridge Assessment designs/creates the test materials. This test is predominately focused on applicants who use this test as a prerequisite for study, work and migration.
The Company is also the largest international provider of student placements into tertiary educational institutions and is the largest student placement agent in Australia with ~23% market share.
Key Fundamental Drivers
Strong Underlying Volume Trends in Core Operations
Volumes from IELTs have returned to pre-COVID levels (we estimate ~5% above), with IEL noting strong IELTS volume growth in most markets, as structural demand growth remains a tailwind.
IEL expressed confidence in a strong rebound in Australian student placements from 2H22, returning to a normalised environment. Volumes for Australian student placements are expected to reach ~20,000 by the end of FY22. However, this is still well below the previous peak of ~30,000 in calendar year 2019 (i.e. pre-COVID). There is a strong possibility that student placements in Australia may increase above pre-COVID levels as demand catches up following the reopening of international borders.
Multi-destination student placements have comfortably exceeded pre-pandemic peak of 27,400. Overall, IEL’s volume growth for multi-destination student placements is expected to continue above system as it grows share towards the 20-25% seen in Australia.
Potential for Operating Leverage to Accelerate
The 1H22 result showed evidence of operating leverage. EBIT growth of +71% vs 1H21 outstripped revenue growth of +47%, despite IELT gross profit margin dilution due to the British Council India acquisition. In context, 1H22 revenue was 25% below that for the full FY21 period. However, EBIT was 12% higher. Accordingly, operating leverage is an important factor underpinning consensus EBIT growth estimates of +30% to FY24 on a CAGR basis.
Importantly, operating leverage was achieved despite an increase in overhead costs. The overall cost increase was +34%, with marketing expenditure increasing by 73% reflecting a focus on building the pipeline for incoming demand. Occupancy costs increases 18%, largely reflecting the inclusion of higher office overheads from the BC India acquisition.
Operating leverage over the medium term is expected to be underpinned by:
i. IELTS online launch – IEL is launching an online version of the IELT which accepted for university entrance. This will allow IEL to enter geographies without a physical presence and provides students an alternative to computer delivered centers or paper-based tests.
ii. IDP Live – This is a key platform that guides students down the funnel towards enrollment and offering deeper insights for universities. There has been encouraging progress to date, with 27 universities on board at 500,000 downloads. The Company is targeting 60 universities by the end of calendar 2022.
iii. Delivery of upgraded synergies from the British Council India acquisition – The integration of the BC India acquisition has progressed ahead of the Company’s initial expectations. Accordingly, the synergy target has been upgraded from A$6-8m to A$20m.
Balance Sheet Capacity to Pursue Growth
The net cash balance of $48m as at 31 December 2021 was lower that the balance of $250m as at 30 June 2021. This was primarily due to the completion of the BC India acquisition utilising cash reserves ($159m) in excess of the drawn debt ($100m).
Notwithstanding the decline in net cash levels, the balance sheet remains in a strong net cash position to pursue further acquisitions and organic growth in its core operations of IELT, student placements and education technology.
Is the Change in Leadership a Concern?
On 11 May, the Company announced that Andrew Barkla (CEO and MD) will step down from his current role in September 2022, after more than seven years in the position. Mr Barkla will continue to assist IEL in an advisory capacity for a further 12 months (until September 2023) to assist with key strategic projects and then intends to move to the Board as a non-Executive director. Mr Barkla is highly regarded and while his impending departure is a negative, we do not expect a material change in the future structural direction of the Company.
IEL’s 1-year forward P/E multiple has declined from ~90x in November 2021 to ~39x at present, which is well below the range over the last two years.
However, this multiple is not overly demanding in the context of consensus EPS growth forecasts of +70% from FY21 to FY24 on a CAGR basis. This may well be augmented by EPS-accretive acquisitions given current balance sheet capacity.
Importantly, long-term structural growth in international student volumes and IELT testing demand should drive earnings growth beyond FY24.
The decline seen earlier this year resulted in IEL finding some very strong support near $25. However, after bouncing from that level, it was unable to make a higher high, which has left it with a double top (arrows), and that was a potential sell signal. The share price then started to ease back again and that ultimately led to a break under $25. Price action is looking negative for the time being, with nearest support now back at $20. Investors can therefore be patient and wait for lower levels.
Michael Gable is managing director of Fairmont Equities.
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