IDP Education’s (ASX:IEL) share price has declined from around the $26 mark since the release of full year results in August. Market concerns about the outlook for IELTS volume growth has been the key Company-specific factor. More broadly, overall weakness in equities markets (especially for high P/E stocks such as IEL) have also weighed on the shares.
In context, IEL’s P/E multiple is at the bottom end of the range over the last four years. Are market concerns about the outlook for IELTS volume growth starting to be mostly factored into the share price? And what are the catalysts for a recovery in the share price?
About IDP Education
IDP Education (IEL) 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. Cambridge Assessment designs/creates the test materials. This test is predominately focussed 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. IEL is the largest student placement agent in Australia with ~23% market share.
Key Fundamental Drivers
Pricing Power Evident Across Both Divisions
During FY23, Average student placement fees increased +7%. This growth was driven by commission rate increases and higher tuition fees. The Company noted improved conversion rates from the use of Artificial Intelligence and lead indicators remain at record highs, with leads +26%, applicants +40% and course enrolments +53%. These trends underpin the expectation for further pricing growth.
In the IELTS business, lower volume growth was significantly offset by pricing increases. Increased investment in marketing and a fee increase from Cambridge is expected to result in margin contraction in FY24. However, this is expected to be mitigated to some degree by pricing growth. This is despite subdued volume growth, given that discounting is rarely used given market structure / demand inelasticity to price.
Operating Leverage to Continue
As has been the case with recent financial results, operating leverage was evident in FY23, with EBIT growth of +39% outpacing revenue growth of +24%.
At the FY23 results release, the Company provided guidance for operating expenditure growth to be towards the upper end of +10-15% growth. In context, the step-up in costs is considered necessary to support future revenue growth. Importantly, the Company has a track record of achieving operating leverage.
To this end, we consider IEL to be well positioned to deliver substantial operating leverage as the Student Placement gains further scale, and on the back of ongoing investments into technology. In particular, IEL’s Fastlane technology has enabled market share gains, primarily in Australia and has further growth potential. Notably, FastLane currently only accounts for ~10-15% of total offers. FastLane also generates a higher conversion rate to student enrolment compared to offers not generated via FastLane.
Importantly, the stronger operating leverage generated from Student Placements is expected to overcome margin weakness in IELTS. In particular, IELTS margin is expected to contract given elevated competition in FY24 following the additional Pearson test approval in Canada from August 2023. The Company also flagged volumes will be subdued as a result of competitive pressures.
Balance Sheet Position Remains Solid
The underlying balance sheet position has minimal gearing but is typically stronger than that reported by the Company at period end. This is due to adverse working capital movements as a result of strong growth in student placement revenue, which is booked ahead of university invoicing.
Importantly, the strong balance sheet position enables the Company to internally fund a multitude of capital expenditure requirements. These include IDP Live and Fastlane, IELTS platform modernisation and a refresh of IT assets.
We highlight several catalysts for the shares over the short-to-medium term:
i. Ongoing recovery in Student Placement volumes, combined with strong market share gain opportunities.
ii. A strong competitive position in IELTS, where pricing power remains. This provided upside to group margin as IELTS volumes recover towards the Company’s target growth rate of high single-digit over the medium term.
iii. Upside to consensus EPS growth forecasts (+12% for FY24; +18% over FY23-26 on a CAGR basis). This is due to the likelihood of IEL using its under-geared balance sheet position and/or re-investing free cash to pursue Merger & Acquisitions.
After breaking an obvious support level near $26 in May, the shares fell sharply towards $21. They managed to recover but in late August, when it got back near $26, the selling kicked in and the share price headed back towards $21 again. Price action has recently looked encouraging and there appears to be a good chance that IEL has found some support and should head higher again. Initial stops should be considered just under $21. We expect IEL to attempt another retest of the $26 area.
Michael Gable is managing director of Fairmont Equities.
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