IDP Leveraging the Growth in Demand for Education

IDP Leveraging the Growth in Demand for Education

IDP Education listed on the ASX under the stock code IEL in the latter part of last year.  Education Australia, which comprises 38 Australian Universities owns 50 per cent of IDP, and has agreed to escrow this shareholding until the release of the FY 2016 results in August.

The IPO was facilitated by SEEK selling its 50 per cent shareholding in the company to investors at A$2.65 per share. Since listing, the share price has increased 60 per cent to A$4.25.

IDP has four business units with the English Language Testing and Student Placement divisions accounting for more 90 per cent of the Company’s revenue and gross profit.  The English Language Teaching and Event Management Divisions account for the balance.

IDP co-owns the International English Language Testing System (IELTS) high stakes English language test with its developer, Cambridge Assessment and the British Council.  High stakes English language tests are used as a pre-requisite for foreign applicants and is set by tertiary institutions as well as by companies and immigration departments in English speaking countries.  A test score of at least 6-7 out of 10 is generally required to apply to various institutions, to obtain visas and to be qualified for certain jobs.

IDP operates and contracts 400 test sites in over 50 countries, mainly in Asia and the Middle East.  IELTS is the dominant high stakes English language test, with around 60 per cent market share.  Of the 2.7 million IELTS tests administered in FY15, IDP administered 826,000 or 31 per cent.  Over the last 12 years, the number of IELTS tests taken each year has grown at a compounding rate of 17 per cent. The average revenue per test is around $250, which is expected to deliver $241 million of revenue in the year to June 2016.

Operating costs are largely variable, including a royalty paid to Cambridge Assessment, currently estimated to be around 30 pounds per test, and direct fees paid to the test sites, many of which are operated by third parties.

The Student Placement division markets tertiary education courses at over 600 institutions based in Australia, the US, the UK, Canada and New Zealand, to overseas students, as well as providing counseling and visa application services to prospective students.  IDP sources students through 89 offices across 30 countries.

Importantly, as it deals with full fee paying international students, IDP has no exposure to the current investigations into VET FEE HELP payments and resulting regulatory uncertainty that are significantly impacting stocks like VOC, ACO and IQE NZ as well as others.

In 2012, Asia accounted for 52 per cent of the 4.5m foreign student enrollments, and with the strong development of their middle class, the International Education Advisory Council estimates international student numbers will grow at an average 5 per cent per annum over the next five years.

International student enrollment numbers peaked in Australia in 2009 at nearly 600,000.  The tightening of visa regulations, the alteration of student’s working entitlements and the appreciation of the Australian Dollar, saw this number decline to 480,000 by 2012.  Government implemented reforms streamlining student visa processing combined with the provision of increased post-study work entitlements to certain graduates and the decline of the Australian Dollar has since seen the enrollment numbers recover to near the 2009 peak.  The Australian Government is focused on growing the international student market, which is now an A$18 billion export industry.

In the first quarter of 2016, international student enrollments in Australia increased 14 per cent on the prior year according to Government data, with Chinese arrivals increasing 18 per cent and Indian arrivals up 31 per cent. These are both key markets for IDP.

IDP generally receives a fee that is determined as a percentage of the first year’s tuition, while operating costs are largely denominated in the local currency of the source market.  Operating costs are expected to be higher than normal in FY16 with IDP acquiring Beijing Promising Education in May 2015, which included 11 new offices in China.  IDP has also recently opened a number of new offices in India to support future growth.

IDP’s prospectus forecast for Earnings before Interest and Tax in the year to June 2016 is $50.5m. The business has a relatively capital light business model – management believes sustainable maintenance capital expenditure is around $6 million per annum.

Potential investors, however, should be aware of two points.  The first is the Company hedged its British Sterling cost base for FY16 at GBP0.545, using 12-18 month forward contracts, and this compares to the current rate of GBP0.499, a 9 per cent increase.  This provides a one off benefit to the FY16 earnings forecast in the prospectus of around A$4-5m, and should drop out in FY17.

At the current share price, prospectus forecasts would indicate that the stock is trading on 30 times FY16 EPS and 20.7 times EBIT. While these multiples look pretty full, if we strip the one off benefit from the FX hedging gain out of the prospectus forecasts, the PE increases to almost 33x and the EBIT multiple to 23 times. Even if we account for increases in consensus earnings forecasts relative to prospectus, the earnings multiples are high.

The second is the very gentle hurdle rate for the long term incentive plan designed for the Company’s executive team, as well as the degree in which the strike price of the options are well “in the money”. Management will be rewarded with their full long term incentive plan entitlement if the total shareholder return is greater than 8 per cent a year and net profit grows by more than just 6 per cent a year over a 3 year period. The low hurdles are totally inconsistent with the growth rates implied by the earnings multiples on which the stock is currently trading.

The performance of the stock since listing shows the scarcity of companies with long term growth opportunities. We like the long term outlook for the company, and the benefits that are likely to flow from increased demand for tertiary education from international students. However, at current prices the stock is factoring in a lot of earnings growth upside.

Stuart Jackson is a Senior Analyst with Montgomery Investment Management. To invest with Montgomery domestically and globally, find out more.