IDP Education’s future looks bright, despite the share price fall

IDP Education (ASX: IEL) has just reported its half-year results, which came in below market expectations, largely due to COVID-related restrictions. The initial market reaction was quite severe, pushing the share price well below its November 2021 high. IDP has a solid pipeline of leads and, with borders reopening, the future is looking bright.

IDP’s results were below market expectations primarily the consequence of ongoing COVID-related restrictions in South East Asia lowering university student placement volumes and English Language Teaching revenue. Equally unhelpful was the company’s habit of exceeding its own guidance and analyst expectations. Consequently, broker expectations were arguably optimistic. 

The perennial rhetorical question in these situations is always the same: when a company misses analyst expectations, who’s fault is it – the company’s or the analysts’? The company reported higher capital expenditure but better than expected free cash flow. The company ended calendar 2021 with net cash of A$47 million.

At the time of writing, IDP’s share price is 23% below its peak on 17 November 2021. We believe IDP is a very high-quality company, however, and despite recent falls, the shares don’t represent a bargain.

Inevitably, analysts will lower or ‘downgrade’ their short-term forecasts, however, we expect the impact to be temporary. Once the market appreciates the scale of the opportunity – from raising prices and margins in the India International English Language Testing System (IELTS) business, and from growing student placement volumes as Australian, UK, Canadian and US borders reopen fully, and universities chase international student revenue – we believe more optimistic forecasts will be re-integrated into analyst thinking.

IELTS operations

The first half of FY22 revenue was slightly below market expectations. Excluding the strategic acquisition of the British Council’s stake in the India IELTS operations, revenue increased 34.3% year-on-year to A$212.6 million and has now almost returned to pre-COVID revenues A$215.3 million (1H20). Volumes increased 78.8% to 966,000, well above forecasts. The average revenue per test was a lot lower than forecast due to the higher proportion of tests taken in India.

Tests in India are priced around A$100 less than the global average of A$325. The Average Revenue Per Test was also impacted by a 20% fall in the royalty received from British Council (BC) on tests in China. Chinese volumes also declined by 20% due to China’s COVID-19 zero policy and restrictions on movement and test centre openings.

This is expected to recover in the medium term.

Positively, IDP has upgraded its expected cost synergies from the BC acquisition, from A$20 million in total to A$10 million in FY22 (A$4 million realised in 1H22) and an additional A$20 million in FY23. In other words, a total A$30 million is now expected from synergies alone.

The synergy target does not include the benefits from raising prices, on the one-million IELTS test administered by IDP in India, toward the global average. While IDP will never fully close the A$100 gap, it is reasonable to expect it to reduce it by A$30-40 over three to five years given it was the price tension between IDP and British Council historically that prevented IDP from raising prices. Such a price move would add A$30-40 million to IDP’s EBIT over time.

Combined with the synergies, there’s potentially an additional A$60 million flowing to IDP’s IELTS business over time.

We however don’t expect revenue benefits until the back-end of FY23. As part of its acquisition terms, IEL agreed not to raise prices materially in the short term.

IDP management stated they expect gross margins to improve in 2H22 to around 43 per cent, from 42.2% in 1H22. This will add approximately A$2-3 million to gross profits in 2H22. Because we have hitherto assumed the full-year impact from the British Council acquisition to dilute gross margin to 41.8% in 2H22, the statement from management is a positive surprise.

In summary, the above factors point to meaningful upside potential for the IELTS operation’s earnings over the next three to five years.

Additionally, there’s the potential for more acquisitions from British Council over time.

Student placement operations

Multi-Destination student volumes largely explain the disparity between the results and the market’s expectations. Volumes were very strong, rising 62.3 per cent year-on-year, but the market had assumed an even larger increase given the demand for positions that have flowed over from a locked-down Australia into the UK and Canada.

One possibility could be the strength in Canadian placements. Historically, the UK has accounted for most volumes for the multi-destination business, hence volume had a 1H skew. But now, Canada is generating similar volumes, with growth into Canada (+71%) stronger than into the UK (+37%).

Canadian placements are skewed more to the second half (60%), rather than the first half (40%) according to the company. The UK however is skewed 65% first half, compared to 35% for the second half. The combination of growth and individual country skews will balance volumes more equally between 1H and 2H in the future.

Based on 1H22 volumes, and assuming a 40/60 split in Canada and 65/35 in the UK, 2H22 volumes would be around 18,500 – about 4000 higher than estimates.

Average Australian commissions per placement were marginally below estimates due to a lack of value-added services commissions in Australia. A mix-shift toward postgraduate (from 51% to 62% of volumes) was a positive for commission rates offsetting the negative mix from a higher proportion of Canadian placements.

Management expects to realise A$6.4 million of additional revenue from higher commissions in FY22, with A$4 million of this already achieved.

IDP has opened 23 new offices in India in 1H22 taking the total to 64. These are in second-tier cities where IDP has historically been unrepresented. These offices will be small but will offer the opportunity to materially increase market capture and share over the medium term. To enhance its capacity and scalability in India, IDP is investing in a centralised processing centre, reducing the administrative burden on counsellors.

The company is also about to go live with offices in Nigeria, which is the third-largest source of international students for UK universities.

IDP management noted they have never seen such a supportive environment for chasing student volumes, one where all destination markets have very pro-student visa and work-rights regulations.

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