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Who's the dux of the education sector? As seen in September Equity Magazine

By James Greenhalgh, Senior Analyst at Intelligent Investor

The verdict is in – international students already think Australia is the clever country. Australia earns more than $20bn in export revenue from education, making it the country’s third-largest export industry behind coal and iron ore.

Demand is booming, with 13% growth in the number of international students over the past year. The weakening of the dollar since 2013 means Australia is now much better value for studying, but that’s not all. Our high-quality universities, laidback lifestyle and reputation for safety make for an attractive destination.

What’s good for students might be even better for investors in ASX-listed companies. So what opportunities exist in Australia’s higher education sector?

For such an important sector there are fewer quality investment candidates than you might think. Indeed, there are only two higher education-focused companies in the S&P/ASX 200 index – and one of them listed last year.

The main reason is that higher education is still largely the preserve of government. Our 43 universities provide degrees, while state-based technical and further education colleges (TAFEs) provide much of Australia’s vocational education and training (‘VET’).

The two elephants of the education sector, Navitas and IDP Education, mainly provide services to international students before they attend university in Australia or other countries.

Navitas partners with universities in Australia and overseas, preparing international students for their degrees. The universities obtain access to a steady flow of international students, while the students are eased into university life at their chosen destination. It’s been a successful and lucrative model, with Navitas’s main business – University Partnerships – growing its operating earnings (before depreciation and amortisation) from $48m to $137m over the past 10 years.

The company’s main risk is that its university partners decide to operate student preparation programs themselves. Running programs in-house means the universities retain tighter control over education standards, as well as gaining access to a lucrative fee stream. Macquarie University took its program back in-house this year and, while Navitas’s diversification ensured earnings fell by only 2%, it’s a risk that might surface again.

Nevertheless, this is a very good business and one to put on your watch list. Whilst currently not cheap enough to buy, the recommendation remains HOLD.

IDP Education has only been listed on the ASX since December 2015 but it has an excellent pedigree and impressive long-term performance. Still 50% owned by 38 Australian universities, IDP runs two main businesses. The first is a student placement service, which sources students from Asia and the Middle East to study at universities in Australia and other countries.

Almost 70% of revenue, however, comes from IDP Education’s co-ownership and distribution of the IELTS ‘high stakes’ English language test. This is no ordinary English test but one of only a few that is globally accepted for university entry, work or immigration purposes.

Not app-y

IDP administers around one-third of the 2.5m tests undertaken annually at a cost of about $260 each. It’s a diversified revenue stream although competition is rising. There’s even an argument that official tests like IELTS and its main competitor, TOEFL, might eventually be displaced by apps such as Duolingo.

That’s unlikely over the next few years but the importance of the IELTS test to IDP’s earnings means the competition will need to be watched carefully. Like Navitas, IDP Education is a high-quality business but not quite cheap enough to buy. HOLD.

So what of the other companies in the higher education sector? Well, there’s daylight between the two elephants and the rats and mice. From here on the risks rise exponentially, so be warned.

Table 1: The candidates

Company

ASX code

Market cap. ($m)

Comment

Navitas

NVT

                              2,192

Reco: Hold

IDP Education

IEL

                              1,067

Reco: Hold

Intueri Education

IQE

                                    28

Not interested

Academies Australasia

AKG

                                    19

Worth further research

Redhill Education

RDH

                                    26

Worth further research

Ashley Services

ASH

                                    30

Not interested

Site Group

SIT

                                  110

Not interested

iCollege

ICT

                                       8

Not interested

UCW

UCW

                                    15

Not interested

The remaining companies are mainly private providers of vocational education, a sector still in its infancy. Unfortunately, government de-regulation of the VET sector a few years back unleashed many opportunistic and untested education providers that flocked to the sector to take advantage of public funding. By 2014 initial public offerings of VET businesses were float-bombing the ASX.

Unscrupulous student recruitment practices, aggressive business models and insufficient attention to long-term reputations was the result.

Former market darlings Vocation Limited and Australian Career Network – both of which floated on the ASX during the 2014 boom – have already gone into administration. Others like Intueri Education Group, remain on life support. The government has since cracked down on the VET sector but the fallout continues.

Few private education providers have emerged unscathed – and the risks remain very high – but a couple of the smaller college operators could be interesting opportunities.

Whilst very small, Academies Australasia Group runs 18 colleges in Australia and Singapore. Debt levels are too high, and the company will report a loss in 2016 but directors are showing confidence by buying shares on market.

Also interesting is Redhill Education, which has positioned itself at the premium end of the private vocational education market and, interestingly, Academies Australasia owns a 10% stake. Redhill’s earnings will fall in 2016 but the absence of debt suggests it’s one of the better quality companies.

Elsewhere, there’s been some director buying in labour hire and training group Ashley Services – another 2014 listing, although management changes and multiple profit downgrades are a worry. Site Group, which provides training to clients in the energy, mining and construction sectors, is still bedding down acquisitions and its international operations add risk. iCollege is apparently ‘positioned to become one of Australia’s leading educators’ but is a very long way from it and UCW’s acquisition-driven strategy isn’t reassuring.

So what can we conclude from this roundup of the ASX-listed higher education sector?

Navitas and IDP Education are the standout candidates for your watch list while the listing of other providers like Study Group – a company similar to Navitas – should deepen the sector. But there are slim pickings from the slew of floats of a few years ago.

The larger companies might end up the big winners. Navitas’s management hinted earlier this year that it might be interested in acquiring vocational training businesses down the track and sector consolidation looks inevitable.

Whilst small now, the private education sector almost certainly has a big future. So keep an eye on the large companies and a few of the promising smaller players.

Disclosure: Staff members may own securities mentioned in this article.This article contains general investment advice only (under AFSL 282288). Authorised by Alastair Davidson. To unlock Intelligent Investor stock research and buy recommendations, take out a 15-day free membership at http://landing.intelligentinvestor.com.au/asa

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