Back to School: How to Play Growing Student Loan Debt for Profits

By Bill Edson - October 24, 2012 | Tickers: APOL, BPI, DV, ESI, STRA | 0 Comments

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Is there a bubble in for-profit education? Though many students benefit from these institutions, there are many who emerge from them saddled with debt and without jobs.

The growth of for-profit colleges has been rapid and is not sustainable. Enrollment is dropping, and many stock prices are falling as well. In such a challenging environment, investors must demand low valuations for any investments.

Mounting Student Loan Debt

The Institute for College Access and Success reported that student debt burdens continued to rise in 2011. Students who earned bachelor degrees using student loans graduated with an average debt of $26,600 in 2011. This was an increase of 5% over the $25,250 average in 2010. The report also found that two-thirds of students take education loans for their studies.  

Different states had different statistics. New Hampshire was one of the leading states in terms of highest debt, whereas Utah had the lowest amount of debt. State averages of student loan debt at graduation ranged from $17,227 to $32,450.

Outstanding student loans have reached a total of $1 trillion. This is due to the rapid increase in college fees and a competitive job market that directs students towards more education as a requirement for employment. Sadly, more than one out of every ten students with student loans defaults, as per the latest statistics released by U.S. Education Department for the 12 month period ended Sept. 30, 2011. Student loan information was compiled through data from federal and survey of 1,057 schools, which included loans from public and non-profit colleges. Default rates could be higher if for-profit schools were included.

Enrollment Down

Apollo Group (NASDAQ: APOL), the parent company of the University of Phoenix and the largest for-profit college in the U.S., fell after it announced lowered revenue guidance for fiscal 2013. Revenue guidance was projected by the firm to between $3.65 billion and $3.8 billion for Apollo’s fiscal year-end in August 2013. This range is much lower than the $4.07 billion average of prevailing analyst estimates. This drop was extrapolated from a 14% decline in University of Phoenix student enrollment.

In response, the University of Phoenix plans to close 25 campuses and 90 learning centers, actions that will affect 13,000 (4%) of its students enrolled in degree programs.  Cuts include 800 positions nationwide and are expected to save Apollo Group $300 million.

Spokesman for Apollo Group Alex Clark said, “These eliminations will happen over the course of the coming year, as it will take some time to phase out these campuses and learning centers.”

Unlike many organizations, the University of Phoenix system is well poised to make good on its downsizing plan. Many of its staff work part-time as contractors. Its learning centers are often little more than extensions and auxiliary classrooms for its campus network. Moreover, many of the students who will lose access to physical classrooms can either supplement or replace their course load with online courses offered by the University of Phoenix.

Wells Fargo Securities senior analyst Trace Urdan readily incorporated these cuts into his forecasts. His analysis revealed that they were an appropriate response to declining enrolment. All in all, he concluded, “The net result is that our fiscal year 2013 earnings per share estimate moves to $3.05 from $3.45 and our FY2014 estimate moves to $3.19 from $3.84. Our valuation range moves comparably lower to $35-39 from $37-41.”

This reduced forecast hardly justifies the 60% year-to-date decline for Apollo Group's shares.

Value Buy or Value Trap?

Piper Jaffray analyst Peter Appert warned, “Education stocks are value traps, burdened by a downward bias in estimates, limited enrollment visibility and increasingly intense competitive dynamics.”

With this in mind, investors should carefully weigh the investment metrics of different firms in this space:

Fortunately, many of these stocks are trading at appropriate valuations. Apollo Group, Bridgepoint Education (NYSE: BPI), and DeVry (NYSE: DV) are all trading at low price multiples. They are turning a profit, produce positive free cash flows, and have manageable levels of debt. Value investors should consider placing small investments in these firms since they are likely to survive. It will be a bumpy ride, but there is a need for colleges like these to help high school graduates enter the workforce.

Other firms on this list are not attractive because they are not cheap enough for their industry’s gloomy outlook. Grand Canyon Education and K12 have price-to-earnings multiples that are in excess of the price-to-earnings ratio--this is unacceptable. Strayer Education (NASDAQ: STRA) and ITT Educational Services (NYSE: ESI) have price-to-book ratios that are very high, much higher than peers. This is troubling, since the assets of these firms are not going to be worth much upon liquidation since other buyers would be primarily other for-profit schools. ITT Educational Services and Strayer Education are also unattractive and risky based on their debt loads.

Conclusion

This industry will be rocky for the foreseeable future. However, three stocks appear attractive based on their financial metrics. Apollo Group, Bridgepoint Education, and DeVry are interesting, risky, and contrarian picks.

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