3 Education Companies Trading At Compelling Valuations
Bill is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
For-profit education had a great run as a growth industry. But now that the economy is recovering, the bubble in education is slowing and, in some areas, deflating rapidly. Many potential enrollees are selecting other education options.
The explosive growth of for-profit colleges was not sustainable. In the current, challenging environment investors need to find rock-bottom valuations before taking long position. Fortunately, Bridgepoint (NYSE: BPI), Apollo (NASDAQ: APOL), and ITT (NYSE: ESI) are cheap enough that they are compelling buys in a terrible industry.
Competition from State Schools
Many United States secondary education students are turning towards online programs and tutorials, which are less expensive than brick-and-mortar schools. That is the reason many colleges are turning towards online programs. Colleges like Harvard University and Massachusetts institute of technology are offering online classes for free. Many students are complaining that the for-profit colleges charge them more for their college degrees than online state schools.
As the competition is rising, it is becoming more difficult for state schools to make profits. Apollo group is down by a whopping 65 percent this year citing concerns over increasing competition in this space. However, the management of Apollo feels that they will be able to overcome this rise in competition. Mark Brenner, an Apollo senior vice president says that the company is highly competitive. According to Peter Appert, an analyst at Piper Jaffray, the near term growth story of these state schools will remain weak based on fierce and accelerating competition. He said, “In the old days, they would take anyone who was breathing. If they dropped out after a semester or two, so what? You’ve collected your money.”
Many institutions are cutting down jobs and closing campuses. Many analysts feel that this trend will follow and competition will continue to rise.
Mounting Student Loan Debt
Student loan debt is increasing among college graduates because of a persistently tough job market and rising tuition. An Institute for College Access and Success study revealed that the average student loans balance was $26,600 (among college students with student debt). Sadly, 37.8% of employed graduates work jobs which do not need college degrees.
This study also highlighted the widening gap between a new graduate’s ability to make payment and increasing college costs. Enrollees in 2011 had to borrow more for education because of state budget cuts and fees increases. The mounting debt burden has also been fueled by an increase in federally-funded financial aid.
People are finally starting to question the value of a college education. Such discussions must take note of the higher unemployment rates for high school graduates who lack college education. The college graduate unemployment rate was about one half of the unemployment rate for high school grads: 8.8% versus 19.1%.
Apollo Group shares plummeted after the company lowered revenue guidance for fiscal 2013. Apollo is the parent company of the University of Phoenix and the largest for-profit college in the U.S. Revenues were projected between $3.65 billion to $3.8 billion for Apollo’s fiscal year-end in August 2013. This is below analyst revenue estimates of $4.07 billion. Guidance was lowered because of a 14% decline in University of Phoenix student enrollment.
In response, the University of Phoenix has proposed cutting costs with the closure of 90 learning centers and 25 campuses. These closures will impact 4% or 13,000 students enrolled in degree programs and will end 800 positions nationwide. These changes are expected to save $300 million.
Apollo spokesman 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 cost cutting measures proposed by management teams, these are credible. University of Phoenix learning centers are sometimes little more than campus extensions. Many of its staff work part-time as contractors and can easily be laid off or have their hours reduced. Many students can ease into these changes because they can either supplement or replace their course load with online courses.
Wells Fargo Securities senior analyst Trace Urdan 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.” His analysis revealed that these cuts would be an appropriate response to declining enrollment.
In all fairness, this lowered guidance by itself does not justify the market’s 61% year-to-date decline for Apollo shares.
Searching for Value
Peter Appert warned, “Education stocks are value traps, burdened by a downward bias in estimates, limited enrollment visibility and increasingly intense competitive dynamics.”
Investors must carefully search for discounted stocks in this space:
Some firms on this list are not bargains, and their valuation levels do not justify jumping into such a horrible industry. DeVry (DV) is an industry leader with a high price-to-earnings multiples that are would only make sense for a less-than-terrible industry outlook. It’s a good company in a bad industry trading at a price multiple that is appropriate for a great stock. At current prices, buying DeVry shares is not a deal.
Similarly, Grand Canyon Education (LOPE) has a price-to-earning, price-to-book, and price-to-book ratios that are just too high. There is no incentive for investors to jump into this declining industry at high price multiples.
Strayer Education’s (STRA) price-to-book is high and its long-term debt load is also a little high. Investors should avoid buying Strayer Education until it trades at a substantial discount to the broader market.
Fortunately, a few of the stocks in this distressed industry trade at compelling low price multiples. Bridgepoint Education, ITT Educational Services, and Apollo Group are all trading at low price multiples. Apollo and ITT are earning a profit, generate positive free cash flows, and are partially financed by manageable levels of long-term debt. Bridgepoint is generating a profit, positive free cash flows, and does not rely on long-term debt for financing. These companies are good picks for survival.
Value investors should consider placing small investments in these firms since the industry as a whole is likely to survive in some form. There will be consolidation and many companies will liquidate, but there is a niche for colleges like these to help transition high school graduates enter the workforce.
Since the industry will be rocky for years to come, investors should only buy when presented with bargain valuations. Bridgepoint, Apollo, and ITT are trading at low enough prices to constitute bargains. Investors should only buy them as tiny speculative positions.
BillEdson11 has no positions in the stocks mentioned above. The Motley Fool owns shares of Bridgepoint Education. Motley Fool newsletter services recommend Bridgepoint Education. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!