Is There Value in this Hated Sector?
Chad is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
I would suggest that outside of the banking industry there might not be a more hated sector of the market than the for-profit education sector. Whether it's an article like I've written before about loans “exploiting” students, or the educational institutions, there isn't a lot of positive press about these companies. With a contrarian's bent, I decided to see if one of the companies in this industry could be a good investment. As long as unemployment remains high, there will be a place for workers to go to schools to learn a new trade. Even if unemployment improves, these institutions offer flexibility in learning that many local colleges and universities can't match.
There are three names that are brought up consistently in the for-profit education sector: Bridgepoint (NYSE: BPI), ITT (NYSE: ESI), and Strayer Education (NASDAQ: STRA). Each of these companies came to my attention through different sources. I actually owned ITT for about a year before selling the shares. I originally bought the shares because I remembered ITT's commercials, and I reasoned that with high unemployment, ITT should benefit. Bridgepoint came to my attention through multiple informative articles on The Motley Fool. Strayer is a long-term name in this field, and for a while you couldn't turn on the television without seeing an ad for Strayer. You would think that three companies in the same industry would share similar characteristics. If that's your assumption, you are way off. This is the story of the grower, the slower, the payer.
The growth story in the for-profit education field is Bridgepoint. The company sells for just a little over 8 times forward earnings estimates, and is expected to grow EPS at over 17%. While the company doesn't pay a dividend, I'm sure growth oriented investors are fine with that, if the company continues to beat earnings estimates. In the last year, the company has actually beaten estimates three out of four quarters. With the company generating over $186 million in free cash flow last year, and no debt on the balance sheet, there is a lot to like about Bridgepoint's story.
I call ITT the slower because the company's growth rate has been cut dramatically over the last few years. I owned ITT about two years ago, and at that time analysts expected over 15% growth in EPS. The company turned in a few uninspiring quarters, and I sold my shares when I realized my investing thesis was wrong. While the company has managed to beat earnings expectations in two of the last four quarters, investors are haunted by these negative surprises in the past. The fact that ITT was cash flow negative last year isn't as worrisome, only because the company carries virtually no long-term debt. Even with the stock selling for just 10 times forward earnings, it doesn't seem like a bargain because earnings growth is expected to come in at 7.7%. The company does pay a dividend which helps to prop up the stock price, but at 2.10% there are better options available.
If you are an income seeking investor and want a stock that gives you exposure to the for-profit education field, Strayer is the way to go. The company is valued more highly than either Bridgepoint or ITT. However, a respectable growth rate of 8%, and a 4% dividend are solid reasons why. Not only is the dividend the highest of the three companies, but last year this payout only used 39.48% of free cash flow. In theory, this argues well for future increases. In addition, Strayer is no slouch when it comes to earnings performance, as the company beat estimates in three of the last four quarters. Additionally, the company is very efficient with its assets in creating free cash flow. In the last year, Strayer generated more free cash flow per $1 of assets ($0.54), than either Bridgepoint ($0.30), or ITT (negative). If there is a hole in the Strayer story it is the company's balance sheet. Strayer carries $62.5 million in long-term debt versus $56 million in stockholders equity. This would be more worrisome, but the company does also have over $52 million in cash. With strong free cash flow, and nearly the same amount of cash as debt, Strayer's not in any trouble. What is troublesome is the trend with student lending.
Investors need to be aware that financing for students is going to get tougher to find and afford. With all of the negative press, companies like JPMorgan Chase (NYSE: JPM) are cutting down their student loan portfolios. In fact, starting July 1 if you are not a client of the bank, JPMorgan won't consider offering you a student loan. With the possibility of the Consumer Financial Protection Bureau looking into these lending practices, it's possible that more lenders will take a step back as well. Additionally, student lending is normally tied to short-term interest rates, and as rates eventually rise this will directly affect variable rate student loans. Even with these potential issues in the future, I'm sure the government realizes it's in everyone's best interest to make student loans as affordable as possible. I also find it interesting that though this segment of the market gets a lot of negative press, in two out of the three stocks we've looked at I see opportunity. It just goes to show, you learn something new every day.
MHenage owns shares of JPMorgan Chase & Co. The Motley Fool owns shares of Bridgepoint Education and JPMorgan Chase & Co. 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.If you have questions about this post or the Fool’s blog network, click here for information.