The Sell-Off of This Educational Stock Is Overdone

Vladimir is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

As the costs of higher education rise, the stocks of for-profit education companies find themselves in trouble. Apollo Group (NASDAQ: APOL) has recently reported its first quarter earnings, showing that new degree enrollment has slumped 24.5%. Investors have punished the company's stock, pushing it down 14% year-to-date. It’s worth noting that the company has beaten earnings estimates by $0.20 while missing revenue by $18.27 million. As the company is making money, are investors missing something when selling the stock?

Tough outlook

Education company stocks greatly depend on student loan interest rates and the country's employment situation. Total student loan debt is near $1 trillion in the U.S., surpassing both credit card debt and auto loan debt. The main problem is that a lot of families do not do the necessary planning before enrolling in an education program. This leads to problems with debt repayment.

Fears about the student loan bubble as well as dropping enrollment have put pressure on some educational stocks, though some others have done fairly well this year. ITT Educational Services (NYSE: ESI) and DeVry (NYSE: DV) are up 40% and 35% respectively. Enrollment trends in these companies do not differ greatly from Apollo’s, however, as the whole industry is facing headwind.

Valuation

Apollo trades at a 9.76 forward price-to-earnings ratio, having roughly the same valuation as ITT, which trades at 9.69 a forward price-to-earnings ratio. DeVry trades at a premium compared to the other companies' stocks, scoring a 12.79 forward price-to-earnings ratio. The fact that DeVry has zero debt and pays a dividend that yields 1.07% could be a part of that premium. ITT has a 0.95 debt-to-equity ratio, while Apollo has low debt and 0.08 debt-to-equity ratio. Apollo is the most attractively stock in this group, thanks to a sell-off that occurred after the earnings report. Attractive pricing alone does not move stocks higher, however; it’s the future prospects that matter. Let us take a look at what could happen.

What’s behind the corner?

Here’s what we have. The cost of education is rising, and fewer people are enrolling. Estimated sales decline for current fiscal year is -14.5% for Apollo, -16.9% for ITT and -5.3% for DeVry. The companies are trying to confront this trend by cutting their costs. Doing so has helped them beat earnings expectations in the recent quarters.

Investors are more focused on what might happen further down the timeline. Earnings estimates for the next year have shed 19% for Apollo, 2.5% for ITT and 7.5% for DeVry. It is highly unlikely that education companies will be able to counter declining enrollment rates with further cost cutting because cutting costs has its limits.

The problem of possible debt defaults is more long-term. If you do not plan to own any of the abovementioned stocks for a decade, you should probably not be concerned. The declining enrollment trend is the main problem in the foreseeable future. This trend is fueled not only by rising fees, but also by a shift that is happening in the way that people want to get their education. More emphasis is put on immediate results, and fewer people can afford to wait for several years before receiving their degrees.

Apollo is working to meet this trend with learning format changes at Western International University. The university has eight-week courses that put more of an emphasis on practical context. It’s too early to say whether this model will bring more money to Apollo, but it’s certainly a step in the same direction that higher education is heading.

Bottom line

On the positive side, there will always be a demand for knowledge as our world becomes more complex than ever. You cannot expect enrollment trends to continue declining at the same rates year after year. Education is a must for a great number of people, and people seeking education will have to pay for it.

I think that the sell-off in Apollo presents a buying opportunity. The stock is trading at a discount to its peers. The company has no big specific problems except for those that it shares with the whole industry. DeVry and ITT have yet to present their results heading into the upcoming earnings season. As investors show increasing concern over the growth prospects of educational stocks and easily become nervous, I would recommend staying on the sidelines and waiting to see the earnings numbers.

The Motley Fool's chief investment officer has selected his No. 1 stock for this year. Find out which stock it is in the special free report: "The Motley Fool's Top Stock for 2013." Just click here to access the report and find out the name of this under-the-radar company.

 


Vladimir Zernov has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. 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!

blog comments powered by Disqus

Compare Brokers

Fool Disclosure