Apollo Group Inc. (APOL) reported FY13 Q1 results after the bell on January 8. The company reported revenues of $1.055 billion and adjusted earnings of $1.22 per share. This easily surpassed the Street estimates of $1.03 billion and $0.90.
In after-hours trade, the shares quickly jumped over $22 only to fall back below $20 after investors were able to absorb the report and listen to the conference call. The disappointment was largely due to weaker-than-expected new enrollment and lowered guidance. Apollo reduced revenue expectations for FY13 to $3.65-$3.75 billion (down from $3.65-$3.80 billion) and operating income to $500-$505 million (down from $525-$575 million).
The lowered guidance was primarily driven by increased grant programs, increased marketing expenses in Q2, and a tuition freeze. According to Apollo, the grant program will increase tuition discounts from the 6% we have seen in the past four quarters to nearly 10% in Q2. On the positive side, the company's restructuring efforts are on track and should deliver $300 million in savings through FY14. More than two-thirds of those savings will be realized in FY13.
The Drop In Student Enrollment Is Nearing a Bottom
A year ago, Apollo's shares were trading at over $57. At that time, enrollment was dropping at around 14% on a year/year basis. Investors apparently believed that this was a temporary problem and things would turn around later in FY12.
That turned out to be wishful thinking. The enrollment declines continued throughout FY12 (and continue today). At this point, Apollo's enrollment has dropped from a high of 476,500 students at the end of FY10 Q3 to 319,700 at the end of FY13 Q1. Overall, that is nearly a 33% decline from the peak.
So what is different now? Over the past several quarters, Apollo was focused on restructuring the company and getting its costs under control. The company is now putting more emphasis on new enrollment. During the FY12 Q4 conference call, Apollo set a goal of returning to positive year/year growth in enrollment sometime in the second half of FY13 (and reiterated that goal again this quarter). Apollo is also taking the actions necessary to make this happen. The tuition freeze, increase in grants, and increased marketing expenses that caused Apollo to lower guidance are all focused on achieving the company's enrollment goal. So there is good reason to believe that the hemorrhaging in the form of student enrollment will come to an end soon.
Apollo Presents a Good Risk / Reward
Although revenue has declined significantly, Apollo has been able to maintain respectable profit margins. Looking at the company's bottom-line profit margins on a four-quarter rolling basis, they are sitting just under 10% (which is down from the 16% level during FY10). The chart below shows the rolling profit margins over the past 16 quarters.
The midpoint of Apollo's lowered revenue guidance is $3.7 billion. Assuming profit margins decline to the 9% level over the next few quarters due to the increased investment in enrollment, Apollo should still generate $333 million in bottom-line profit. With just over 112 million outstanding shares, that equates to $2.97 in earnings this year. At $20, the stock will be trading at a 6.7 P/E multiple based on FY13 earnings.
Keep in mind that a year ago, APOL traded at a 12.5 multiple based on trailing earnings. If enrollment does, in fact, stabilize and revenues begin to grow, there is a lot of upside in the shares. A move back to a 10 P/E would mean a $30 share price, and a 50% move up from where APOL closed in after-hours trading following its earnings report.
The reward here seems to greatly outweigh the risk. During the market drop in the November-December time frame (and APOL's removal from the NASDAQ-100), the shares found support around $18.50. Although the guidance in the latest earnings report was disappointing, the beat on revenues and earnings this quarter should keep the shares from breaking down below support. The overall risk/reward here makes APOL a buy on any dips caused by the reaction to FY13 Q1 earnings.
Disclosure: I am long APOL. I plan to increase my position over the next 72 hours.