The for-profit post-secondary (collegiate) education industry is one of the most out of favor areas on Wall Street. With an average price divided by earnings (P/E) multiples of about five times, the street's view is obviously quite pessimistic. This is primarily due to substantial declines in student enrollments according to Securities and Exchange Commission filings, which in turn decimates revenues across the board for the industry. In addition, worries over high student loan balances have increased, discouraging attendance of the already costly collegiate programs. Matched with a lackluster employment market, college to some seems to have lost much appeal. It is argued that the for-profit post-secondary education industry will continue to underperform the market over time due to continued declines in enrollments and plummeting earnings; however, as the United States (U.S.) jobs market makes a steady recovery, the demand for enrollment should start increasing, causing the education industry to outperform the broader market. Stocks in the for-profit post-secondary education industry make great potential turnaround investments because they have sound business models, challenging but improving fundamentals, and an overly pessimistic view by Wall Street.
Sound Business Models
To begin, industry leading education companies have sound business models given their typically high profit margins, strong balance sheets, low capital requirements, and growing student demand. Having an average net profit margin nearing 13%, industry leaders are well equipped to monetize their businesses. Net profit margins are also expanding, as management decides to continue cutting costs and limit capital expenditures, along with the gradual stabilization and eventual increase of student enrollments. The balance sheets of education companies are quite strong, something not seen by most small- and mid-cap companies. Industry leaders such as Apollo (APOL), DeVry (DV), ITT (ESI) and Strayer (STRA) have small amounts of debt and large amounts of cash on hand. Despite many education companies not paying dividends, with the exception of DeVry and Strayer, the abundance of cash on hand that can be utilized by management gives educational companies an opportunity to invest for growth as enrollments recover. Another aspect of education companies' sound business models is their low capital requirements. Since most education companies lease, i.e. rent, their campuses, they do not need to spend large amounts buying buildings. Their major costs are paying teacher salaries and developing curricula, which are expensed each year. The cost of curriculum development actually decreases over time, as the curriculum only needs to be updated instead of being remade.
Steadily Improving Fundamentals
Furthermore, despite having sound business models, in recent years education companies have encountered challenging but now improving fundamentals caused by a difficult regulatory environment, bloated cost structures, and declining student volumes; all of which seem to be reaching an inflection point. Over the course of the last several years, the government has been increasing regulations on educational companies. This is in response to how the admissions process had become so distorted that the general standards were held quite loosely. Due to how administration is paid based off upon the number of students admitted, they began to care less about student achievement and program completion. Indeed education companies have low capital requirements; however, declines in student enrollments have resulted in the industry having a bloated cost structure. The companies are paying for services, curriculum, and teacher salaries that are no longer required. Cutting costs will lead to the conversion of headwinds into tailwinds, in addition to increasing net margins and profitability. Student volumes have taken quite a hit over the last several years, being decimated over the course of the last three years. With U.S. high school graduation reaching an all time high of 78.2%, post secondary education companies are well positioned with a long-term horizon in mind. Education stocks have actually seen recent upswings in their stock prices, as investment firm J.P. Morgan upgraded industry leader DeVry from neutral to outperform. Actually, neutral in some ways can be used to not offend company managements, as it really means to not buy. Nevertheless, a concentrated, yet noteworthy area on the street has begun to back the industry, especially after stabilization in student enrollment declines.
An Overly Pessimistic View By The Street
Nonetheless, despite seeming to have reached an inflection point, Wall Street still has an overly pessimistic view on education companies as evidenced by institutional analyst ratings, their valuations, and recent stock market performance. With the exception of JPMorgan, who recently upgraded DeVry, institutions have downgraded most of the education industry. Clearly, Wall Street has taken a "half empty" approach to these companies, and by the inflections in many aspects of education companies shown above, one can argue that the psychology on these stocks is overly pessimistic. Albeit most investment firms have only downgraded education companies to neutral, indicating a scenario that lacks an overly bearish side to it. A more accurate valuation on the education industry is reflected in historically low P/E ratios, with many companies trading below a multiple of six. This differs greatly from the beginning of the 21st century, where a P/E of 20 was not uncommon for education stocks. The largest indicator that the education industry is out of favor is depicted by decimations in share prices. Recent stock performance has been nothing but atrocious, with industry leaders' performance over the last year alone being down more than 60%. This has been exacerbated even further by Wall Street's response to the education industry's current earnings skydive. From a value standpoint however, a plethora of these firms have the capability to make potential turnarounds into multi-baggers.
ESI Total Return Price data by YCharts
Granted, with the exception of DeVry, the industry leaders are down dramatically just over the last year alone. ESI has doubled in the last couple months and the industry as a whole is up nicely. In comparison to the past however, the industry still has plenty of room
Revenue & EPS Outlook
ESI EPS Estimates for Current and Next 3 Fiscal Years data by YCharts
Currently, analysts believe that education stocks in general are going to continue their downwards spiral, ultimately pushing earnings far lower. While this may be a short term outcome of the restructuring efforts that education companies are undergoing, I find it hard to believe that the Street thinks earnings will stay the same as they are now until 2017. Here is a perfect example of the stock market presenting investors an opportunity to go against the rest of the Street. One must weigh the merits of the opportunity at stake, and if the opportunity is found to be true, an exceedingly large return can be made.
In conclusion, stocks in the for-profit post-secondary education industry make great potential turnaround investments because they have sound business models, challenging yet improving fundamentals, and an overly pessimistic view by Wall Street. Long term prospects for these companies seem positive, as high school graduation rates are at an all time high, and student volumes have undoubtedly begun to recover. Improving cost structures will lead to a revival of profitability along with driving margins forward. Wall Street pessimism has resulted in these companies trading near all time lows, and according to P/E valuations, they appear dirt-cheap. As high student loan balances begin to decrease, the demand for collegiate programs will rise again. APOL in particular appears to have the most opportunity as of now, as ESI has already doubled. Indeed, the outlook for the education industry has begun to clear up.
Disclosure: I am long APOL, STRA, ESI, DV. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.