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Elevator Pitch

Short-term fluctuations in the price of the stock and in the revenue are not relevant to those who are willing to invest in the business and not in stock. Apollo group (NASDAQ:APOL) experienced a drop in its revenue in 2012 and thus investors may shy away from Apollo. I have a different opinion. Apollo has strong past performance in terms of financial results. In this article, I will try to justify the idea of considering Apollo for investment.

Company Description

Apollo Group, Inc. is one of the world's largest private education providers and has been in the education business for approximately 40 years. The company offers innovative and distinctive educational programs and services both online and on-campus at the undergraduate, master's and doctoral levels through its subsidiaries: University of Phoenix, Apollo Global, Institute for Professional Development and College for Financial Planning. The company offers programs and services throughout the United States and in Latin America and Europe, as well as online throughout the world.

Thesis & Catalyst For Apollo Group, Inc.

In the case of Apollo, it is useful to look at the price past performance.

(click to enlarge)

Source: Google finance

As it can be seen in the picture above, the price of Apollo was considerably higher only five years ago than now. At the beginning of 2009, it reached $89.22 per share and afterwards started quite consistent downward movement till it hit the bottom of approximately $16 per share in the march 2013. As you'll see in the valuation section, the intrinsic value of Apollo is remarkably higher than present price but still it is lower than previous heights in 2009. What I want to say, is that a few years ago Apollo probably was priced at its intrinsic value. When the crisis struck the markets, Apollo's price went down, as well. What is more, interestingly, the performance of Apollo didn't really support so long and consistent downward movement. More views on financial performance will follow.

Valuation

Today, June 21, Apollo is being traded at $19.73. In my opinion, Apollo at this moment is undervalued. To consider a stock for purchase, I have a requirement that discounted cash flow valuation outcome as well as Graham valuation model outcome has at least 25% margin of safety. First of all I calculated DCF outcome, which proposes that intrinsic value for Apollo share is at $64.80, which gives 69.6% margin of safety. To come up with this result, I discounted estimated future free cash flows with Apollo's weighted average cost of capital of 9.5%. Secondly Graham valuation model outcome was calculated using today's Bloomberg US Corporate Bond Index yield of 3.25% and the outcome of Graham valuation model stated that intrinsic value for Apollo is at $69.20, which gives 71.5% margin of safety.

Both values propose that Apollo's intrinsic value is considerably higher, and the stock should cost at least $64.80. This value gives a potential upside move with a potential profit of 228%.

Big picture

It is important to look at the big picture. When I value a stock, I want to find a business with growth potential in the future. There are facts that are in favor for Apollo's business. Apollo estimated that, in 2010, the domestic postsecondary degree-granting educating industry was $460 billion industry.

Greg Cappelli CEO of Apollo group wrote in the 2012 annual report's Letter to Shareholders:

Post-high school, career-driven education and training will drive our ability to compete and win in the 21st Century-period. Arming students with proven workplace skills is crucial to our success as a country. Yet, with more than 132 million people in the US labor force over the age of 25 today, the unfortunate reality is that fully two-thirds do not have a bachelor's degree, fifty million have never tried, and thirty million did not complete their degree.

This shows a good outlook in the future. Also, with increasing importance of knowledge based industries, postsecondary education will have even higher role for individuals in finding jobs and keeping jobs.

Revenue & EPS Outlook

As mentioned before, in my opinion, Apollos' price performance during last five years didn't correspond with the performance of the business. After reaching it's heights in the beginning of 2009 Apollo's stock started to go down while Apollo was able to increase its revenue by 29.5% in 2009 comparing to 2008, and in 2010, there was another 23.9% increase. Only in 2011 Apollo had a slight decrease in revenue, which was followed with further revenue decrease in 2012. The most important argument here is that when Apollo reached its heights it was right after 2008 where it had revenue of $3.14 billion and at that moment market priced Apollo's stock at approximately $89 per share. In 2012, Apollo had $4.25 billion and the price right now is more than four times lower than in 2009. Although the net margin decreased from 15.2% in 2008 to 9.9% in 2012, the EPS increased from $2.87 inn 2008 to $3.45 due to the shares repurchases.

After the latest Q2, (ended 2/28/2013) it seems that Apollo experiences tough times and that the revenue will continue to decrease this year. I imagine that, with the decrease in the revenue, the price of stock may go even lower, and that is even better news for me due to the fact that I will be able to buy Apollo's shares even cheaper than now.

Apollo's P/E right now is 7.28. It is a huge decrease comparing it to 2004 P/E when it was 51.8 and still is a decrease compared with 2007 P/E when it was 25.00. The low P/E is signaling the pessimistic outlook of Apollo's investors.

Conclusion

In my opinion, Apollo is undervalued, and that presents a great opportunity for long-term investors to grab it while it's cheap. I have to include warning that there is quite a big possibility that the stock of Apollo will continue to decrease in the price. If this scenario comes to life, I would appreciate it and would try to purchase even more shares at lower prices. In this moment, I would suggest gradual purchases throughout the next two years.

My target for Apollo stands at $64.80, which could result in a potential profit of 228%. The time frame is definitely long term, and I don't expect to see some results sooner than two years from now.

Source: The Long Case For Apollo Group, Inc.