5 Reasons We Are Long CECO Into Q2 Results

Jul.15.14 | About: Career Education (CECO)

Summary

We are long Career Education into Q2 2014 results (early August), as we expect Q2 2014 to mark a return to growth, reversing four years of double-digit declines.

We believe the company will surprise investors by showing flat student enrollments (slightly negative or slightly positive) vs. a year ago.

This would affirm CECO is on track to show positive revenue growth, EBITDA and FCF by Q4 2014. Enrollments lead revs by two quarters.

The stock is trading at its $4.71 in cash per share (no debt), meaning this inflection is not in the stock today.

In other words, investors are getting a $960mm revenue biz, $67mm of EBITDA ('15E) and $0.69 of FCF per share ('15E) for zero.

We are long Career Education Corporation (NASDAQ:CECO) into 2Q14 results (early August). Why? We believe 2Q14 marks a return to growth for CECO, reversing four years of double-digit declines in student enrollments and revenues. We believe the company will surprise investors on 2Q results, by showing student enrollments flat (slightly negative or slightly positive) versus a year ago (2Q13) and in turn, show the company is on track for positive gains in revenues, EBITDA and FCF by 4Q14E.

In other words, 2Q14 will mark a validation of the strategic turnaround initiated by Scott Steffey (became CEO a year ago). And this is not yet reflected in the stock price, which at $4.79, is trading at cash per share of $4.71. Investors are paying zero to buy a business set to generate $960mm revs in 2014E and $67mm in EBITDA in 2015E. Based on historical multiples (25% cash as % stock price 10-yr avg) and also on FCF multiples (peers trade at 15X), the fair value of CECO is $16-$19 today. Thus, the risk/reward to owning CECO into 2Q results is extremely attractive heading into 2Q results. Here are the 5 reasons we are long the stock into 2Q14 results:

No. 1: 2Q14 New student enrollments flat with year ago, reversing 4 years of continuous declines. As we discuss below, there has been continuous improvement in new enrollment trends for the past 4 quarters (-2% in 1Q14), reversing 4 years of double-digit declines.

No. 2: Leading to positive revenue growth by 4Q14E (reversing declines since 2010). Historically "new enrollment" trends lead revenue trends by two quarters. We believe 2Q14E revenue declines will be -5%, the best performance since 2010.

No. 3: Sharply reduced operational EBITDA losses in 2Q14 and material positive by 4Q14E as revenues recover. We expect CECO to post a modest EBITDA loss of $5mm (ex-transitional costs) in 2Q and the company to affirm positive EBITDA by 4Q14E. The drivers behind this are: 1) shrinking losses from transitional schools as they complete their teach-outs; 2) cost savings realized from programs initiated in 2013 ($75mm in lower expense in 2014 vs 2013) and 3) as revenues increase, positive operating leverage is realized.

No. 4. Stock is trading for cash, implying zero value for a $1b revenue education business about to generate sustained growth. CECO has $963mm in revs (forecast for 2014E) and projected $46mm in FCF in 2015. Thus, the business is trading at less than 1X FCF. A more appropriate multiple is 15X FCF, or $10.35 for the business, add in $4.71 in cash per share and we get a fair value of $16 today. Historically, cash has represented 25% of its stock price (10-year average) implying fair value of $19.

No. 5. CEO has been buying shares. CEO Scott Steffey bought shares of CECO in early June, his second purchase since becoming CEO (he last acquired shares in November). We see his purchases as bullish. The CEO already has 150,000 shares and 450,000 additional options plus additional grants of restricted stock. In other words, the CEO is very long the stock already and we see his purchases as his own confidence of the business trends at CECO.

Figure: Material Improvement in Key Metrics Over Next Few Quarters

Click to enlarge

Source: investagainstthecrowd forecasts.

Bottom line: We want to be long the stock now. The stock has stalled this year, after reaching the high $7s in February. Part of this, we believe, is impatience by investors hoping 1Q14 would mark the inflection quarter. We believe it will be 2Q. There were some one-off items in 1Q we do not expect to see in 2Q, including pull forward of advertising, etc. Hence, we are buyers of the stock, particularly given it is trading at cash value today.

More Discussion of Each of the 5 Reasons Below

No. 1. On the cusp of positive new student enrollments starting in 2Q14. Since peaking at over 100,000 students in 2010, CECO has seen total students decline to around 50,000 (as of 1Q). Over the past few years, the company has take several dramatic steps including bringing in new management, offering new degree programs (i.e., two-year programs at the Culinary Arts), closing underperforming schools and a performance-based focus and these initiatives are starting to bear fruit. Today, CECO offers current students practical degrees that help them find careers with improved wages (vs. a high school degree) and placement rates have remained in the 65%-70% range.

  • A good measure of success in these efforts is the trend in "New student enrollments." New enrollments is a leading indicator for population growth (as long as retention rates are constant and in CECO's case, actually improving). Thus, to gauge the company's return to growth, a metric that leads this is new enrollments.
  • Take a look at the figure below. New student enrollments have improved sharply over the past 4 quarters (after declining double-digits for 12 quarters) and are set to be flat (to slightly positive) in 2Q14E.

More importantly, 2Q14E marks the inflection point. Going forward, new student enrollments are set to show consistent improvements and post consistent single-digit gains by YE14.

Figure: New Student Enrollments to Be Positive (Slightly) in 2Q

Click to enlarge

Source: investagainstcrowd forecasts.

Already, AIU (American Intercontinental University) had posted positive y/y gains in new enrollments (1Q14) and in 2Q, CTU (Colorado Technical University) looks to show positive gains. And by 3Q14, we expect Culinary Arts. This leaves only the career colleges showing weak new enrollment trends.

Figure: By 4Q, All Segments Are "New Enrollments" Positive

Click to enlarge

Source: investagainstcrowd forecasts.

No. 2: Leading to positive revenue growth by 4Q14E. The return to positive new student enrollments, leads to growth in student population (as retention holds, or improves, as in case of CECO) and in turn, leads to revenue growth. This relationship is seen in the Figure below, which shows "new student enrollments" change has led revenue declines by one to two quarters:

  • As shown below, CECO is set to post a -5% revenue decline in 2Q14, its best performance in more than two years and progressively improve to reach positive growth by 4Q14E.
  • A -5% decline is half of the decline seen in 1Q14 (-10%) and a dramatic improvement from 2Q13 (year ago), when the company posted a -17% y/y decline in revenues.

Figure: On the Cusp of Positive Positive Revenue Growth Year Over Year

Click to enlarge

Source: investagainstcrowd forecasts.

As shown below, looking at segment results, the inflection to positive revenue growth looks to be happening in three of the four segments by 3Q14E. The positive growth, however, is not enough to offset the double-digit declines forecast at the Career Colleges.

The Career Colleges, which continue to see weak enrollment trends (hopefully flat in 2015) are not expected to show any growth until 2016. That said, declining 11% in 2Q14 is an improvement over the -19% declines seen a year ago (2Q13).

Figure: By 3Q14E, 3 of 4 Segments Showing Positive Revenue Growth

Click to enlarge

Source: investagainstcrowd forecasts.

No. 3: Sharply reduced EBITDA loss in 2Q14 (ex-transitional costs) and material positive by 4Q14E as revenues recover. We expect CECO to post a modest EBITDA loss of $5mm (ex-transitional costs) in 2Q and the company to affirm positive EBITDA by 4Q14E. The drivers behind this are: (1) shrinking losses from transitional schools as they complete their teach-outs; (2) cost savings realized from programs initiated in 2013 ($75mm in lower expense in 2014 vs 2013) and (3) as revenues increase, positive operating leverage is realized.

  • Take a look at the Figure below. We forecast EBITDA, ex-transitional schools, is forecast to be -$2mm. Seasonally 2Q tends to be weaker on EBITDA than 1Q, but for 2014, because CECO pulled forward some ad-spend into 1Q, we believe this will result in better 2Q14 EBITDA performance.
  • Like the trends in enrollments and revenue noted above, EBITDA is set to steadily improve over the next few quarters. The drivers, noted above, are declining losses from transitional schools, realized savings from cost initiatives and revenue improvements.
  • We forecast CECO to generate positive overall EBITDA by 4Q14 (a 7% EBITDA margin) and $67mm of total EBITDA in 2015. Excluding losses from transitional schools, 2015E EBITDA is forecast to be closer to $105mm.

Because the company has no debt, the 2015E EBITDA of $105mm is implies $46mm in operating free cash flow, or $0.69 per CECO share.

Figure: Operational EBITDA (Ex-Transitional) to Be Close to Breakeven in 2Q

Click to enlarge

Source: investagainstcrowd forecasts.

No. 4. Stock is trading for cash, implying zero value for a $1b revenue education business about to generate sustained growth. For a company on the cusp of a meaningful turnaround in growth, one would think this is reflected partially in the share price. This is not the case for CECO. Take a look at the figure below. The company has a market value of $321mm today. The cash and cash equivalents balance is $316mm (1Q14), implying only $5mm of value is ascribed to the operating business. CECO is only forecast to burn another $32mm over the next two quarters before turning FCF positive.

  • What is an investor getting for this $5mm implied value ($0.08 per CECO share)? Look below at the Figure. CECO has $963mm in revs (forecast for 2014E) and projected $46mm in FCF in 2015. Thus, the business is trading at less than 1X FCF.
  • A more appropriate multiple is 15X FCF, or $10.35 for the business. Add in $4.71 in cash per share and we get a fair value of $16 today.
  • Looking 12 months out, FCF grows to $1.45 and at 15X implies $22 per share. Add in $5.00 in cash (projected YE2015E) and we get close to $27 in fair value.

Figure: Excluding Cash, CECO Biz Valued at Zero for ~$1b in Revs and ~$70mm EBITDA

Click to enlarge

Source: investagainstcrowd forecasts.

The current valuation relative to its cash (of CECO) is a steep discount to its historical multiples. As shown in the figure below, the company's 10-year average cash as % stock price is 25% compared to essentially 100% today.

  • If CECO were to trade at its historical average of 25% (cash as % stock price), the stock would be worth $19 today ($4.71 divided by 25%).

Figure: Stock is trading at cash value; 10-year avg cash (as % stock price) is 25%

Click to enlarge

Source: investagainstcrowd.

No. 5. CEO has been buying shares, always a bullish sign. We also want to be long CECO shares into 2Q results because the CEO has been buying shares. As shown below, Scott Steffey, CEO, bought shares of CECO in early June.

  • This is his second purchase since becoming CEO. He last acquired shares in November. That was a well-timed purchase as the stock made a subsequent rise to $7.80 within 3 months.

Obviously, we see his purchases as bullish. The CEO already has 150,000 shares and 450,000 additional options plus additional grants of restricted stock. In other words, the CEO is very long the stock already and we see his purchases as his own confidence of the business trends at CECO.

Figure: CEO Steffey Bought Shares Twice in Past Year

Click to enlarge

Source: insidercow.com.

Disclosure: The author is long CECO. The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.

Additional disclosure: CECO needs to be the primary ticker... it is not showing up above...