Why DeVry Deserves Higher Marks Than Strayer Or Apollo

| About: DeVry Education (DV)

The for-profit higher education sector has been under public scrutiny for some time. Questions are being raised pertaining to the quality of the education offered by these institutions -- statistics such as graduate placement rates and loan repayment rates suggest little value for the money. As many of these companies rely on federally funded student loans for income, regulators have taken interest. The Government Accountability Office (GAO) recently released a report titled, "Experiences of Undercover Students Enrolled in Online Classes at Selected Colleges", which found that nearly half the 15 investigated schools engaged in dubious practices.

The fall-out from all this unwanted public and government attention has led to lower student enrollments, a damaged reputation for the entire industry and most relevant to value investors, discounted stock prices. With increased regulation now in force and more scrutiny a possibility, investors have deemed the sector too risky. But is the market overreacting or is the for-profit education sector irreparably damaged?

Headline risk often leaves opportunities for the discerning value investor and that may be the case here as the market paints all of these stocks with the same sell brush. DeVry (NYSE:DV) has been one of the hardest hit in terms of share price but may be the best pick of the class. The stock first came to my attention via a 52 week low screen a few months back and has since fallen 6% further.

DeVry provides higher education services via organizations like Advanced Academics, Becker Professional Education, Carrington College and Carrington College California, Chamberlain College of Nursing, DeVry Brasil, DeVry University, and Ross University. DeVry has a strong vocational focus, which is borne out in its graduate placement rates which historically come in around 90% with average salaries starting at $43,000. While no school has escaped the stain of this bruising controversy, DeVry may have weathered the reputation hit better than some of its peers. And with the company's focus on future growth areas like medical and healthcare as well as a spotless balance sheet with nearly $5 of net cash per share, DeVry may be the best-positioned of its peers in the new operating environment. Certainly, recent actions by DeVry's board to boost the dividend and authorize a $100M buyback illustrates the company's confidence in this regard.

From a valuation standpoint, DeVry looks like a good prospect, trading at 4.2x EV/EBITDA compared to Strayer (NASDAQ:STRA) at 4.8x. Based on past years' free cash flow (FCF), the stock could be worth $42 - $50. Of course, DeVry may not be able to replicate its past results if increased regulations forces substantial changes in the business model but so far, the company is coping as TTM FCF of $252M is 25% higher than its annual average since 2007. Throw in almost $5 cash per share and investors may be paid to take the headline and regulatory risk. STRA may have better margins historically and pays a much higher dividend at 4.3% (DV yields 0.8%) but with the regulatory uncertainty facing the industry, maintaining margins is not a given for any company in the sector. STRA shares are pricier as well, trading near my estimated fair value of $100.

Readers may notice my omission of the largest operator in the sector: Apollo Group (NASDAQ:APOL). I am taking a page out of the legendary Peter Lynch's book, which stated that investors should invest, or in this case, not invest in what they know. I may receive some email or comments from company representatives but a person close to me recently completed a University of Phoenix program and described a lax (to put it mildly) academic environment. While one person's experience may not be indicative of the entire company's operations, it is sufficient to dissuade me from even considering APOL for investment.

Disclosure: I have no positions in any stocks mentioned, but may initiate a long position in DV over the next 72 hours.