Strayer Education: Excellent Long-Term Prospects

Last week, Strayer Education (STRA) reported earnings for the first quarter of 2007. Revenue came in at 80.2M, a 20% increase over the year-ago quarter and just shy of analysts’ estimate of 80.8M. Net income rose 18% to 18.8M, and EPS rose 18% to 1.30, slightly above analysts’ estimate of 1.29. The extra penny was due to a half a percent decrease in the number of shares outstanding compared to the year-ago period. Despite the good report, the stock price has remained virtually flat since the earnings release. This is due to the fact that the stock was already trading at a premium prior to earnings and to the fact that Strayer has a history of positive earnings surprises in the neighborhood of 6%. Merely meeting expectations is considered disappointing for a stellar performer like Strayer.

Enrollment figures look strong. Total enrollment increased 16%, new student enrollments increased 17%, continuing student enrollments increased 16%, and out-of-area online students increased 21%.

Strayer finished the quarter with 151.4M in cash and no debt. Stockholder’s equity stands at 200M. During the quarter, the company repurchased 68K shares at an average price of 117.41. An additional 24M remains authorized for stock repurchases.

One thing to keep an eye on is bad debt as a percentage of revenue. This figure has been growing over the last several years, from 2.3% in 2004 to 2.5% in 2005 and then to 2.9% in 2006. For the first quarter of 2007, the percentage is 2.6% compared to 2.5% for the year-ago quarter.

The company is on track with its plan to open eight new campuses in 2007. Earlier this year, it opened two new campuses in Kentucky and two in Florida. In the press release, it was announced that the company has received approval from the New Jersey Commission on Higher Education to open campuses in that state. In the second half of 2007, Strayer will open two campuses in New Jersey, one in Knoxville, and one in Atlanta, bringing the total number of Atlanta campuses to five.

The company estimates second quarter 2007 EPS in the range 1.13-1.14. Analysts had projected 1.13. Included in these estimates is an .11 expense due to stock-based compensation.

Here are some considerations which will give us an idea of the current valuation:

Market cap: 1.85B
Share price: 129.68
Enterprise value: 1.7B
TTM revenue: 276.8M
EV/revenue: 6
Price/book: 9
TTM EPS: 3.82
PE: 34
Analyst growth estimate over the next 5 years (per annum): 18%
PEG: 1.9
2007 EPS estimate: 4.21
Forward PE (fye ending 12/31/07): 31
TTM owner earnings (net income + D&A – maintenance capex): 59.8M
EV/OE: 28
(EV/OE)/G: 1.6
Return on equity: 28%

Over the last 12 months, the PE has ranged between 27 and 35. Thus Strayer is currently trading near the upper end of its PE range. A 31 multiple applied to the 2007 EPS estimate of 4.21 produces a price of 130.51 which is just about where the stock sits now and so there is little upside potential in the near term. A 31 multiple applied to the 2008 EPS estimate of 4.96 produces a price of 153.76 which represents a 9% per year return over the next two years. Again, the upside potential from the current price level is limited. A dip in price to 115, corresponding to a PE of 30, would produce annual returns of 16%. I will look to add to my position at that level.

Strayer generally trades at a higher multiple than its peers. This is due to its stellar fundamentals, its nearly flawless execution, and the fact that the company has never been implicated in any of the misdeeds which plague the education sector. Perhaps even more important than these factors in explaining the premium price is the underlying growth story. Strayer is a classic example of a company moving from a regional presence to a national one. It is just beginning to break out of the Southeast and has massive growth potential which will play out over many years.

Unlike the typical small cap growth stock which may grow 20-25% per year for 5 or so years before tapering off, Strayer gives every indication of maintaining its 18% growth rate for decades. Chairman and CEO Robert Silberman makes the point very often that growth is being managed carefully so as not to over-extend the company’s human capital. There is no shortage of markets into which to move, and the rate of expansion is determined by the availability of the human capital needed to start up new campuses. The company currently has 47 campuses in 11 states and Washington, D.C. Its goal is to expand throughout the entire U.S. Put another way, they want to reduce the number of out-of-area online students to 0. It is not clear at present just how many campuses this will require, but at the current rate of expansion, which is 8 new campuses per year, it will take 25 years to reach 250 campuses. The attractiveness of investing in Strayer is the prospect of a decent level of sustained growth over a long period of time.

Disclosure: Author has a long position in STRA

STRA 1-yr chart