In this piece, we have analyzed various education companies in light of the respective earnings releases that they have posted. Overall, the results posted were disappointing, and all of the companies suffered from enrollment declines. Moreover, cohort default rates are on the rise for a majority of institutions, and the numbers are edging closer to the specified limit. Violation of the 90/10 Rule is also in sight, with companies like Apollo (APOL) and DeVry (DV) very close to breaching the 90% limit. Most education stocks have lost substantial value since the start of the year, and with enrollment declines expected to continue going forward, as well as a tough regulatory environment, we are reiterating our bearish stance.
Valuations for many education stocks have become extremely cheap. For instance, education stocks price earnings multiple range is between 3x-8x. However, considering the declining revenues and bottom line we consider them as value traps.
DeVry Inc. provides education services through various institutions that offer a range of business, healthcare and accounting programs. In its latest press release, the company announced that it expects its 4Q2012 revenues to be somewhere between $500 and $510 million. Moreover, it announced that the company will likely post EPS of $0.46 in the fourth quarter, well below the consensus estimates of $0.56. It seems like the company is going for another negative earnings surprise. The reason given by the company for the disappointing revenues and earnings was a drop in revenues because of more scholarships being given to students. Moreover, higher than expected operational costs led to the deterioration in results. According to the press release, the company is expecting the slowdown in new enrollments to continue, as compared to the previous quarters. The company has seen such slowdowns before, when it reported a drop of almost 4% in revenues in 3Q2012. Lower enrollments, as well as more scholarships awarded, led to the decline.
The company's Business, Technology and Management segment has seen negative trends in enrollments over the last few years, and the trends have persisted in both its undergraduate and graduate programs. In the fall of 2011, the segment saw its undergraduate new student enrollments drop 25% from the same season of 2010. Similar declines in enrollments were seen in its undergraduate total student enrollment, which, in the spring of 2012, declined 15% compared to the same season of 2011. Similar deteriorating trends in enrollments are also visible across the board with other education providers, with the persistent economic turmoil and resulting unemployment playing a part in reducing interest from potential students. Despite an increase in enrollments for the company's Medical and Healthcare segment, which includes the Chamberlain College of Nursing and Ross University Schools of Medicine and Veterinary Medicine, its other colleges have suffered from a decrease in enrollments. According to the company's management, persistent demand for doctors and nurses helped increase its enrollments in the aforementioned colleges. However, despite the increase, its Medical and Healthcare segment's operating income dropped by almost 11% to $26 million in the third quarter of the current year.
DeVry is subject to extensive regulations under government financial assistance programs. One such regulation is the 90/10 Rule, under which the education provider is ineligible to take part in the Title IV funding program, if for two consecutive years it derives more than 90% of its revenues from the said program. The table below sets out the percentage of revenues from the funding program for DeVry.
Ross School of Medicine
Carrington College California
From the table below it is clear that several educators are close to violating the 90/10 Rule, with Apollo, DeVry and Capella (CPLA) at the top of the list. Moreover, the requirement for the cohort default rate is 25%. To keep their funding going, these educators must stay within the prescribed limits. Apart from Capella, the majority of schools are edging closer to the 25% limit for the default rates.
Cohort Default Rate
We have previously discussed education stocks including APOL, DV and CPLA. We liked CPLA for its business model, which caters to the online education segment. Given the current economic slowdown and rising tuition fees, students are finding this method of learning far more cost effective, and this trend has reflected positively in the company's enrollment declines, which have slowed down YoY as compared to other schools, who have seen further deteriorations. Its two-year cohort default rate (6%) also ranks above other educators.
Since our last article on DV, the stock has dropped almost 30%. We reiterate our recommendation for DV, as it suffers from a continued decline in enrollments. It is also fighting the threat of the 90/10 Rule violation, with its default rates also edging up.
Click on education stocks for a detailed analysis.
Apollo Group Inc.
Apollo Group , a provider of educational programs at the undergraduate and master's levels, reported its results for 3Q2012 on June 25, posting revenues of $1.13b. Even though the revenues figure improved sequentially, it represented a decline of over 8% from the same quarter of the previous year. The University of Phoenix, which provides the group with almost 90% of its revenues, has seen a recent decline in revenues, and is largely responsible for the company's deterioration in revenues. In the third quarter, revenues from APOL's major contributor, the University of Phoenix, declined almost 9%, primarily due to weaker enrollments. In the second quarter, weaker enrollments led to an almost similar decline in revenues for the company, and the trend has pretty much continued in the third quarter. Below is a brief summary of the declining trend in enrollments for the University of Phoenix.
New Degree enrollments
The company has warned that it expects weak enrollments to continue in the next quarter, which is also the case with the Education Industry as a whole. During its conference call, the company's executives said they were unable to forecast when APOL was likely to return to growth, as they expected the weakness in student numbers to continue. The continued decline in enrollments has translated into a weakness in the group's bottom line as well, which contracted in the third quarter by almost 40%. The company posted EPS of $1.13 compared to $1.52 in 3Q2011. As mentioned previously, the group is very close to violating the provisions of the 90/10 Rule, and as of the year-end 2011, the percentage stands at 86%. Even though the company doesn't expect the rule to be breached in FY2012, it remains very close to the 90% limit, and might exceed it in the near future. In case of a breach, the company will be deemed ineligible to take part in the Title IV program. APOL could face further troubles going forward, if the current legislative proposals to tighten the requirements of the 90/10 Rule are adopted. The proposal that asks for a reduction in the limit, bringing it to 85% from the now 90%, would mean that APOL would be in violation, with its percentage currently at 86%. The company's cohort default rates have also consistently increased over the years, and even though it is not at a risk of violating the specified 25% benchmark for defaults, the rates are higher for APOL as compared to its peers.
Despite the company raising the lower end of its revenue guidance for 2012, we believe APOL will continue to suffer from declining enrollments going forward. The stock has dropped almost 16% since the earnings release, and in the absence of any clear catalyst for growth, we reiterate our previous stance on the stock. APOL is currently trading at a forward price of 8.8x, relative to its earnings, compared to 9x for its peer DV. Other multiples like EV/EBITDA (2.6x) and P/S (0.72x) are also in line with DV's multiples of 2.1x and 0.6x, respectively.
ITT Educational Services Inc.
Educational Services Inc. (ESI), a provider of post-secondary degree programs, reported its results for the second quarter on July 27, posting EPS of $1.96, down 10% from analyst expectations of $2.18. Earnings were also down from the previous quarter, when the company posted EPS of $2.38. Revenues have also fallen short of expectations; analysts were expecting $339.4 in revenues, however, the company fell short by 3%, generating only $329.8 million.
The company's profitability has almost been cut in half in the second quarter, largely due to a decrease in student enrollments. Net income for the company took a downward dive of almost 45%, as compared to the same quarter of the previous year, posting total earnings of $46 million. ESI's enrollments have continuously decreased, both on a quarterly and a yearly basis. In the recent quarter, the company was able to add only 15,698 new students, is down 10% from 2Q2011's new student enrollments. A similar weakness was seen in total enrollments, which were down over 15% as of the quarter end. Due to increased unemployment levels and the economic slowdown, the company has been focusing more on awarding scholarships to attract students, which is impacting ESI's profitability. Moreover, strict government policies aimed at reducing the overall student debt burden are also detrimental for companies like ESI, as they have to tighten their admission policies. This phenomenon explains the weak enrollment figures coming in from various education providers, including ESI. Following is a brief summary of enrollments for the company, compared on a quarterly basis.
New student enrollments
Other fundamentals for the company also deteriorated in the quarter. Operating margins were booked in at 23%, at a substantial decline from the previous year quarter's 33%, reflecting the strain on the company's operations due to the overall enrollment declines and tighter admission policies. Operating cash flows slipped into the negative territory in the second quarter, after generating positive cash flows of almost $61 million in 2Q2011. ITT is trading at an EV/EBITDA of 1.73x and a forward P/E multiple of 4.7x, as compared to 2.6x and 8.8x for APOL. The stock has dropped almost 22% since the earnings release, and almost 40% since our last report; it is currently trading at its 52-week low of $32.5. Going forward, we expect the lack of growth in enrollments to continue for the company, Also, tightening of admission policies will likely lead to deteriorating financials. On the basis of the reasoning given above, we believe the capital appreciation potential for the stock is limited. It is also worth noting in the end that the company does not pay any dividends.
Another education company that recently released its quarterly results is Bridgepoint Education Inc (BPI), which posted EPS of $0.84 and gave a positive earnings surprise of 13%. However, the company's earnings fell in the quarter, despite a slight rise in revenues, as compared to the previous year's quarter. The rise in revenues was still not enough to beat consensus estimates, and the stock has lost almost 55% of its value on a YTD basis.