Visit With Brazilian Estacio IR Team

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About: Estacio Participacoes S.A. ADR (ECPCY)
by: Holmes Osborne
Summary

Estacio is the second-largest for-profit education company in Brazil.

For-profit education is much more prominent in Brazil than in the U.S.

Morgan Stanley recommends Estacio as one of nine companies in Latin America.

I had the opportunity to sit down with the investor relations team of Estacio Participacoes (OTCQX:ECPCY) last Friday in the suburbs of Rio de Janeiro. The takeaway is that education is the way to advance in the Brazilian society and the government is not building many new schools. Therefore, private education companies do quite well.

The stock trades for 29.65 reais, there are 309 million shares, and the market cap is 9.16 billion reais ($2.49 billion). It takes 3.68 reais to buy one dollar. Earnings per share were 2.01 reais and the price to earnings ratio is 14.75. That’s a nice valuation. The company recently paid a special dividend of 1.47 reais.

Sales were 2.4 billion reais ($652 million) in 2014 and grew to 3.39 billion reais ($921 million) in 2017. That’s growth! Earnings were basically flat at 425 million reais ($115 million). Estacio is a free cash flow beast. It produced 600 million reais ($163 million) for a free cash flow yield of 6.55%. Nothing wrong with that.

The balance sheet shows 8.6 million reais ($2.33 million) in cash and 798 million reais ($217 million) in receivables. 133 million reais ($36 million) in payables and 428 million reais ($116 million) in debt. I like that balance sheet. EBITDA margins were 33.2% in the latest quarter.

Estacio is the second-largest private education company in Brazil with 531,000 students. Kroton (OTCQX:KROTY) is the largest with a 9.2% market share and Estacio has 6.2%. The industry is fragmented with many other companies. 65% of campuses are in larger cities and 34% in small towns. There are also online courses where students can come into testing centers for proctored exams. Private equity firm Advent owns 10% of the shares and a South African company is the second-largest shareholder.

In Brazil, public schools are the most sought-after because they attract the best teachers. Public schools pay more. Unfortunately, Brazil does not have enough public schools for its population and is not building many more (according to the IR team). Therefore, it falls on private schools like Estacio. The second tier of schools is Catholic schools. The third tier is private schools.

Estacio has the largest medical school in Brazil. It costs 8650 reais a month (I’m not sure if that’s 12 months) which works out to be $2350 a month. That’s a lot of money in Brazil. It takes six years to achieve a medical degree, not counting one’s bachelors. In 2018, Estacio opened four medical schools and plans on opening another four this year.

The company often works with other schools as a franchise model. Students will take online courses and use the facilities of another school for tests. The average class costs 781 reais ($212) and 251 reais ($68.20) for distance learning classes.

I asked about how the company keeps its reputation intact and not be like Phoenix and other for-profit schools in the U.S. The IR team stated that it is very difficult to receive government approval in Brazil to open a school and that they are watched closely over. It seems that the for-profit model in Brazil is popular.

Management showed me a graph which made a lot of sense to me. There are 8.2 million people with undergraduate degrees in Brazil, 16% of the population. The US has 47% of its population with at least an undergraduate degree. I’ve always heard that Chile is the most advanced country in South America and now I see why. If memory serves me correctly from the presentation, Chile has double the percentage of undergrads than Brazil.

In the latest quarter, the number of students from the previous year remained flat at 531,000. However, revenues rose 5.5% because of the increase in class prices. Retention for students was 85% and 81% for distance learning students. There was a special dividend of 400 million reais ($109 million). Net income margins were an incredible 22.8%.

The Brazilian government has cut down on its student loan program, known as FIES. This really hit Estacio in the third quarter with a 32% drop in on-campus enrollment. Fortunately, Estacio offset this with distance learning. You can see how the Brazilian economy and government can affect Estacio or any other company in the country.

Brazil has a lot of room to grow in educating its population. Poverty in Brazil is incredible. The top 5% of Brazilians earn about $30,000. Imagine if the country could double or triple its number of undergrads? It won’t be easy.

Morgan Stanley (NYSE:MS) is bullish on the stock and lists it as one of its favorite picks in Latin America. It has a base case price target of 32.9 reais and a bullish case as 43.7 reais. Bullish reasons include new students and reduced drop-outs, prices versus inflation, sustainable profits, new accreditations from distance learning, and M&A. Management did mention M&A to me. What’s impressive about Morgan Stanley’s recommendation is that it only lists nine companies and two of them are huge - Petrobras (PBR) and Cemex (CX).

I will briefly discuss Kroton. Kroton has not put up the growth that Estacio has. Sales grew from $5.2 billion in 2015 to $5.56 billion in 2017. It is a much larger company and has more than double the market cap.

I like Estacio. I had no particular reason to visit the company other than that I was curious. I’m impressed. The company does some good stuff in Brazil. Educating oneself is about the only way to get out of poverty. Barring more economic problems, Estacio should do well. My only concern is about how Brazilians will pay for education? If Estacio can ramp up its distance learning, this stock might be a home run.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.