Strategic Education: Monitor This Safe Investment Choice

Summary

• STRA is a recession resistant stock that is attractive in the face of prolonged economic declines.
• Plans of growth supported by macro conditions tell a good story about the firm.
• Shares are appropriately priced at $184.48 (vs target price of $167.60).

Strategic Education (NASDAQ:STRA), formerly known as Strayer Education, provides education services through two fronts - campus-based (Strayer University) and online-based (Capella University). We are issuing a HOLD recommendation for the company with a target price of $167.60. Our core thesis for this stock is that the firm's campus growth plans will enable the company to thrive even in the face of recessionary periods. Although the stock seems slightly overvalued, investors seeking a safe and defensive stock in their portfolio can make an entry when weakness presents itself if prices were to decline.

Source: Strategic Education

Business

The company has two main subsidiaries - Strayer University and Capella University, representing 54% and 46% of total revenues, respectively.

Source: Company Annual Report

Founded in 1892, Strayer University offers 31 undergraduate and graduate degrees such as Business Admin, Accounting, IT, Education, Healthcare, Criminal Justice at 77 physically campuses spread across southern and eastern US. The university has been expanding over the past few years, building 3-5 campuses annually.

Campus Locations; Source: Strayer University

A Strayer University Campus; Source: Inside Higher ED

On 1st August 2018, the company completed its merger with Capella Education, an online-based university that provides a variety of undergraduate and graduate degree programs, primarily targeting working adults. The programs span across 6 primary disciplines in Public Service, Nursing and Health Sciences, Psychology, Business & Technology, Counselling and Human Services and Education. The acquisition was an attempt to diversify and to ride on the growing trend of learning online. Leveraging on the company's expertise in opening brick-and-mortar campuses, the company has opened its first physical campus center in Atlanta.

Source: Campus Technology

The company plans to continue pursuing its aggressive expansion with 4-5 new campuses in 2020 and possibly 4-5 additional campuses later in the year, pending US's recovery from the coronavirus crisis. We believe that 5 new campuses would be more likely for the entire fiscal year of 2020 and have included it in our projections accordingly.

COVID-19 Impacts & Measures

Apart from the pausing of campuses expansions as part of the company's measures to tackle the coronavirus outbreak situation, the company has closed all physical campuses and fully transited to online classes. We believe that a side benefit of the acquisition of Capella University was that Strayer University could carry out this transition smoothly. All large-scale student events and graduation ceremonies were postponed, and these measures are likely to continue even as lockdown measures are lifted by the government. We believe that this move enables the company to save some operating cost due to the closure of campuses.

Recession-Resistant

Education, being a defensive sector, is resistant to recessions. What I mean by that is revenues and earnings are typically not affected that much (or even at all) by periods of economic declines. In fact, we will look at a graph later showing how unemployment rates may boost the revenues in the education industry. The share price of the company since its inception shows exactly how the prices have reacted in past recessions. We can see that in the 00/01 crisis, the prices were stable before increasing in 2001. In the 08/09 crisis, the prices were volatile, but there was a general upward trend yet again.

Source: TradingView

Macro & Industry Drivers

The number of Americans completing post-secondary education is ever-increasing. In fact, that percentage has grown to about 37% of all Americans in 2019 and projected to continue increasing.

Source: US Census Bureau

We looked at the percentage of the population aged 25 and over who have completed a bachelor's degree by the different states to get a rough sensing of the demand for education in the states of the campuses (highlighted in dark blue). We found that the University has campuses spread out across the spectrum. This is an excellent sign as it shows how the university can capture drastically different markets and demand. This gives us confidence that in the expansions' success across the states as STRA can tailor their services to meet the demand.

Source: US Census Bureau

Historically, we saw education revenues rising when non-farm unemployment rates increase. This relationship can be contributed to a few factors such as unemployed individuals who saw a chance to upgrade themselves with degrees and certifications during recessions. In the graph below, we saw STRA revenue rising when unemployment rates grew in 2008 to 2010 due to the 08/09 recession. Readers should disregard the divergence in 2018/2019 as that's when STRA acquired Capella and had periods of aggressive expansions.

Source: Trading Economics, Company Financial Reports

In April 2020, we saw non-farm unemployment rates shooting up to a record high of 14.7% because of businesses shutting down as part of government-implemented measures to handle the coronavirus outbreak. We expect this to boost the company's revenue, especially if the recession drags on longer.

Source: Trading Economics

Financials

Looking at the company's financials, we can see that revenues from our core business segments have been steady and increasing over the last few years with a quarterly CAGR of 1.15%.

Source: Company Financial Reports

Profit before tax and net income margins are steadfast over the past few years, hovering around 10-17% and 7-13%, respectively. The only exception was a sharp drop in profitability in FY18Q3 due to one-off acquisition-related costs.

Source: Company Financial Reports, Author's Analysis

The revenue per enrollment has been very stable and forms the basis of our revenue projections for the company. We expected this as the amount payable by students for their degrees and courses rarely deviate much.

Source: Author's Analysis

We analyzed the universities' enrollment growth figures based on the number of campuses they build in any given year. What we found for Strayer University students was that each additional campus has historically increased the total number of enrollments by ~2%. In FY19, 5 campuses were opened under Strayer University, which brought in ~11% increase in enrollments compared to FY18. As mentioned earlier, the company plans to finish building 4-5 new campuses in 2020. We foresee 4 additional campuses as the most likely scenario for FY2020 and delaying their other planned expansions to FY2021 (8 new campuses). Meanwhile, for Capella University, we forecast a conservative estimate of ~2% growth based on historical growth. In reality, we expect to see a much higher increase, possibly due to lockdown measures and rising unemployment rates.

Data: Company Financial Reports, Author's Analysis

With the above assumptions in place, we built our revenue model and extended the company's stable margins, which appeared to be "cyclical". Upon further analysis, this cyclicality makes sense as payment schedules do not call for the same payment every quarter.

Data: Company Financial Reports, Author's Analysis

Our projections give us an FY20 EPS of $4.99 (vs 3.66 in FY19) and FY21 EPS of $5.47. The "cyclical" margins are seen here as well.

Data: Company Financial Reports, Author's Analysis

Valuation

Keeping in mind that the company has 2 different business segments, we valued them separately with a Sum Of The Parts (SOTP) valuation methodology. We used 2 different sets of public comparables and multiples to value Strayer University and Capella University.

Education is a defensive sector where we don't expect a huge deviation in revenues. We would have loved to perform a DCF valuation for this segment, but the amount of data available limits us from doing so. Thus, we used EV/REV and EV/EBITDA multiples for Strayer University to recognize the quality and growth of the revenues. Capella University, being an online-based program, has little data to offer because it is relatively new. We used EV/EBIT multiple, which is substantially higher than non-online education companies, to value this segment. Combining the implied EVs from both valuations, we arrive at a final target price of $167.60 (vs current price of $184.48), which suggests that the company is slightly overvalued at this given moment.

Source: Author's Analysis

The respective list of comps can be found below. We tabulated forward ratios based on the current share price of the respective companies over the NTM values, removing any anomalies.

Brick-and-Mortar Comps for Strayer University; Data: Capital IQ

Online Education Comps for Capella University; Data: Capital IQ

Bottom Line

The key investor takeaway is that we have a recession-resistant stock that has been steadily increasing their revenues and earnings while making use of macro and industry trends. Given that our target price is slightly under the current share price, we recommend investors to wait for weakness to present itself if the general market declines.

I will cover other companies in this industry in future posts as I believe there is a great investment opportunity to be found here. Do follow me to be kept notified of further updates!

Analyst’s 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.