Is There a Lesson to Be Learned From For-Profit Educators?

Strayer Education (Nasdaq: STRA  ) was among several for-profit education companies in the news last week, as it reported disappointing quarterly earnings of $1.85 per share on revenue of $146.3 million, down from $2.53 per share on $163.8 million in revenue year over year. DeVry (NYSE: DV  ) reports on Aug. 9, but preguided lower. ITT Educational Services (NYSE: ESI  ) reported last week, and also disappointed. Stocks of Apollo Group (Nasdaq: APOL  ) and American Public Education (Nasdaq: APEI  ) were down in sympathy.

All five education companies cited increased costs, shrinking enrollments and the revenue associated with lower enrollments, the inability to raise tuitions in line with rising costs, and dim job prospects for graduates. All see the need to spend more on "student acquisition" to attract students to their classrooms.

As usual, analysts were busy lowering earnings expectations and downgrading these stocks in recent weeks. However, a review of each company's underlying financial trends might have identified increased prospects for disappointment prior to analysts' reports.

The Motley Fool Earnings Quality Score database rates these consumer discretionary stocks as either "A" or "B" for earnings quality. The database ranks stocks "A" through "F" weekly based on price, cash flow, revenue, and relative strength among other things. Stocks with poor earnings quality tend to underperform, so we look for trends that might predict future outcomes.

Strayer Education
Strayer's revenue trend is down, and costs are rising year over year, and this combination produces lower margins. In turn, lower margins result in lower earnings per share unless the latter has been manipulated.

Metric

6/30/2012

6/30/2011

6/30/2010

Revenue (millions) $146.3 $163.8 $159.28
YOY % change (10.68%) 2.84% --
Cost of goods sold 52% 47% 42%
Selling, general & administrative % 24% 23% 22%
Operating margin % 25% 31% 37%
Net profit margin % 15% 18% 22%
Operating cash flow (millions) $6.18 $20.26 $24.75

Source: S&P Capital IQ.

Management noted that summer enrollment decreased 7% year over year, and continuing enrollment declined 11%. New student enrollment increased 9% but is expected to decrease 8% for the full year. Strayer was able to raise tuition only about 3% for the year, less than the historical average of 5%. Moreover, the company estimates only $0.30-$0.32 per share earnings next quarter, and expects its operating margin to be around 5%-6%, down from 18% year over year. Revenue per student for 2012 is expected to decline by 1%-2%.

Strayer's stock started 2012 at $94.44 but reached a recent high of $111.99 on July 3. The company pays a $4.00 dividend (5.4%), but with declining revenue and operating cash flows this dividend may not be safe. Analysts estimate virtually no revenue growth for 2013, and the forward P/E is actually higher at 12.9 than its current 9.8. Based on its decaying financials and management's guidance, I would expect further price declines going forward.

DeVry
For the quarter ending March 31, DeVry's revenue declined 3.9% on rising costs, resulting in shrinking margins year over year. The company revised its fourth-quarter outlook for revenue to be between $500 million and $510 million, a 6.7% decrease from last year. Operating cash flow was $135.83 million, down from $211.3 million last year. In its quarterly preview, management noted it faces increased operating costs, a rise in spending, and enrollment declines over the coming year. The company expects a decline in summer enrollment of 15%-17% at DeVry University and a decline of 19%-21% at Carrington Colleges Group, compared with the same period last year. This suggests continuation of the revenue trend. Lesson one: Don't buy.

Apollo Group
For the quarter ended May 31, Apollo cited an 8.5% revenue decrease and an earnings decline from $1.51-$1.13 per share, or 25% year over year. Degreed enrollment declined 13.1%, while new enrollment declined 8% compared to last year. Still, Apollo's earnings beat analysts' estimates of $0.96 a share, creating short-lived investor enthusiasm. Along with increased operating costs, operating cash flow fell to $31.3 million from last year's $285.91 million. Lesson two: Refer to lesson one.

ITT Educational Services
ITT's costs increased 10% on declining revenue year over year. New enrollments decreased 9.5%, and ITT noted its new applications for enrollment for the coming semester decreased 7% from last year's levels. Revenue and cost metrics are similar to the other companies under consideration here. Lesson three: Ditto lesson one.

American Public Education
American is set to report quarterly results on Aug. 8, and financial trends indicate there may be a glimmer of hope here. Revenue has been rising and margin erosion has not been nearly as bad as the other companies in this group so far. Analysts estimate $72.01 million revenue and $0.45 per share earnings versus $60.8 million revenue and $0.49 earnings last year. The stock has taken quite a hit in recent weeks but may see some upside if it meets analysts' expectations. But don't chance it. Wait.

Foolish bottom line
Investors continue to be misguided by analysts' recommendations because their reports are based on earnings expectations. A prudent investor can use readily available trend data to accurately estimate future results. Foolish readers should base investment decisions on earnings quality.

To read more about these education stocks, make sure to add them to your watchlist.

Fool contributor John Del Vecchio is Co-Advisor to Motley Fool Alpha and co-manager of the Active Bear ETF (NYSE: HDGE  ) . You may follow him on Twitter @johnfdelvecchio. He does not own any shares in the companies mentioned in this article. The Motley Fool owns shares of American Public Education. The co-manager of the Active Bear ETF is an independent contractor with The Motley Fool. Motley Fool newsletter services have recommended buying shares of American Public Education. The Motley Fool has a disclosure policy.

We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. Try any of our Foolish newsletter services free for 30 days.


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  • Report this Comment On August 04, 2012, at 12:56 AM, PaintedApache wrote:

    The trouble is most of these students don't complete the Pedagogy process.

    They drop out and the school is left looking like the bad guy.

    Those that do graduate go on to begin careers, most of them do anyway.

    Getting those dropouts back in school is the challenge.

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