Apollo Education Group: A Case of Investor Overreaction

Last Wednesday, shares of Apollo Education Group (NASDAQ: APOL  ) rose an impressive 14.2% after the company announced earnings results Tuesday evening for its first quarter of 2014. The company's results actually fell short of analyst estimates, but after adjusting for one-time expenses Apollo saw a meaningful uptick in profitability. After such a rise in share price, some investors are probably wondering if now is the time to sell, while those who didn't buy are likely kicking themselves pretty hard. Is it possible that the company's situation is still dire and that it, like rivals ITT Educational Services (NYSE: ESI  ) and Career Education Corporation (NASDAQ: CECO  ) , is still a very risky investment for the Foolish investor?

Apollo couldn't meet expectations
Despite the company's share price appreciation on Wednesday, it actually fell short of what Mr. Market expected. For the quarter, analysts estimated that revenue would come in at $860.6 million, 18.8% lower than the $1.06 billion the company reported for the same quarter a year earlier. At $856.3 million, the company's sales fell short of last years' performance by 19.2%.

The drivers behind the decline in sales were lower enrollment and decreased revenue per student. During the quarter, Apollo saw the number of degreed enrolled students fall by 17.7% from 319,700 to 263,000. The single largest decline in this measurement of students came from those seeking an associate's degree. The number of students in this group fell by 25% in comparison with the same period a year earlier.

Looking at new degreed enrolled students (those who recently began attending the company's schools), the picture is even worse. Student count in this category fell 22.9% from 54,100 in the first quarter last year to 41,700 in this year's quarter. Just as in the case of degreed enrolled students, the largest area of decline in this category was in the number of new students working toward an associate's degree. Compared to the same quarter last year, enrollment in this section fell 28.8%.

On top of fewer enrollments, Apollo was hit hard by a decline in revenue per student as it strives to maintain competitively priced. This was coupled with an increase in tuition discount on a per-student basis. For the quarter, revenue per degree-seeking student came in at $3,219.30. This is 1.1% less than the $3,255.73 the company saw last year. Similarly, the discount granted to students, on average, was slightly higher than it was a year ago. According to the company's earnings release, the average student received a $235.19 discount for the quarter, 13.3% more than last year's $207.57.

All of these factors and more led to Apollo reporting substantially lower earnings for the quarter. After adjusting for a modest increase in the number of shares outstanding, the company reported earnings per share of $0.87. This is $0.03 lower than the consensus estimate and 26.3% lower than the EPS of $1.18 that the company reported for the same quarter last year. However, if you remove the company's (hopefully) one-time restructuring costs for each quarter and the $16.9 million litigation charge incurred last year its EPS would have been $1.04, versus $1.22 last year.

Apollo isn't alone in having a hard time
If you thought that Apollo was the only company having a hard time in the for-profit education sector, think again! The business has plenty of company with competitors like ITT and Career Education.

Since 2010, revenue for Apollo has dropped 25.3% from $4.93 billion to $3.68 billion. This decline has come about as a result of lower enrollments following a period in which many college graduates have had a difficult time finding careers in the harsh economic environment, combined with increased government regulation in the sector. During this time, the company's profitability has also suffered, with net income dropping 55.1% from $553 million to $248.5 million. The disparity between the revenue and net income declines can be attributed to costs being stickier than sales.

Looking at the same starting point, we see that ITT's results were better, but not by much. Since 2010, sales at the college fell 19.4% from $1.6 billion to $1.29 billion as the company reeled from the same negative catalysts that infected Apollo. However, the company saved face in revenue but made up for this in profitability. During the same time-frame, net income at ITT fell a stunning 62.5% from $374.2 million to $140.5 million. This disparity, like the one seen at Apollo, can be chalked up to higher expenses as a percentage of sales, particularly in the company's cost of revenue and selling, general, and administrative expenses.

Of the three companies profiled here, none was hit harder than Career Education. Since 2010, revenue brought in by Career Education fell a jaw-dropping 28% from $2.07 billion to $1.49 billion. Unfortunately, the company's situation in regard to net income was even worse, with its $157.8 million gain in 2010 falling to a $142.8 million loss by 2012. While the company was slammed by general costs, it was also hurt tremendously by restructuring costs which rose from $70.4 million to $127 million.

Foolish takeaway
Irrespective of what Mr. Market indicated about Apollo on Wednesday, the situation facing the company looks quite grim. On top of missing sales, the company faced declining earnings per share in a trend that doesn't look to be getting better anytime soon. However, the company did offer some upside that investors took note of.

Compared to its earlier belief that revenue for 2014 will come in between $2.95 billion and $3.05 billion while operating income will hit between $375 million and $450 million, management estimates that results will be a little better now. For the year, management expects revenue to fall between $3 billion and $3.1 billion while operating income should come in somewhere in the range of $400 to $450 million. Before using this improved forecast as a sign to buy, investors should be cognizant of the fact that this will still represent a substantial haircut from the company's 2013 results. I don't know about you, but that doesn't sound too exciting for me.

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