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3 underachievers need to buckle down
Bad behavior has kept education stocks from living up to their big growth potential. We find the companies worth keeping an eye on.
By Robert Walberg
The back-to-school season may have come too soon for the kids, but not so for the secondary-education industry. Since late May, or about the time the kids left school, education stocks have been giving investors a lesson in pain. The groups average decline off its 52-week high is an alarming 33%.
Summer, however, didnt wilt these stocks. Shrinking enrollment, earnings warnings and a rash of regulatory investigations are the real reasons behind the industrys woeful performance. Unfortunately, none of these concerns is likely to be erased any time soon. But the stocks seem to be near a bottom, and, with some careful examination, there are a few companies that may see turnarounds in the next year.
Bad news already priced in?
Most worrisome to investors are the regulatory investigations and class-action lawsuits involving Career Education (CECO, news, msgs), Corinthian Colleges (COCO, news, msgs) and ITT Educational Services (ESI, news, msgs). The companies have been accused of:
- Inflating enrollments in order to collect more student loan reimbursement than they deserved.
- Altering financial aid documents to fraudulently receive funds from the federal government.
- Doctoring grades, graduation rates, admissions and salaries of graduates.
The investigations have been ongoing since as far back as February, but a modest retreat for this once-high-flying sector turned into a rout after Corinthian warned that fourth-quarter and full-year earnings for fiscal 2004 would fall short of expectations.
Citing higher marketing, advertising and educational services expenses, along with lower revenue due in part to negative publicity, the company lowered its estimates for quarter four to 19 to 20 cents a share from 28, and for the full year to 86 to 87 cents from 97. The company hit those targets Wednesday, with shares soaring 15% after the results were announced. The company said same-school enrollment had grown 15% over the last year, and it affirmed current guidance for the first quarter at 17 to19 cents a share.
Another thing for investors to watch: How the overall industry reacts to any more bad news. The news cycle over the past few months has been as ugly as the sectors price performance. The question now is, will the industry continue to implode or is all the bad news already priced in?
While additional price weakness is possible, if not probable, current valuations suggest that a bottom is fast approaching. With few exceptions, such as Apollo Group (APOL, news, msgs) and Strayer Education (STRA, news, msgs), the stocks in the group now trade at a discount to the market, with an average forward price/earnings ratio of 17.5.
But remember this: Growth in the sector remains very strong compared with most industries, and long-term trends point to increased demand for postsecondary education. Consequently, once the regulatory concerns pass and the companies put their houses in order, the fundamentals are in place for renewed gains. Lets face it; finding industries with long-term growth rates of 20%, positive cash flow and little to no debt aint easy. So you might want to consider taking advantage of some short-term troubles to load up on some long-term bargains.
3 candidates to lead the turnaround
Which stocks make the best turnaround candidates? One way to play a reversal is to scout out those stocks that have held up best during the sell-off and buy them on the assumption that once conditions improve these stocks will continue to outperform. Apollo Group, Strayer Laureate Education (LAUR, news, msgs) and Education Management (EDMC, news, msgs) fall into this category. Though off their highs by about 20%, only Education Management is posting a loss over the past year, and even that is a relatively modest 5.5%.
But relative strength is only one consideration, and, given inflated valuations at Apollo and Strayer, neither looks that attractive going forward. Neither does Laureate, with its relatively low profit margins and its industry low return on equity (ROE). So out of this group, the only stock worth considering is Education Management. Consistent growth, decent margins, discounted valuations and a lack of regulatory improprieties leave it well-positioned to pace any group turnaround later this year.
Two more stocks that could see considerable price appreciation once the worm turns are Career Education and Corinthian Colleges. Neither is likely to emerge from their funk until late this year, at the earliest, but at 13.3 and 11.9 times estimated fiscal year 2005 earnings of $2.29 and $0.98, both are becoming very cheap. It should also be noted that both companies enjoy relatively high operating margins and ROE.
Rising bad debt expense and the federal probe into its enrollment practices should continue to depress Career Education shares over the short-term. However, when you consider that the stock has already shed 57% from its high and that it has an enviable track record of bolstering margins and delivering above industry revenue and earnings growth, the company seems well-positioned for a turnaround over the next 12 to 18 months.
The same can be said for Corinthian Colleges. Down almost 68% from its high, the stock is apt to struggle until the company starts controlling expenses and until the regulatory clouds lift. But based on the companys strong enrollment growth, its lofty ROE of 30% and its industry low valuations, Corinthian is a natural turnaround candidate. Again, the rebound might not occur until late this year or early next, but when it does, the bounce could be considerable.
One battered stock to avoid in all this mess is ITT Educational Services. Accusations of document-shredding and manipulating admissions records are too serious to dismiss, especially considering that the charges come from multiple employees at multiple campuses. Sometimes stocks are cheap for good reason, and this appears to be one of those cases.
Nevertheless, as investors watch their kids go back to school, they might want to return to the school industry themselves, as valuations are becoming downright cheap for an industry projected to deliver strong double-digit growth over the next several years. Three stocks that are well-positioned to lead any turnaround are Education Management, Career Education and Corinthian Colleges.
At the time of publication, Robert Walberg neither owned nor controlled shares in any equities mentioned in this column.
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