The for-profit education business has enjoyed a nice run as unemployment rates continue to rise ever higher. The largest of the sector is Apollo Group (APOL), owner of The University of Phoenix. Apollo reported earnings after the close on Monday which handily beat what the street had expected. Third quarter profit rose to $201.1 million, or $1.26 per share, from $139.1 million or 85 cents per share. Revenue topped a billion ($1.05B) from $835.2 million last year, up 26%. Clearly, the current operating environment has propelled the online educator to substantial enrollment growth. The earnings beat was not unexpected as analysts have been raising estimates for this quarter over the past few months. Shares are trading about 9% higher in Tuesday mid-day trading, which is in contrast to the broad market indices that are down about 1%.
“This traded up to $90 in January, traded back down, it’s actually technically done a lot of nice things recently, UBS raised price target on it a couple of weeks ago… I think you can own Apollo Group, it’s trading up after hours, got back what it gave overnight, but I think APOL works. It’s probably easing, I think APOL’s worth a look.” CNBC’s Fast Money 6/29/2009
Apollo Group has had a tougher 2009 than most of the market, as coming into the day APOL was down nearly 15% year to date. This is worse than the return of the broad market, and it is likewise worse than its closest competitors including Corinthian Colleges (COCO) or ITT Educational Services (ESI) which are both up about 7% year to date. With the growth that Apollo Group has experienced in enrollment and revenue what is the declining share price due to?
Some would say that Apollo was overvalued at the beginning of the year, but the main cause as we see it has been the possibility of industry reform alluded to by President Obama’s administration. What this could mean for the amount of revenue coming in from government sponsored student loans is unclear, but we do know that Apollo is receiving a greater percentage of revenue from these loans lately. Apollo, being the largest company in the space, takes the brunt of the fears surrounding increased government scrutiny. Last quarter, Apollo management stated that they expect that they will be subject to annual reviews by the U.S. Department of Education. Some analysts believe that the speculation over scrutiny has been overblown, and in turn this is an opportunity for investors.
Fundamentally speaking, it is hard to ignore the strength of APOL right now. Unemployment nearing 10% nationally has helped increase degree program enrollment by 22% year over year. Many believe that the economy is in the process of recovery, but it is also true that unemployment is a lagging indicator. This has been shown in recent recessions, as the improvements in the macro-economy have not led to net job creation right away. So, we think it is not unreasonable for Apollo Group to expect there to be further enrollment gains in the near future. Management has also stated that they will be increasing tuition rates by 2% to 6%, which is generally in line with most educators.
Furthermore, the company bought back about 7.2 million shares for an average of around $61.62 per share, and the companies board recently agreed to increase the buyback to an aggregate of $500 million. We always like to see this sort of aggressive activity by management when they believe that their stock is too cheap. At Ockham, we happen to agree that the stock is still too cheap even after today’s appreciation. Both price-to-cash and price-to-sales numbers are still attractive and the growth is very attractive. We think that the strong fundamentals have still not been fully recognized by the market and could propel this stock back into the heights it saw in January. Until we see some sign that the revenue and earnings growth trends are slowing we will reaffirm our Undervalued valuation on Apollo Group shares.