ITT Educational Services is Still Undervalued

For-profit educator ITT Educational Services (ESI) reported strong results to close out fiscal 2009 on a high note. On a morning where yet another disappointing jobs report was released, ESI reported fourth quarter profits rose 49%. Logically it makes sense that ITT and other for profit educators thrive when unemployment is high as enrollment surges. ITT also has the advantage of being heavily geared towards teaching students about technology and related fields, which is obviously in demand for the job openings that do come available. According to Amy Junker, analyst at Robert Baird, ITT should continue to benefit as the wage disparity between those with a postsecondary degree and those with only a high school diploma continues to grow.

ITT Educational Services reported profits of $93.7 million or $2.56 per share, which exceeded analysts’ estimates by 8.5%. Net enrollment jumped 30% in the quarter and the tuition per student also climbed to $4727 from $4525, which led to overall revenue gains of 34% to $374.4 million slightly ahead of estimates. Operating margins also improved to 40.8% from 36.4% as the company utilized its resources more efficiently as enrollment grew. The stock was boosted by the results as high as $110 per share, but it has tapered off in afternoon trading and with an hour left in the day is up only 6% at about $104.

The company seems to be predicting further weakness in the labor market for the year ahead and has guided EPS for 2010 to come in above $10 per share. This guidance is even more bullish than analysts who were expecting EPS of $9.48, which implied a nearly 20% earnings growth. In a scenario where prolonged joblessness remains an issue it is easy to see how this scenario would continue to benefit ITT Ed. However, it may not be all smooth sailing for the firm, as the Obama Administration has already said increased scrutiny may be on the way for the for-profit education sector. Recruitment practices may see additional regulations as well as examining what benefits these educators actually provide their students.

At Ockham, we are reiterating our Undervalued stance on ESI following their even better than expected results. Perhaps, the fear of regulatory issues in the future is keeping the stock’s valuation depressed but we think that this is a risk worth taking. Over the past ten years, ITT has traded for between 15.5x and 28.5x cash earnings, but the current price-to-cash earnings is only 12.5x. Similarly, for price-to-sales ITT is selling below its historically normal valuation range of 3.1x to 5.7x. We are not saying that this will necessarily happen, but if ESI traded at the midpoint of these historical valuation ranges (based on current fundamentals) would imply a price of $167. It appears to us that there is enough of a margin of safety built into this stock that any investor who believes in a jobless recovery should be curious about ITT Educational Services.

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Ockham Research is an independent equity research provider based in Atlanta, Georgia. Security analysis at Ockham Research is based upon the principle known as Ockham's Razor, named for the 14th- century Franciscan friar, William of Ockham. The principle states that a useful theory should utilize as few elements as possible, because efficiency is valuable. In this spirit, our goal is to make the investing environment as simple and understandable as possible, yet no simpler than is necessary.

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