When you name your company after the Greek sun god, suffice it to say you are establishing some high expectations. For-profit education provider Apollo Group (Nasdaq:APOL) could certainly use some of Apollo's prophetic capabilities right now, as the company tries to navigate an evolving regulatory and economic environment. Although for-profit education has probably already seen its peak, Apollo looks to have what it takes to be a survivor for the long haul.
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A Mixed Start to the Fiscal Year
Apollo's first quarter was positive in many respects, but still evidences many of the significant challenges in front of this company. Reported revenue fell 11%, due in large part to lower enrollments. A company-described metric called "degreed enrollment" fell almost 15% this quarter, while the company did see higher revenue per enrollee (up more than 3%) and a larger number of credits earned per student (up about 4%).
Apollo is definitely struggling with profitability in the new environment. Operating income fell 30% and operating margin retreated by almost seven points. Some of this is transitory and due to the immediate impact of enrollment declines; some of it, though, may be more permanent as the company has to increase its staffing to comply with new rules and regulations from the federal government. (For related reading, see Understanding The Income Statement.)
New Starts Good, But Not as Good as First Glance
Apollo Group did report that the new student count increased almost 13% this quarter. Unfortunately for longs, there was a timing benefit baked into that number and the real organic growth was more on the order of 6%. New student growth of 6% isn't bad given the current economic climate, but 6% isn't 13%.
Apollo, DeVry (NYSE:DV), Strayer (Nasdaq:STRA) and Career Education (Nasdaq:CECO) have been at this a while, but this is arguably one of the most difficult and uncertain environments that for-profit educators have faced. For starters, the federal government has gotten a great deal more attentive about whether these companies deliver what they advertise and are worthy of federally-subsidized student funding. While this storm has largely passed for now, failure for the sector to lift its performance will reopen this matter.
Come to think of it, the issue of federally-funded education could be on its way to a moot point anyway. More than a few would-be candidates for U.S. president alter the federal government's role in supporting higher education. A worst-case scenario could spell the end of Pell grants and subsidized loans - and 88% of Apollo's revenue currently comes through these programs. A self-pay education environment isn't "game over," but it would be a dramatic shift and bad debt expense would become a very relevant issue.
There is also a question of the viability of for-profit education as a career enhancement. Many for-profit degree holders have found that their degrees are, in fact, not "just as good" as traditional college degrees in the eyes of employers. What's more, with plenty of highly-educated people in the unemployment line and a shifting attitude about the prudence of using debt to fund education, there may be a longer-term existential risk to this industry. (For related reading, see Keeping Up With Your Continuing Education.)
The Bottom Line
There will always be a need for vocational programs to train welders, mechanics and other tradespeople. That should be supportive over the long haul for names like Universal Technical (NYSE:UTI) and Lincoln Educational (Nasdaq:LINC), that have strong offerings in vocational and skilled trades and less reliance on programs like MBAs.
For Apollo, it will be not so much about the survival of the industry as the survival of the competition. In other words, even if for-profit education has seen its peak, Apollo is much more likely to be a survivor (if not a thriver) than many of its rivals. This is a cash-rich company and one of the relatively few to establish a solid reputation for many of its programs.
Even with revenue growth assumptions in the modest mid-single-digit percent range and below-historical-average free cash flow margins, Apollo looks at least 25% too cheap today. Sentiment seems to be improving towards this sector and while there are ample threats in the near-term (especially depending upon the outcome of the GOP primaries), Apollo looks like a worthwhile name for 2012. (Free cash flow is a great gauge of corporate health, but it's not immune to accounting trickery. For more, see Free Cash Flow: Free, But Not Always Easy.)
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At the time of writing, Stephen Simpson did not own shares in any of the companies mentioned in this article.