Apollo Group Earnings Eclipse $1 bil Last Quarter

Investors in for-profit education stocks are seeing gains this morning after Apollo Group earnings were released.  Revenue crossed the $1,000,000,000 mark this past quarter.  With revenue at a new record high, and growing by 27% over the past year, it truly looks like the company (and the sector in general) is sidestepping much of the economic weakness during this recession.  Student enrollment was 22.6% higher in the company’s fiscal third quarter which includes the final semester of the school year (fiscal year end is August 31).

Profitability was strong so while revenue came in basically even with analyst expectations, Apollo Group earnings beat expectations by 14 cents and came in at $1.26.  Enrollment for the quarter was up 22.6% over last year which is a bit lighter than the 23.1% seen in the previous quarter but still very impressive.  In early trading, the stock is up more than 7% as buyers cheer the report.

Apollo Group (APOL) has an excellent balance sheet with nearly $800 million in cash and very little debt.  Over the past quarter the company used $444 million to repurchase shares at an average price of $61.62.  In June the board approved what appears to be a small increase in the cash available to repurchase shares.  The press release states that the amount increased to an aggregate of $500 million which seems a bit odd considering the majority of that has already been used.  It is likely that the statement was supposed to read “an additional $500 million” but that has yet to be confirmed.

Other uses of cash include acquisitions as Apollo Group recently announced the purchase of BPP Holdings which is a UK company offering educational services for the legal and financial industries.  The purchase will cost $540 million (assuming conversion rate remains steady) and is expected to close in the current quarter.  The acquisition is likely to be profitable considering the ability of the company to leverage back office functions, and management’s strong track record of driving profitability.

The excitement over Apollo Group earnings is pushing other equities higher in the education sector.  It appears that while APOL is relatively fairly valued, some of the company’s peers may be trading at dangerous levels and be worthwhile short candidates.  Strayer Education, Inc. (STRA) and New Oriental Education (EDU) may be particularly vulnerable as the valuations are higher representing more investment optimism and higher expectations.  While neither of these companies have significant debt levels, the lack of liquidity for students may once again become a factor as we move into the fall semester both in the US (for Strayer) and in China (for EDU).

Education companies have typically been strong during recessionary periods as unemployed or underemployed make the decision to further their education order to build earnings power.  However, this time around we are experiencing a much deeper contraction which includes incredible destruction of wealth and corresponding cuts in the availability of capital.  Recent reports on bank loan charge offs and delinquency statistics point to further pain and will likely cause banks to cut back on lending.  This liquidity is necessary for most for-profit schools to maintain growth levels.  Up to now, the government (both US and internationally) has stepped in and filled this funding gap but now governments on the local and national level are finding themselves overextended and may pull back on lending programs.

The bottom line is that while investors are largely bullish on the for-profit education industry, and while Apollo Group earnings have helped to drive this optimism, there could be significant contraction over the coming months.  Investors in education stocks should watch valuation metrics closely and consider hedging against declines associated with lower growth rates.

FD: Author does not have a position in stocks mentioned

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