Apollo Group Sent to the Principal?

Tickers in this Article: LOPE, CECO, STRA, ESI, APOL

Last week, investors sent for-profit educational provider Apollo Group (Nasdaq:APOL) to the principal's office over short-term concerns about its profit outlook. In addition, investors were concerned about the company's ability to maintain its enrollment base and to stay current on tuition bills during the current economic downturn. However, Apollo continues to experience robust growth due to the tough jobs market; its long-term prospects appear strong, too.

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Quarterly Results
Second quarter sales grew an impressive 26.3% to $876.1 million on a 20.4% jump in enrollment, with growth primarily from the flagship University of Phoenix. Strong top-line growth allowed the company to "leverage its fixed costs", as illustrated by more muted expense growth. Instructional costs increased 13.9%, while selling and promotional expenses increased 11.9%. The only category to grow faster than sales was general and administrative, which was up 29.2%.  Total degreed enrollment ended the quarter at 397,700, with students seeking associates and bachelors degrees making up the majority of total students and revenues. 

Earnings per diluted share (diluted EPS) reached 77 cents, which handily beat analyst consensus estimates of 65 cents. In addition, its diluted EPS soared well above last year's 41 cents, minus hefty litigation charges in the prior period. Sales also beat analyst projections, but the stock fell sharply on bad-debt concerns and coming margin pressure, as Apollo spends to build physical campuses to stay ahead of the competition. However, management also relayed that the University of Phoenix is "continuing to leverage its fixed costs, such as certain employee wages, classroom space and depreciation expense." It works to achieve economies of scale, as it builds classrooms to better compete with traditional universities.  While bad debt increased 30 basis points from last year's quarter, and 50 basis points sequentially, the majority of revenue comes from U.S. government-backed federal student aid. (Learn more about what the numbers mean in Understanding The Income Statement.)

Other Online Educational Players
At 17.4x forward earnings expectations, Apollo's share price isn't overly compelling, but it is one of the lowest in the industry. Peers such as ITT Educational Services (NYSE:ESI), Strayer Education (Nasdaq:STRA), Career Education (Nasdaq:CECO) and Grand Canyon Education (Nasdaq:LOPE) also are growing sales and earnings into the double digits and have appealing growth prospects. Yet, in terms of market capitalization, Apollo is more than twice as large as the next largest competitor, which, combined with its favorable relative valuation, is hard to ignore.

Bottom Line
Near-term margin and bad-debt concerns are valid, but overblown, as are worries over whether or not growth will slow when the economy picks up and job opportunities increase. However, Apollo has grown sales at greater than 20% annually for more than a decade through numerous peaks and valleys in the business cycle since it was founded in the early 1980s. Apollo has no long-term debt, nearly $1.4 billion in cash on its balance sheet and posts extremely high returns on invested capital.

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