Career Education Corporation: recovery is on its way

Primary ticker: CECO

Long/short: long

Entry Point: market price

Target price: 7.8

Stop Loss: 5.06

Investment horizon: long-term

Key points:

• The US for-profit education sector is recovering: Moody’s expect that aggregate operating revenue will grow at or above 3% over the next 12–18 months due to steady sector-wide demand and improving economic conditions.
• The business model of the company has been changing significantly. Management is liquidating loss-generating divisions and focusing on key division with good margins.
• Recent results confirm that new business strategy is a value-generator. Operating margin has been improved from -10.7% in Q1 2015 and -2% in Q4 2015 to 3.5% in Q1 2016.
• CECO demonstrates a very strong share price momentum: +24.35% in the last quarter and +42.64% in the last year (S&P 500: +2.94% and -0.26%). Fundamental upside is still more than 100%.

Description of the company:

Career Education Corporation (CECO) was incorporated in Delaware in 1994. The company offers an education to a diverse student population in a variety of disciplines through online, campus-based and hybrid learning programs. It’s operating segments include University Group, Culinary Arts, Transitional Group, and Corporate and Other (technical segment with negligible revenue). The Company’s University group consists of American Inter Continental University (AIU) and Colorado Technical University (CTU), which provide degree programs through the master’s or doctoral level as well as associate and bachelor’s levels. The AIU and CTU offer academic programs in the career-oriented disciplines of business studies, information systems and technologies, computer science and engineering, design technologies, criminal justice and health sciences. As of December 31, 2015, students enrolled at CTU and AIU represented approximately 74% of total enrollments, 92% of them are fully online.

The Culinary Arts segment includes Le Cordon Bleu institutions in North America (LCB), which offer hands-on educational programs in the career-oriented disciplines of culinary arts and patisserie and baking in the commercial-grade kitchens of Le Cordon Bleu. LCB also provides online programs in culinary arts and hotel and restaurant management. As of December 31, 2015, students enrolled at LCB represented approximately 18% of total enrollments.

The Transitional Group segment offers academic programs primarily in the career-oriented discipline of health education complemented by certain programs in business studies and information technology, as well as fashion design, film and video production, graphic design, interior design and visual communications. It includes non-LCB campuses, which are in teach-out. As of December 31, 2015, students enrolled at the Transitional Group campuses represented approximately 8% of total enrollments.

Peer Analysis:

The Company’s main competitors are Apollo Education Group, Inc. (APOL), DeVry Education Group Inc. (DV) and ITT Educational Services, Inc. (ESI). Let’s check some key numbers and multiples of 2015 to begin with. Earnings multiples are not relevant because positive net income for CECO in 2015 was a result of huge one-time benefit from income taxes and 2016’s net income will likely be very low or even negative.

At first glance, CECO doesn’t look so attractive compared to its peers — only gross margin ratio is better. Although the company’s overall operating margin is -11%, the same indicator for University Group division is 17% and we’ll see later why this particular number is more important. It should be noted that CECO’s total general and administrative expense has been steadily decreasing from 72.2% of total revenue in 2013 to 66.6% in 2015 and 62.1% in Q1 2016, weaken its pressure on operating margin.

Speaking of trends, recent results are looking much more favorable for CECO. For the first quarter, revenue was $198.9 million, which is down 12.4% year-over-year. But University Group segment posted a 4.9% increase year-over- year, and the decline in total revenue is attributed to the teach-out strategy at Culinary Arts and Transitional group segments. Total student enrollments for the University Group were 33,900, compared to 33,800 in the prior year quarter. Only DeVry Education Group was able to also enlarge its number of students from 143,935 to 158,300, or +10%, but its revenue decreased by 3.2 percent nevertheless. For APOL and ESI enrollments went down from 227,400 to 176,900, or -22% and from 51,201 to 43,000, or -16% respectively. Total revenue decreased by 18% for APOL and by 16.7% for ESI. CECO’s operating margin has been improved considerably from -10.7% in Q1 2015 and -2% in Q4 2015 to 3.5% in Q1 2016. Year-over-year dynamic for its peers is much weaker:

APOL: from -6.5% to -17.4%, DV: from 10.1% to 12.8%, ESI: from 12% to 7.4%.

These positive financial trends have been reflected in the stock’s recent performance. CECO demonstrates stronger price momentum both quarterly and yearly compared to its peers and the overall market.

Performance in the last quarter: CECO +24.35% APOL +9.06%, DV -16.59%, ESI -48.44% (S&P 500 +2.94%).

Performance in the last year: CECO +42.64% APOL -45.28%, DV -47.99%, ESI -64.52% (S&P 500 -0.26%).

In fact, this is the best performance in the education industry among 300mln+ market cap companies.

Why the company is undervalued?

Last year was a turning point for Career Education Corporation. After several unprofitable years the company has made strategic decisions to address the changing industry dynamics and appointed Todd Nelson as its new CEO to implement new strategy. The company decided to teach-out and sell campuses and to focus all resources on University Group segment. CECO has 25 campuses remaining within the Transitional Group and 17 campuses within the Culinary Arts segment, which will complete their teach-out at varying dates through 2018 with the majority being complete by the end of 2017. The company also began adjusting its staffing and right-sizing corporate structure to be in-line with these teach-out decisions. Q1 2016 total operating income of $7.0 million vs prior quarter operating loss of $24.4 million reflects strong execution against the company’s strategic initiative.

The main segment of CECO, University Group, is in a good shape at present. The company invested in technology and other program enhancements to drive improvements in student experience, student retention and outcomes in the future, including the rollout of mobile application for both CTU and AIU in fourth quarter of 2015. New programs got positive feedback and management believes that their University platform is positioned to succeed in the future. U.S. News has recently listed AIU among the top programs in multiple categories for 2016. AIU also received E-Learnings Best of 2015 award for its intellipath adaptive learning platform. CTU received the Instructional Technology Council’s 2015 award for Outstanding E-Learning programs.

During 2015, CECO also launched four new degree programs across AIU and CTU institutions in the areas of education (AIU), business administration (AIU), nursing (CTU) and healthcare management (CTU), as management sees strong opportunities for these institutions to provide value to students seeking new career opportunities in these fields.

DCF model based on new company’s strategy shows that its shares are highly undervalued, even though the cost of capital for CECO is much higher compared to sector’s average (9.4% vs 5.4%). Its implied share price is $11.8 using the Perpetual Growth method and $18.8 using the Exit Multiple method. That means that according to both methods there is more than 100% upside to current market price ($5.72).

The liquidity position of CECO is solid: the company has zero debt and about $170 million in cash and short term investments. Taking into account its off balance sheet lease obligations, this cash exceeds their total amount up to 2018. The management expects that total cash will decrease to $140 million in 2017 and will start to increase thereafter.

Finally, despite that the company doesn’t seem too cheap compared to its main peers, its multiples are attractive against education sector. CECO P/B is 1.13 vs 1.79 for sector, P/S is 0.46 vs 1.08 and EV/sales is 0.26 vs 1.37.

Catalysers:

As we saw earlier, new strategic decisions had already made a very positive impact on recent financial results and it’s just the beginning of the process. Forward-looking statements after Q1 report confirm that the new strategy is successful and the company is going to stick with it. Todd Nelson, President and CEO, said that management remains confident in the positive outlook they provided previously. Their priorities for the near-term will continue to be focused on improving the market position of AIU and CTU by strengthening the breadth of program offerings, faculty and technology, with the goal of continuing to enhance student retention and outcomes as well as continuing to responsibly manage the teach-outs of Career School campuses.

Investors used to think of CECO as an ineffective company with shrinking revenue and too large expenses, which struggle to become a profitable. And now it’s pretending to become a stable income generator with good margin levels. I think that such radical changes require a plenty of time for investors to adjust. Most of them are still skeptical and wait for confirmations. That’s why financial reports are very important and probably will continue to be the main triggers of stock movements, as they has been since February.

The Q2 2016 report is coming in about 2 months (August 4–8). The company has already topped analysts’ estimates 3 times in a row with its last quarterly reports and can continue to do it in the future. Asset impairment charges related to trade name and fixed asset impairments will likely to decrease in a process of Career Schools’ teaching-out and it could help to bring positive surprises for net income.

Sector overview:

The US for-profit education sector was under pressure in recent years. Not everyone had successfully adapted to significant changes in formats of education presented by online platforms like Coursera. According to data from the National Center for Education Statistics, the sector is shrinking, with almost 100 fewer for-profit colleges operating in 2014–2015 than in 2012–2013. Moreover, for-profit universities and colleges have increasingly come under scrutiny for their marketing tactics and admissions standards. Critics point to the large proportion of student loan defaults among industry operators and an abnormally high drop-out rate compared with traditional colleges. As a result, bad press has caused many would-be enrollees to search for other options.

However, the future is not looking that grim. Moody’s outlook for sector had been negative since January 2013, but was revised to stable in July 2015. This means modest real growth in a low inflationary environment as well as constrained but consistent revenue improvements. In their March 2016 report, Moody’s expect that aggregate operating revenue will grow at or above 3% over the next 12–18 months due to steady sector-wide demand and slowly improving economic conditions. Expense pressures will remain a key risk to the sector’s stability, but will be mitigated by ongoing cost containment.

The sector is highly fragmented and increasingly competitive with no education company controlling substantial market share: the fifty largest companies represent just 30% of the total revenue in the industry. CECO is a small player with a market share less than 1% and is unlikely to become bigger in the near future. Nevertheless, the company has some competitive strengths such as its virtual learning platform and its mobile platform. 92% of both CTU’s and AIU’s total enrollments are fully online already. Therefore, Career Education Corp. should remain competitive in challenging environment.

Valuation:

https://drive.google.com/file/d/0ByCwT1KadLZdLVE5ZVdFejNORkE/view?usp=sharing

Key assumptions of the model:

Transitional Group and Culinary Arts segments will complete their teach-out at varying dates through 2018 with the majority being complete by the end of 2017 (in line with company’s outlook).

Slightly negative total enrollment growth and declining revenue growth within the University Group (more conservative than company’s expectations).

Stock chart:

https://www.tradingview.com/chart/E8qw98s0/

Conclusions:

Overall, Career Education Corporation is a great investment opportunity with 100% upside potential, which can be easily reached on a 1-year horizon due to a strong price momentum of the stock.