Markets & Finance

Class Acts among School Stocks


By Michael Jaffe and Massimo Santicchia Shares of education companies were down sharply on Tuesday, Oct. 22 after several brokerage firms downgraded Career Education (CECO

) for reasons varying from valuation to disappointment with its earnings outlook. Career Education reported better-than-expected third-quarter earnings per share but said it expects its October population and new-student starts to increase 22.6% and 18.9%, respectively, from year-ago levels. This guidance was below some analysts' projections, and that sent the stock plunging 16%, to $43.99. Just a day earlier, it had hit a fresh 52-week high of $52.50.

We at S&P, however, remain positive on Career Education, which is ranked 4 STARS (accumulate). The Hoffman Estates (Ill.) company reported third-quarter EPS of 30 cents, vs. 17 cents a year ago. That's 4 cents above S&P's estimate. New-student starts were up 19% from a year ago, to 15,100. The strong results were driven by gains across all segments of its student population and educational programs, which include visual communication and design technology, information technology, business studies, and culinary arts. Career Education generated $25 million in cash flow from operations, up from $16 million a year ago.

We increased our 2002 EPS estimate to $1.35 from $1.31 to reflect the third-quarter results, continued growth in student enrollment, and improving operating margins. Our

discounted cash-flow model indicates an intrinsic value for the stock of between $50 and $52. We think its current weakness offers an opportunity for investors.

EXTRA CREDIT. Shares of other post-secondary education providers -- such as Apollo Group (APOL

), Sylvan Learning Systems (SLVN

), and Corinthian Colleges (COCO

) -- dropped after Career's earnings report. We at S&P also reiterated an accumulate ranking on shares of Apollo Group, which declined 8.2%, to $41.92, on Tuesday. We remain positive on Apollo given its leadership position in an industry poised for major long-term growth.

Even after Tuesday's drop, Apollo stock trades at premium valuation of 36 times our fiscal year 2003 (ending August) EPS estimate of $1.15. Apollo provides an attractive way for working adults to attain educational degrees, as well as to enhance their skills levels, in a variety of areas that are in demand, such as accounting, education, and nursing. Apollo's exceptional growth has kept the shares at a big premium to the market for the past decade and should allow for ongoing above-market returns in coming months.

Most for-profit education stocks were leading performers in 2001, and so far in 2002 many of them have surged (see BW Online, 9/26/02, "Investors Are Giving Colleges an A+"). Shares of Apollo and Corinthian have jumped around 50% so far this year, thanks to strong enrollment for courses or advanced degrees in growth areas like business management and culinary arts. But other education providers that focus mostly on technology training, such as DeVry (DV

), are out of favor, given the downturn in the tech industry.

BRUSHING UP. We expect further gains for the stocks we cover, Apollo and Career Education. Investors have found shelter here, as weakening employment markets prompted many laid-off workers to seek additional education and pushed revenues in the sector even higher.

Yet, with rising ambition levels also luring many workers to go back to school to enhance their skills, we foresee education demand to remain strong even as the economy bounces back. While expectations of a recovering economy might drive some investors to more cyclical areas, we still think the strong business performance of selected education companies will help their stocks outperform the overall market. S&P analysts Jaffe follows Apollo Group and other diversified commercial services and Santicchia follows Career Education and other emerging growth stocks


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