In this analysis, I am looking at APOL as a long investment opportunity. A quick review of APOL’s financials attracted me to the company:
- High cash flow generation
- High returns on equity and assets
- Strong Balance Sheet
- Relatively low valuation (on a cash return and P/E basis)
- Strong level of share buybacks
The analysis will first evaluate the company’s performance which in turns informs a discounted Free Cash Flow model, coupled with the determination of a reasonable margin of safety and likely intrinsic returns of the company.
Apollo and the for profit education at large have been in the news quite often following the US Department of Education (“DOE”) release of a notice or proposed rulemaking on gainful employment. The initial proposal could have limited for-profit school student access to financial aid. However, through the summer the proposal was revised and it is now estimated that only 5% of the programs in the US would lose access to aid if the rule was currently in place (per DoE). The criteria for eligibility are based on students’ ability to pay down their loans as well as tests on debt/income.
Even before the multiple discussions and revisions to the DoE’s proposal, APOL proactively put in place a 3-week orientation program required for students with fewer than 24 credit hours. The program, which is free, lets student “try out” classes for 3 weeks before taking on any debt. As most “drop out” usually leave school early in their curriculum this program should reduce the long term drop-out rate while it may, in the short term, slow down growth in enrolment. (~80% of students complete the orientation program).
While there has been significant noise around the industry, it seems that APOL has taken good steps to improve its student’s understanding of their financial options and APOL should comfortably meet the loan requirements from the DoE going forward. The “noise” could lead us to increase our requirements for margin of safety, but could also have created a good opportunity for a patient investor…
Over the last 5 years, free cash flow (“FCF”) has improved 17% on average and FCF/Sales remained in a 17% to 20% band. On a 10-year basis, FCF growth has been even more impressive, with a 26% average! In addition, FCF’s have been rather stable with a standard deviation vs. regression trend-line of 23% and only one down year over the last 10 years. Earnings have also been stable, with a similar standard deviation vs. trend line and EPS have increased consistently in all but one year (decreasing by 1cts/share!) in 2006.
Looking forward, I will be using a growth rate of “only” 8% over the next 5 years, which is below historical revenue performance, but in line with Net Income growth over the last 5 years. This rate of growth is also quite a bit less than analysts’ consensus of 13.8%. As a starting point for 2010, I will be using 2009’s FCF of 833 (i.e. using a flat year) which is conservatively below the regressed trend line due to the current TTM performance, slightly below 2009’s FCF.
Turning to returns, APOL’s performance has been strong with ROE’s and ROA’s of 60% and 28% over the last 5 years, respectively. These are extremely high levels and I will be using a “more conservative” 40% ROE (in line with APOL’s 10-year average) going forward as an input to the sustainable growth rate calculations.
Based on APOL’s strong returns and cash generation over the long term, I believe APOL has a business moat. However recent “news” and a – somewhat moderate – recent slowdown in FCF generation couple with ~20% volatility vs. trend line suggest that I should be using a higher margin of safety than the 25-30% I would use for a strong stable business. I will use 40% as a margin of safety in order to evaluate the attractiveness of the stock.
I will post the rest of the analysis tomorrow. If you want you can also check it out on my website http://margionofsafetyinvesting.com
Don't hesitate to share your thoughts and questions below.
Many happy returns!
Ben
- High cash flow generation
- High returns on equity and assets
- Strong Balance Sheet
- Relatively low valuation (on a cash return and P/E basis)
- Strong level of share buybacks
The analysis will first evaluate the company’s performance which in turns informs a discounted Free Cash Flow model, coupled with the determination of a reasonable margin of safety and likely intrinsic returns of the company.
1 Company Analysis
1.1 Company overview
Apollo group is the largest for profit education company, with more than 450,000 students in its core school (representing >95% of revenues) the university of Phoenix. Programs (on line and off line) range from associate to doctorate degrees in areas such as business, education, healthcare, technology and social sciences. The company was founded in 1973 on the realization that education would become “lifelong” and that 50% of students in the future would be (working) adults. APOL has experienced strong growth recently, partially because of the weak economy over the last couple of years but also as a result of a long term trend in lifelong eduction.Apollo and the for profit education at large have been in the news quite often following the US Department of Education (“DOE”) release of a notice or proposed rulemaking on gainful employment. The initial proposal could have limited for-profit school student access to financial aid. However, through the summer the proposal was revised and it is now estimated that only 5% of the programs in the US would lose access to aid if the rule was currently in place (per DoE). The criteria for eligibility are based on students’ ability to pay down their loans as well as tests on debt/income.
Even before the multiple discussions and revisions to the DoE’s proposal, APOL proactively put in place a 3-week orientation program required for students with fewer than 24 credit hours. The program, which is free, lets student “try out” classes for 3 weeks before taking on any debt. As most “drop out” usually leave school early in their curriculum this program should reduce the long term drop-out rate while it may, in the short term, slow down growth in enrolment. (~80% of students complete the orientation program).
While there has been significant noise around the industry, it seems that APOL has taken good steps to improve its student’s understanding of their financial options and APOL should comfortably meet the loan requirements from the DoE going forward. The “noise” could lead us to increase our requirements for margin of safety, but could also have created a good opportunity for a patient investor…
1.2 Profitability and Growth
While APOL’s growth has been high (15% over the last 5 years), APOL has also experienced a decrease in its margins leading to operating and net income growing at a lesser rate of 8% – 9% on average over the last 5 years. Margins remain healthy at 22% operating and 13% net.Over the last 5 years, free cash flow (“FCF”) has improved 17% on average and FCF/Sales remained in a 17% to 20% band. On a 10-year basis, FCF growth has been even more impressive, with a 26% average! In addition, FCF’s have been rather stable with a standard deviation vs. regression trend-line of 23% and only one down year over the last 10 years. Earnings have also been stable, with a similar standard deviation vs. trend line and EPS have increased consistently in all but one year (decreasing by 1cts/share!) in 2006.
| $ millions, except per share data | Growth Rates | |||||||||
| 2005 | 2006 | 2007 | 2008 | 2009 | TTM | 3-yr | 5-yr | 10-yr | ||
| Revenue | 2,251 | 2,478 | 2,724 | 3,141 | 3,974 | 4,753 | 20.8% | 14.7% | 22.7% | |
| Op. Income | 713 | 650 | 626 | 749 | 1,039 | 1,059 | 28.8% | 9.4% | 25.3% | |
| Net Income | 445 | 415 | 409 | 477 | 598 | 605 | 20.9% | 7.6% | 24.6% | |
| OCF | 566 | 551 | 589 | 726 | 960 | 955 | 27.7% | 14.3% | 23.5% | |
| FCF | 462 | 440 | 484 | 621 | 833 | 814 | 31.2% | 16.5% | 25.5% | |
| EPS | 2.39 | 2.36 | 2.35 | 2.87 | 3.74 | 3.98 | 26.1% | 11.5% | 26.3% | |
| Note: Growth rates calculated using log-normal regression and exclude LTM | ||||||||||
Looking forward, I will be using a growth rate of “only” 8% over the next 5 years, which is below historical revenue performance, but in line with Net Income growth over the last 5 years. This rate of growth is also quite a bit less than analysts’ consensus of 13.8%. As a starting point for 2010, I will be using 2009’s FCF of 833 (i.e. using a flat year) which is conservatively below the regressed trend line due to the current TTM performance, slightly below 2009’s FCF.
Turning to returns, APOL’s performance has been strong with ROE’s and ROA’s of 60% and 28% over the last 5 years, respectively. These are extremely high levels and I will be using a “more conservative” 40% ROE (in line with APOL’s 10-year average) going forward as an input to the sustainable growth rate calculations.
Based on APOL’s strong returns and cash generation over the long term, I believe APOL has a business moat. However recent “news” and a – somewhat moderate – recent slowdown in FCF generation couple with ~20% volatility vs. trend line suggest that I should be using a higher margin of safety than the 25-30% I would use for a strong stable business. I will use 40% as a margin of safety in order to evaluate the attractiveness of the stock.
I will post the rest of the analysis tomorrow. If you want you can also check it out on my website http://margionofsafetyinvesting.com
Don't hesitate to share your thoughts and questions below.
Many happy returns!
Ben
