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Apollo Analysis: Good opportunity with a margin of safety (part 2)

October 04, 2010 | About:
This is the second part of my analysis of APOL as an investment opportunity. The 1st part can be found on GuruFocus or on my blog.

2.3 Financial Health Liquidity



APOL’s working capital management is acceptable, with a current ratio of 1.3x as of last reporting quarter. This ratio is in line with the company’s past practices and does not worry me as most of APOL’s current assets are very liquid vs. educational obligations and student deposits in current liabilities. APOL carried ~$50M in short term debt as of 05/2010.

Apollo has a very short cash conversion cycle as it – by definition – does not carry inventory. The company usually gets paid within 25 days (days sales outstanding) and itself pays its obligation within 15 days (days payable).

Debt

APLO only carries $166M in debt which is very low, representing less than a couple of month’s worth of free cash flow. In addition, APOL does not appear to have any pension liability.

$ millions, except per share data
2005 2006 2007 2008 2009 TTM
Total Debt / Equity 0.1 0.0 - - 0.5 0.1
ST % of Total Debt 20% 100% - - 78% 31%
Total Debt / FCF 0.2 0.1 - - 0.7 0.2
Op. Income / Interest - - - - 259.8 132.4


APOL’s strong credit position is also reflected in its Altman z-score of 6.8. APOL’s Piotroski score is 7, missing a ‘perfect score’ of 9 due to an increase (to 0.04x!) in Long term debt / Assets as well as a decrease from 1.55x to 1.50x in asset turnover,

In conclusion, APOL is in a strong liquidity and cash position (un-restricted cash was almost $900M as of May 2010 vs. debt of $166M). Given this strong situation, I will not increase my margin of safety requirement of 40%. As the company is still a “growth” company carrying some amount of risk and volatility due to its legal environment and global expansion through acquisition I will use a cost of capital of 12%.

2.4 Historic use of cash Dividends



APOL does not pay a dividend, unfortunately. However its use of retained earnings has been satisfactory as APOL has been able to gain strong returns on its retained earnings. On a 5-year basis, APOL retained $13.8 per share and increased its EPS by $3.0, a 21.5% return. On a 10-year basis the return has been equally strong, at 19.3%

$ millions, except per share data Growth Rates
2005 2006 2007 2008 2009 TTM 3-yr 5-yr 10-yr
Dividends
Dividends per Share
Diluted EPS
Payout Ratio 2.39 2.35 2.35 2.87 3.75 3.98 26.3% 11.6% 26.9%
Retained earnings per Share 2.39 2.35 2.35 2.87 3.75 3.98
Diluted Shares (M) 186 176 174 166 160 152 -4.1% -3.5% -1.4%
Note: Growth rates calculated using log-normal regression and exclude LTM


Buybacks

APOL has regularly purchased its stock back, retiring 3.5% on average over the last 5 years.

As of May 2010, APOL still had $660M available under its current repurchase plan, enough to buy back almost 10% of its outstanding stock.

3 Valuation

3.1 DCF

To evaluate the value of the company I am relying on a discounting cash flow calculation with the following assumptions:

- 2010 Free Cash Flow of $833M (cf. Profitability and Growth section above)

- Growth for next 5 years: 8% (cf. above), declining to 5.5% years 6-10 and then 3.0% years 11-20

- Cost of capital: 12%

- Terminal value in year 20 with no growth

This leads to a DCF value of $11.2Bn for the company, before accounting for net debt. Using a 40% margin of safety on this valuation leads to a per share entry price of $44, to which I am subtracting APOL’s net debt position of ($300M net cash position) leading to a price threshold for investment of slightly over $46.

I believe this evaluation of APOL’s value to be conservative, using last year’s FCF as a starting position, a forecast growth rate of less than half of historical FCF growth rate and below analyst growth consensus by less than 2/3rds.

APOL has recently traded in the $46 to $49 range and could provide for an adequate investment opportunity. However, in addition to knowing that I can invest with a good margin of safety – providing protection and potential upside – I also like to know that the company’s “intrinsic returns” will be satisfactory.

3.2 Expected returns

In addition to a potential re-valuation of the company’s multiple, its returns for an investor will be driven by: growth and share buybacks / improvement in cash position (given that there is no dividend)

APOL will use 20% of its earnings at 40% ROE to fund its estimated growth rate of 8%, leaving $3.18 for share buybacks/increase cash. At the current price of $46, APOL could buy back almost 7% of its shares back.

Adding these returns together leads us to a total intrinsic return of 15.0%. While this is high, I don’t believe that APOL would be buying such a high level of stocks back, but on the upside could be growing faster.

4 Conclusion

Despite the current noise around the company/industry, I believe that APOL is an attractive investment with a potential for reasonable/high growth and a high level of cash generation which the company will use to buy back its stocks. Based on my evaluation of an entry price with an important margin of safety I am planning on investing into APOL’s stock

If you liked this analysis of Apollo Group, you can find more Company Analysis on my blog: Margin of Safety Investing

Disclosure: I now own APOL shares and could be adding more to my personal portfolio


Rating: 4.0/5 (6 votes)

Comments

JohnZkn
JohnZkn - 3 years ago
Many of the for profit schools look like attractive purchases from a fundamental stand point. However, I do have a big concern about the actual product they provide. Is the education these schools are providing a good enough service to sustain long term growth...or will people find that what they payed for (probably over payed for) is not truly beneficial to their careers? Many view points on this issue, but I stayed out of this sector because I was worried about it being a possible longer term value trap.

Great analysis though!

This is my blog:

www.valuefinancial.blogspot.com
batbeer2
Batbeer2 premium member - 3 years ago
>> Is the education these schools are providing a good enough service to sustain long term growth...or will people find that what they payed for (probably over payed for) is not truly beneficial to their careers?

Not all these schools are the same, most are not in direct competition.

Let's say you are an adult in Chicago seeking further education; where will you go to and whith whom are you going to negotiate ? Will students now suddenly flock to the not-for-profit institutions because the price, like the quality is much better ? How likely is it that the total ammount of title IV spending in five years is lower than it is now ?

In fact, do poeple in Chicago wake up with en general desire for further education or do they have a more specific goal before they look around for a school ?

IMHO, staying away from the sector only makes sense if you are unable to indetify the losers. If you are, then there are bargains to be had.

In short,

COCO competes with APOL like MSFT competes with IBM. Comparing the balance sheets of these companies is of limited use.

Just some random thoughts.

Kanjoos Guru
Kanjoos Guru - 3 years ago
For those who care APOL is also on the Magic Formula screener.
bindradoc
Bindradoc - 3 years ago


Enjoyed your analysis.

?What portion of the revenues of APOL is from Pell Grants and federal loans.
softdude2000
Softdude2000 - 3 years ago
ROE is very good and debt is not high. Only catch I see is that net profit margin is not too high. If the revenue falls a lot, margin should still be enough to sustain but not enough to make a profit. I dont know if revenue will fall in next few years. Can anybody share their idea on revenue trend for APOL or COCO. I read Batbeer article on COCO and satisfied with the description but market is very crazy.
batbeer2
Batbeer2 premium member - 3 years ago
Look up churn for APOL. If memory serves, students stay less than one year on average. If fewer enroll..... revenue falls LIKE A STONE.
softdude2000
Softdude2000 - 3 years ago
Batbeer, I thought University of Phoenix offers long duration courses even phds. How can students on average stay one year. So many many dropouts. Can you provide any link for this 'churn' data?

How can I know if fewer students will enroll or more students will enroll in future? I am confident with WPO. I dont know about COCO or APOL. All I was able to see was APOL had impressive cash flow and even balance sheet in past.

How can you say more people will enroll for COCO in future and not for APOL?
batbeer2
Batbeer2 premium member - 3 years ago
I thought University of Phoenix offers long duration courses even phds.

Yes, they offer them, they just don't deliver them. Graduation rates at APOL are ± 4% !! The industry norm is roughly ten times that number. 4% is by far the worst in the industry. I think it's conservative to assume that 50% of the dropouts leave in the first year. This means that out of 100 new students, ± 40 need to be replaced next year to maintain student population. This week, APOL comes out and says enrollments are under pressure...... the jig is up.

http://www.gurufocus.com/forum/read.php?2,81873,81926#msg-81926

http://oedb.org/rankings/graduation-rate

How can students on average stay one year.

I think the average student stays weeks not years. The few that survive the first months will probably stay the course.

Apollo offers the highest cost stuff (phds etc.) with the lowest graduation rates in the business... Hence the high ROE. Most students leave within weeks pay for the full year.

Debt and defaults are within industry norms because most students drop out quickly. APOL sells dreams.

You look into COCO and you get a different picture...... COCO offers low cost diplomas (Nursing and HVAC) with graduation rates that are within industry norms. ROE is not as high. These diplomas are essential to the US economy. My thesis with COCO hinges on a reasonable expectation that it can adjust to the new rules with manageable impact to revenue; Mr. Market on the other hand is certain COCO is going down.

I don't see how APOL can adjust. Their business model is precisely what the ED is trying to kill.

Then again, I'm capable of writing good things about a business like LVLT.... random thoughts.
softdude2000
Softdude2000 - 3 years ago
>>Graduation rates at APOL are ± 4%

Does it mean for 100 students enrolled and paid fees, only 4 of them get a certificate. Only God knows how many out of that 4 will get a job. How can any college sustain that level of graduation rate? APOL was making lot of money with 4% success rate. How is it even possible even for two years.
batbeer2
Batbeer2 premium member - 3 years ago
Yes, After 6 years, 4 out of 100 make it. Follow the link and read the notes.

You get the same picture from Apollo itself. New enrollments are about ~400k on a student population of ~500k. [phx.corporate-ir.net]

Granted, those numbers include some growth so they overstate churn. New enrollments are down.... guess what this does for revenue !

4% may be a bit biassed. Apollo, unlike other institutions, re-enrolls students who switch to a different program. These students count as dropouts while they may complete a different track.

Still, no matter how I slice it, retention is terrible for an institution that offers multi-year programs.

I can only conclude that a big chunk of the profitability is the result of billing a lot of dropouts for a service not provided.

Fewer enrollments and probably fewer dropouts will compress revenue AND margins. Management is probably glad they don't need to service a lot of debt. You may live to see me bullish if this trades under $20 with an average retention of more than 2 years and some cash profit.

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