It’s that time of year again, at least in the U.S. In about a month or so, the new school year will begin, and if you know any teachers or parents with kids who have yet to graduate high school, you’ve probably gotten at least one panicked phone call about what’s going to happen with the Covid-19 situation if large groups of children are packed into a building in close quarters on a regular basis.
As a result, investors have started to take note of the main online alternative to public schools: K12 Inc (LRN, Financial). The online K-12 education provider facilitates a wide range of both public and private online school systems around the country, with some of the private options even accepting international students. With the fear of sending children to Covid-19 hotspots mounting, shares of K12 have spiked more than 75% over the past month, especially after popular research firm Citron turned bullish on it.
Opposing attitudes
The White House is pushing for schools across the country to do away with online classes and go back to the classroom, despite the fact that the country shows no signs of flattening the curve on new infections. The prevailing attitude among the Trump administration, according to White House sources, is that the government hopes people will grow too exhausted by trying to prevent the spread of the disease and simply accept as fact that there’s no stopping it. Re-opening classrooms would go a long way towards normalizing this attitude, which is why President Trump has declared that he will push for funding cuts to school districts that do not re-open.
Of course, attitudes vary among school districts, boards of education, parents and teachers across the country.
For example, California’s Orange County Board of Education recommended on Monday that its school districts re-open, even going as far as to advise against the use of masks and social distancing, but the county’s largest school districts have decided not to follow the recommendation and instead extend remote learning into the beginning of the new school year.
A Politico / Morning Consult poll conducted in the beginning of July found that out of 1,992 voters surveyed, 53% opposed re-opening daycares and K-12 schools, while 38% opposed re-opening them.
The online alternative
While a certain percentage of parents will need to send their kids to some sort of school or daycare so that they can go to work, those with older kids, a stay-at-home parent or the ability to leave their kids with a friend or neighbor during the day may very well choose to stick with online education this year, even if their local public school is going the cautious route. After all, school districts could choose to move back to the classroom at any point during the year, leaving parents who want to avoid Covid-19 wary of them.
"When the pandemic first started to impact brick-and-mortar schools, our phones began to ring off the hook," said K12 CEO Nathaniel Davis said in the company's earnings call for the fiscal third quarter of 2020. Davis laid out an optimistic macro outlook for the company:
“Looking forward, K12 now sits squarely in the middle of one of the most important changes in our society – distance and digital learning will become an even more important part of how our children learn. Our core competency in helping public school districts, private schools, and charter schools operate their online programs positions us well given how the education market is likely to change.”
The company guided for revenue in a range of $1.033 billion and $1.040 billion, capital expenditures of $45 million to $49 million and adjusted operating income of $48 million to $52 million for full fiscal 2020, which ended in June for the company. Meeting the midpoint of the revenue range would result in a 2% increase from the prior year.
Potential risks
Given the strong macro environment, K12’s strong financial position with a cash-debt ratio of 4.33 and a very high probability of increases in both the top and bottom line in the near future, it seems reasonable to expect that the stock can continue to outperform in both the short and long term, even though it may seem overvalued compared to past earnings.
According to Morningstar analyst estimates, K12 has a forward price-earnings ratio of 57.49 as of July 15, comparing favorably to the current price-earnings ratio of 75.68. With a company set to enter a growth phase, this may seem a fair price to pay for investors who are confident in the macro demand and K12’s market-leading position.
A more notable variable to pay attention to is public school funding. According to the company’s most recent earnings results, about 88% of revenue comes from managed public school programs, meaning that if public schools were to decrease their net spending on K12’s services, it would definitely impact results. Public school funding will depend on a combination of available funds and willingness to allocate those funds to online education options for students.
Conclusion
The weeks leading up to the beginning of the school year are going to be hectic for everyone involved, including investors of K12. I think there could be significant upside for the stock in the short term due to the pandemic situation and the increasing shift to online education, though enthusiasm for the stock could easily wane afterwards as the country becomes accustomed to whatever the new normal is.
I am not as certain that holding on to the stock long-term will produce market-beating results, but it could potentially present an attractive short-term by over the next few months or years.
Disclosure: Author does not own shares of K12 currently. The mention of stocks in this article does not at any point constitute an investment recommendation. Investors should always conduct their own careful research and/or consult registered investment advisors before taking action in the stock market.
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