Friday, May 05, 2006

CECO-Are the Storm Clouds Back?

As readers may recall, I have a strong interest in the education stocks. This is prompted by a number of factors:
  • -the proposed private equity takeover of Education Management (EDMC)
  • -some reduction in the SEC’s witch hunt about accounting in this industry
  • -high returns on invested capital
  • -generation of free cash flow

Please check the following links to see previous commentary

Getting an Education in Education Stocks

CECO Revisited-The Clouds are Parting

Career Education (CECO) cratered today. The company’s first quarter announcement was essentially in line with the consensus view, however, the Street was perturbed over the enrolment trends.

A month ago, I did warn that issues remained despite the excellent progress that the company has made in getting through some of the legal morass, both from a class-action and an SEC investigation standpoint.

What to make of last night’s enrolment figures? Total population as of 4/30/06 was 97,100, up just 0.4% YOY from 96,700. The combination of negative press and uncertainty about accreditation at AIU has had a significant impact on the on-campus enrolment. New student enrolment declined by 12.9%. On-line enrolment was up 23.5% YOY but was down slightly sequentially Q/Q.

The street and obviously many students are concerned about AIU, yet AIU operating margins declined less than 1% YOY. The overall university segment (AIU & CTU) actually showed improved operating profits (because revs were up 15%) nut lower operating margins....not exactly horrible at 33.8%! (compared to 37.2% a year ago!!!

Gibbs is an unmitigated disaster and the culinary schools were surprisingly disappointing. Healthcare training was a nice positive surprise.

One positive that was mentioned in the conference call and missed by most of the Street was the fact that retention rates have actually improved YOY.

Operating margins did decline to 17.7% for the quarter, a decline from last year’s 19.4%

The company generated $105 million in FCF, well ahead of the comparable quarter last year which came in at $86 million. Great cost controls and restrained capex account for the improvement.

The analyst community was rightfully disappointed in the lack of guidance or the unwillingness to re-iterate guidance.
The biggest issue remains the accreditation of AIU as I warned a month ago. To quote,

“The most serious problem for CECO appears to be the probationary status of AIU, American Intercontinental University, which is operating on a probationary basis, a situation that threatens its accreditation (by the Southern Association of Colleges and Schools,) and has obviously impacted enrollment negatively. Management appears to be addressing the specific concerns by adding administrative staff, qualified admissions staff as well as full time faculty. The school's accreditation will be reviewed again in December...”

The valuation statistics have a great deal of appeal. CECO offers a free cash flow yield of 8.7%. Contrast that with its competitors APOL at 6.3%, ESI at 4.3% and DV at 2.2%. Return on invested capital has been just over 20%, below the astronomical returns of Apollo and ITT Education but still quite a healthy return relative to most industry.

On an EV/EBIT basis the stock stands out, trading at merely 7.6 times EBIT. APOL is 12.2 times, DV at about 29 times, and ESI at 14.6 times.

The proxy contest at CECO bears watching. The quarterly results provided an opportunity for Steve Bostic to express his disappointment. Bostic is a 1% shareholder who is battling management for three board seats at the upcoming annual meeting. The battle has gotten quite nasty and personal as the company ran a recent newspaper ad questioning Bostic’s capabilities.

Disclaimer.: Neither I, nor my family have a current position in CECO or any of the other education stocks that were mentioned in this post. Several clients have a current position in CECO.



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