Tuesday, August 09, 2011

Why Apollo Group Could Boost Your Portfolio

Apollo Group (NASDAQ: APOL) is the largest for-profit education company and despite turmoil in its regulatory environment, this owner of University of Phoenix has enjoyed a massive boost in profitability in 2011. With its stock taking a hit in the recent market tumble, does this mean it's time to add it to your portfolio?

Apollo Group has tumbled despite strong profit growth. Since its 2011 high point on July26, Apollo stock has lost 19% of its value, tumbling from $53.86 to its current $43.84. But during 2011 it has boosted its already high profitability even higher -- from a return on average equity of 45% for 2010 (the average S&P 500 company earns 24.4%) to 63% in its second quarter ending May 2011.

But the for-profit education industry has been under regulatory scrutiny for at least the last year. As I wrote in June 2010, Washington uncovered abusive practices in the industry -- including aggressive student recruiting practices, extending student loans to people with little ability to repay them, very low graduation rates, and less-than-advertised job prospects for those who do graduate.

But this does not seem to be stopping Apollo. Here are three reasons to consider its stock:
  • Expectations-beating earnings reports. Apollo has beaten analysts’ expectations in five of the last five reporting periods. In its 2011 second quarter, Apollo reported $0.45 in adjusted EPS -- 11 cents above analysts' expectations as higher tuition fees more than offset a decline in student enrollments.
  • Out-earning its cost of capital. Apollo is earning more than its cost of capital – and holding steady. How so? It produced unchanged EVA Momentum, which measures the change in “economic value added” (essentially, after-tax operating profit after deducting capital costs) divided by sales. In the first nine months of its fiscal 2011, Apollo’s EVA momentum was 0%, based on first nine months' 2010 annualized revenue of $4.9 billion, and EVA that fell from $515 million annualizing the first nine months of 2010 to $493 million annualizing the first nine months of 2011, using an 8% weighted average cost of capital.
  • Rising sales and profits and a stronger balance sheet -- with some debt. Apollo has been growing with declining margins. Its $4.9 billion in revenues have grown at an average rate of 18% over the last five years while its net income of $568 million has tumbled at an 8% annual rate over that period -- yielding a solid 12% net profit margin. Its debt has grown twice as fast as its cash. Specifically its debt has grown from nothing in 2006 to $163 million billion (2010) while its cash has grown at a 38% annual rate from $355 million (2006) to $1.3 billion (2010).
One negative -- it is hard to value its stock. Apollo's price to earnings to growth (where a PEG of 1.0 is considered fairly priced) is undefined. That's because despite a low P/E, analysts expects its earnings to fall fast in the next year. It currently has a P/E of 14.5 and is expected to shrink 33% to $3.24 in 2012.
Apollo Group is likely going to survive the effects of tighter regulation and will be able to grow by acquiring rivals and cutting costs. Its ability to beat expectations despite these challenges suggests that the stock could rise after losing 19% of its value in the last few weeks.


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