APOL Apollo Education Grp., Inc.

Capella Education Company (CPLA), the provider of online education, recently delivered better-than-expected first-quarter 2011 results. The quarterly earnings of 97 cents a share beat the Zacks Consensus Estimate of 82 cents, and grew 9% from 89 cents earned in the prior-year quarter. Management hinted that the growth in enrollment and revenue was marginally above expectations, which lends support to the bottom-line.

On a reported basis, including one-time items, earnings came in at 90 cents a share, down 1.1% from the year-ago quarter.

Behind the Headline

Total active enrollment, which climbed 7.3% to 39,904 from the year-ago quarter, betters 4.5% to 6.5% guidance range provided earlier. However, new enrollment plunged 35.8% during the quarter, reflecting tough market conditions, changes with respect to program accreditation and stringent admissions criteria, which requires students to undergo an assessment priot to enrollment.

The quarterly revenue of $111.4 million jumped 10% from the prior-year quarter, and remained in line with the Zacks Consensus Estimate. The increase in the top-line was slightly above management’s expectation of 8.5% to 9.5% growth.

Capella now expects revenue to remain flat or climb 2% in second-quarter 2011.

Operating income for the quarter dropped 3.2% to $22.5 million, whereas operating margin shriveled 270 basis points to 20.2%. Capella now expects operating margin in the range of 20.5% to 21.5% in second-quarter 2011.

Slowing Enrollment Growth

We observe that the growth in enrollment in the quarter under review has decelerated sequentially. After increasing 16.2% in fourth-quarter 2010, the rate of growth in enrollment dropped sharply to 7.3% in first-quarter 2011. Capella now expects total enrollment to fall by 1% to 3% in second-quarter 2011.

Following this, a negative sentiment may be palpable among the analysts covering the stock, and we could witness a fall in the Zacks Consensus Estimate in the coming days.

The current potential risk looming over the education sector is the regulation proposed by the Department of Education that is weighing upon students’ enrollments and the company’s profits. The Department of Education proposed that an educational program could only qualify for Title IV funds, if it helps in achieving gainful employment, which includes the criteria of loan repayment rate and debt-to-income ratios.

The institutions are under the scanner due to the rise in the default rate of student loans, and are now being asked to submit information relating to recruitment procedures and use of student’s grant.

Capella cautioned that new enrollment in second-quarter 2011 is expected to tumble by approximately 40%. Management hinted that other for-profit education institutes facing tougher norms are chasing Capella's students who are financially sound and have a better loan repayment track record.

The company generally focuses on working adults, and in order to draw students it is also ramping up its marketing and promotional expenditures, which rose 17.9% to $35.3 million during the quarter. The company also hinted at hiking the tuition fees for the 2011-2012 academic year but lower than previous years, and proposes to offer scholarships and grants to woo students.  

To counter sluggishness in students’ enrollment, education companies are also resorting to restructuring their cost base. Capella said that it lowered its headcount by about 120 non-faculty employees. It incurred a charge of about $1.9 million in the quarter for the purpose. Management hinted that the eliminations will result in cost savings of approximately $12 to $12.5 million per year. 

Other Financial Details

Capella ended first-quarter 2011 with cash and cash equivalents of $76.7 million, shareholders’ equity of $198.1 million and no debt. Cash flow from operations for the quarter dropped 18.3% to $23.5 million.

During the quarter under review, the company repurchased 500,000 shares, aggregating $27 million, which were accretive to earnings by a penny. Capella indicated that it has $86 million at its disposal under its share repurchase authorization.

Currently, we have a long-term ‘Underperform’ rating on the stock. However, Capella, which competes with Apollo Group Inc. (APOL">APOL) and Strayer Education Inc. (STRA">STRA), holds a Zacks #3 Rank, which translates into a short-term ‘Hold’ recommendation.

 
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