Investment summary
The hurdle for businesses in the consumer discretionary sector has been set high for FY’24. With ~10% current S&P 500 index weighting, relative to forward growth projections, investor expectations are equally as high.
In that vein, we are on the hunt for businesses in consumer-based industries displaying 1) high-quality business models, 2) superb economic characteristics, exemplified by persistently high returns on capital invested into business operations, persistence in earnings growth, along with incremental returns on all marginal investments, and 3) trading at compressed valuations [i.e., with low embedded expectations].
This investment rationale led me to evaluate the equity prospects of Perdoceo Education Corporation (NASDAQ:PRDO).
Figure 1.
Investment thesis
PRDO conducts its business in the postsecondary education sector, primarily offering quality online education through its accredited institutions, Colorado Technical University (“CTU”) and the American InterContinental University System (“AIUS”). The company also provides campus-based and blended learning programs.
The company has over 4,300 employees and enjoys consumer advantages by differentiating itself as an adult education provider. In FY’23, around 70% of its students were >30, with ~70% of courses under the Bachelor’s designation. Most curricula (>75%) are in the departments of business studies, but it also has ~12% of its courses in IT and health education, respectively.
The former CEO was replaced in November ’23 by Todd Nelson, former chair, and also CEO of PRDO from 2015–’22. This, along with the general strength of the market has lifted sentiment.
Yet, Investors still have low embedded expectations for PDRO at <10x forward earnings and <4.5x trailing EBIT. It trades <1x EV/IC representing a statistical discount on 1) business economics [+15% ROIC with 11.5% marginal return on new capital since FY’21], 2) projected operating leverage in FY’24 [-4-5% sales decline with +11.5% projected EBTI growth], 3) operating on c.9% trailing FCF yield, and 4) potential tailwinds from its federal student loan programs.
I am buy on PRDO based on the dislocations in market value to book value, its fundamentals and valuation.
Net-net, originate buy, eyeing first objectives to $30-$36/share.
Quality business factors
Some of the quality characteristics I’ve identified for PRDO following my research on this name include::
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Innovative learning platforms: PRDO’s institutions, CTU and AIUS, act as platform companies that offer personalized learning technologies like the Intellipath platform. This enables teachers to build bespoke curricula for their classes, ultimately turning education (a commodity-product) into a consumer product, with consumer advantages. This is seen in its high post-tax margins [20% in the TTM] relative to capital turns [<1x].
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Student retention: Both CTU and AIUS have shown strong student retention and engagement in my view. Total student enrollments were +9.0% in Q1 FY’24 due to retention and engagement at CTU. Management expects these trends to continue.
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Management is buying back stock: Shares outstanding have reduced from >70 million in FY’21 to 66 million in Q1 ’24 (5% reduction). It repurchased ~0.4 million shares and announced a quarterly dividend payment of $0.11 per share in Q1. It remains committed to buying back stock moving forward too. Given the stock trades <1x EV/IC, my opinion this is good use of capital.
The issue has been top-line sales compression throughout the pandemic era. Sales were flat from FY’20–’22 before stretching higher again in FY’23 to ~$703 million, on operating income of $165 million. Management guides to $170–$190 million pre-tax earnings in FY’24E ($2.60–$2.90/share) – not unreasonable given 1) consensus’ projected 11.5% growth in FY’24 EBIT, 2) reduced operating costs as a percentage of sales [windback in revenues will <OpEx] and 3) returns on operating capital >12-13%.
Attractive valuation
I believe PRDO shares are attractively valued based on 1) the fact it is trading at <1x EV/IC providing a statistical discount, 2) our estimates of forward economic earnings, and 3) robust fundamentals [for instance, management rolling off ~$100 in avg. FCF every rolling 12-month period – see Figure 2]. At such pessimistic expectations, the risk/reward is skewed in our favour, providing an added margin of safety, and supporting a valuation of ~$30-$36/share.
More specifically, my analysis indicates that investors could be only just recognizing the company’s increased advantage period [ROIC above our 12% hurdle rate] and balanced capital allocation strategy.
Figure 2.
Valuation insights
Despite flat sales growth, PRDO has exhibited characteristics of economic value. This has only just begun to be appreciated by the market:
- Investors have expanded the multiple paid on post-tax earnings and operating capital in the company from 2.7x and 0.5x in FY’21 to 6.6x and 0.9x at the time of publication, respectively. The increase in market return reflects the market’s recognition of the company’s value-creation efforts. The expansion is supported by 1) increased economic profit streams from $9 million in FY’22 to $31 million in Q1 FY’24 [TTM], and 2) increased economic profit contribution per employee from FY’20 [despite a decrease from FY’23].
Figure 2a.
Figure 3.
- PRDO’s operating capital is highly intangible and “off-balance sheet” in that profits are reliant on skilled staff to “do the job”. This may explain the sudden upshift in valuation. There is basically zero capital employed in this company. Total assets are $1.05 billion, or $411 million less cash. The adjusted EV/IC multiple to this is [$765/411 = 1.86x] but I’ve penalized the company for hoarding cash so as not to skew the ROIC profile [thus, any dividend growth, buybacks, or high-return projects should be viewed favourably looking forward]. Yet the $22 million NOPAT growth since FY’21 and $36 million growth since FY’22 was produced on a reduced base of $214 million employed into the business. The rest? A result of its human capital in my view. Economic profit/employee is +$59,000 since FY’22 on my FY’24 growth assumptions. This is with 1) 150 fewer employees, and 2) $33 million less sales income to utilize. Headcount reduced, but profits are up.
Figure 4.
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The consumer advantages of its platform drive +20% post-tax margin [up from 16.3% in FY’21, 14% in FY’22, 19% FY’23] on <1x capital turnover. This is a highly differentiated arena that requires 1) licensing/regulatory approval, 2) heavy compliance burden, and 3) specialized human capital to provide the service(s). The post-tax margin uplift since FY’22 (see below) brings ROIC to FY’21 range of 15-16%. The differentiated offering is a consumer product with protected IP via the curricula. Thus margins drive the business returns vs volume. Reinvestment requirements are low to maintain a current level of operations, not so much if needing to grow. When you strip cash on hand out, this company is very asset-light.
Figure 5.
Figure 6.
Potential catalysts for price change
Several catalysts could propel PRDO’s business forward over our three- to five-years in my best estimation. Critically, the combination of 1) operating leverage, and 2) its capital-light operating model support a valuation repricing:
- Consensus projects ~7% YoY decline in top-line sales calling for $654 million. With +11.5% projected EBIT growth this produces ~500 basis points operating leverage and 19.2% NOPAT growth (assuming 23% tax rate).
Figure 7.
- Two facts are true – 1) The expected life of PRDO’s economic earnings [Any ROIC>12%] has pushed out ~2.5 years to ~3.5 years, and 2) the estimated durability of PRDO’s economic earnings is higher since its Q1 FY’24 numbers (Figure 8). Markets priced an 87% fade rate towards the ‘market cost of capital’ used here, i.e. 12%. Investors capitalized ~$6-$8/share in average market value since then and this is justified.
Figure 8.
- My estimate is investors have reduced their outlook on the company’s growth opportunities and this could produce a 0.8x change in P/NOPAT multiple and get us to ~8.6x based on – 1) the commodity P/E we can assign is 8.3x here (1/0.12 = 8.3x) and the stock is priced below that, despite 2) producing an increasing stream of economic profit. This is not appreciated by the market and could inflect in higher valuations in my view. Note we are using market cap/NOPAT here, which adds back the cash from EV. This is a rare occasion where the enterprise value is priced below the equity value due to the capital structure and heavy cash balance.
Figure 9.
- At the combination of 1) consensus implied FY’24 NOPAT growth of 19.2%, 2) no change in shares outstanding [which is conservative, given management’s recent actions], 3) ~2% forward dividend yield, and 4) the prospect for a 0.8x change in P/NOPAT multiple, this implies an 18% TSR in the next 12 months which gets us ahead to ~$24/share.
Figure 10. Next 12 months implied total shareholder return (TSR).
- I project ~$36/share by FY26E in intrinsic value based on forward growth assumptions of 1) 2%compounding sales growth on 22% EBITA margin, 2) a capital allocation rate of $0.08 per $1 of new revenues. These are conservative assumptions in my view [behind consensus and, bake in a ~100 basis points fade rate to ROIC over the period]. If we’d invest at the hurdle rate, we’d be ~$2/share behind under these assumptions.
Figure 11.
Key risks
Main downside risks to the thesis include 1) worse-than-expected financial growth [although, management has beaten consensus 100% the time the last 2 years], 2) reduction in profits earned on capital running in the business [this would compress the advantage period I believe can increase PRDO’s multiples], and 3) the broader set of geopolitical risks that must be factored into all analyses right now. These simply cannot be ignored and thus emphasis on valuation and owning high-quality earnings is paramount. These risks are supported by empirical facts and must be understood before proceeding further.
In short
PRDO has made several improvements to its value proposition including 1) shedding capital by way of dividends and buybacks to unlock that value [vs. retaining it in the business], 2) deploying funds to an advantage and seeing >12% returns on capital [our key threshold], and 3) are now a more shareholder-friendly outfit given these above points. My view is the market is underappreciating its asset-light model, and now that it can unlock value vs. hoarding cash, this could drive returns on capital higher and produce a market value of ~$36/share if it were to trade fairly. Net-net, rate buy.
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