My most successful strategy has been turnarounds. Career Education Corporation (CECO) is a late-stage turnaround that has quietly become a growth company. The market has not yet woken up to this.
In fact the stock recently got knocked back needlessly by insider sales. Insider activity can significantly move a stock in both directions. CECO’s stock was cut by a third from a peak reached after second-quarter earnings in early August. But often investors don’t look closely enough at the details. Reality couldn’t be more different. Operating results are accelerating, and the stock sold; well, it was mostly given to the insiders one month earlier.
CECO is a for-profit higher education company headquartered in Schaumburg, Illinois. It offers online and campus higher education through two regionally accredited universities – Colorado Technical University (“CTU”) and American InterContinental University (“AIU”). Most of the students are online. Both universities provide degrees from associate and bachelor to master’s and doctoral. CTU offers degrees in business studies, nursing, computer science, engineering, information systems and technology, cybersecurity, criminal justice and healthcare management. AIU offers degrees in business studies, information technologies, education and criminal justice.
The for-profit higher education industry expanded rapidly until the late 2000s. At that point numerous problems surfaced regarding recruiting and quality of the education. The government, in some cases, withdrew student loans from some of the worst offenders, effectively shutting them down. CECO was the poster boy for all that was wrong when 60 Minutes did a smackdown story on it in January 2005. The company survived, but not before closing many of its schools due to declining enrollment. This led to significant losses from 2012 to 2016 as it was forced to teach out the schools being closed. The last discontinued schools were completely closed in 2018. CECO returned to profitability in 2016 and returned to consistent student enrollment growth in 2019. Expenses from the closed schools are now in the past.
The company is now solidly profitable and has a strong balance sheet. Adjusted earnings for the quarter ended September 30, 2019, were $0.33, well above the $0.24 estimate. GAAP earnings were $0.25 per share, and the difference to non-GAAP was primarily a $7.1 million legal settlement. The company raised its adjusted EPS guidance three times this year. It now expects full-year 2019 adjusted earnings to be $1.33 per share (at the midpoint). This was raised from $1.22 at the second-quarter earnings announcement and $1.13 at the first-quarter earnings announcement. Adjusted earnings were $1.05 in 2018. Growth continues, as of September 30, 2019, and enrollments were up 6.1% from one year earlier.
Career Education stock chart
Source: TD Ameritrade
As shown above, the stock was strong in the summer of 2019, especially after the second-quarter earnings announcement in early August. But it retreated significantly starting in September. The slide coincided with significant insider stock sales detailed below. There was no other news during that period other than the $7.1 million legal settlement, which is not that material to a company this size. I believe the insider sales were the reason for the decline as the stock consistently dropped on the days they were filed. What I have done below is drill down to look at the stock sales. What I found was almost all shares sold were given to the insiders in August. Insider holdings are actually significant across the board.
A chart showing all insider transactions since March 31, 2019, is shown below.
Source: Form 4s filed with the SEC
Officers and directors were given a total 306,902 shares on August 12, 2019. Of these, they subsequently sold 80,255 shares at a market price and kept the rest. In addition to those sales, since March 31, 2019, they sold another 30,229 shares, less than 1% of their holdings. Finally, SVP Ayers bought and sold 207,208 shares in several transactions on the same day. He ended up with 6,949 more shares than he started with. After all was done, the insiders had 196,418 more shares than they had on March 31, 2019. Share grants are a taxable event and insiders often sell some to pay their taxes.
I consider the CEO and CFO to be by far the two most important insiders when it comes to stock transactions. That is because they are usually the only ones who can see the full picture. In this case neither CEO Nelson nor CFO Ghia sold any shares in this period. Also, none of the directors sold the shares they were given.
The analysis above and the just announced third-quarter earnings show that the stock slide based on insider sales was baseless. CECO is a growing company that should be able to increase earnings even faster than revenues for some of the reasons given below. Strengths and catalysts of CECO include the following.
1. The balance sheet is strong. On September 30, 2019, CECO had $312 million in cash and equivalents and no interest-bearing debt.
2. The company just announced a $50 million share repurchase program. That’s about 5% of the market cap. It can easily fund this program.
3. The huge cash position will allow CECO to do something it hasn’t until recently, grow through acquisitions. The recovery is over; time to grow. Management has indicated that acquisitions are now part of the plan, and it announced its first in a long time. On March 8, 2019, CECO announced the acquisition of Trident University for $35-44 million in cash. Trident had approximately $46 million in revenue and approximately $9 million in EBITDA during its fiscal year ended June 30, 2018. Since CECO is paying cash, the acquisition should be accretive from the beginning. Subsequent merger efficiencies should also be significant as this is a bolt-on acquisition. CECO will plug Triton into its AIU segment. There is significant more cash available for acquisitions, before they ever need debt.
4. This type of business is often counter-cyclical and makes a good defensive holding as well as for growth. CECO did just fine during the last recession. The year 2008 was a little off, but earnings increased each year from 2008 to 2010. Those were some of their best years.
5. Management just guided new student enrollments to increase 12-13% in all of 2019.
6. Insider stock holdings are quite large. All seven officers listed as insiders own at least $1.5 million of stock. Six are over $2 million. This is a high level for officers.
7. The for-profit higher education industry has turned around in the last few years, and regulatory issues have diminished considerably. There is no longer an industry headwind. Peers are also reporting solid earnings beats.
8. CECO has a small real estate footprint. Most of its teaching is now online. Online is where many things are moving and a simpler business model.
9. Management attributed some of the recent EPS guidance raise to improved student retention. This is due to better analytics, some using AI, and according to the last conference call, “increased staffing, training, and development within our student advising functions”.
10. AIU is much less profitable as a percentage of revenues than CTU. CEO Nelson on the last call mentioned this was primarily due to scale. AIU is growing faster and its earnings are jumping. Operating income went 2.3% of revenues in the first nine months of 2018 to 6.3% in the same period in 2019. That’s on a 16.4% revenue increase. CTU’s operating profit margin was 24.7% in the first nine months of 2019. This indicates, with continued revenue growth, AIU has a long runway of earnings growth ahead. Plugging Triton into AIU should help too.
The major risks I see associated with this investment are summarized below.
This industry is highly regulated and CECO has a history of regulatory issues, though it’s been a while. In addition to the 60 Minutes exposé, the company recently settled two regulatory actions for $30 million and $7.1 million. The $7.1 million is pending court approval. The $30 million was from an FTC inquiry started in 2015. CECO has new management since then. However, CEO Nelson was the CEO of Education Management Corp., another for-profit higher education company from 2008 to 2012. That company went under in 2017 and did have regulatory issues.
Provisions in the recently passed Higher Education Act allow borrowers to seek loan forgiveness if a college or university misled them, or engaged in other misconduct in violation of certain state laws. The law is still pending. This would have been a huge problem a decade ago, but the industry appears to be in a much better place now.
Management compensation is high in my opinion for a company this size. The CEO’s total compensation was $7.2 million in 2018. The top five officers received $13.6 million combined. Much of that was non-cash and about 40% was incentive pay due to the good performance of the company.
CECO’s days in recovery are now over and the market should soon notice this is a growth company. I have found it often takes a while for investors to realize a major change like this.
Below is a comparison of CECO to similar sized higher education peers. The first two concerns I mentioned above also apply to all the peers.
As shown above, CECO’s peers are growing EPS about 5-10% per year on average, though Grand Canyon has gotten better growth recently. Strategic (NASDAQ:STRA) just went through a merger that doubled its size and EPS growth is being driven by merger efficiencies. Both ATGE and LOPE have just reported solid earnings beats. CECO has grown EPS much faster primarily due to coming off a loss. However, its new guidance is for 26.7% EPS growth in 2019, up from a solidly profitable 2018.
CECO’s analyst estimate of 8% growth in 2020 is likely to get adjusted up based on the recent big earnings beat. I expect 10-15% EPS growth in 2020 based on earnings momentum, the stock repurchase plan, the Triton acquisition, and rapid earnings improvements at AIU as it scales up. The first three items are unlikely to be in analysts’ estimates yet.
With an above-industry level of EPS growth and cash levels, I believe a PE ratio of 16-20 is appropriate. That is only slightly above peer average. Using a PE ratio of 18, based on 2019 guided EPS of $1.33, that puts current value of $23.94. That is 51% above the closing price of $15.89 on November 7, 2019. But it is only slightly above the $22.28 high recorded in August, just before the insider sales induced stock slide. That is the value today. My one-year target is $27, which is 12.5% above today’s value.
Disclosure: I am/we are long CECO. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.