Capella Education : Strong Enrollments and Operating Efficiencies in 3Q09 Enhance Outlook

North America Equity Research
Capella Education: Strong Enrollments and Operating Efficiencies in 3Q09 Enhance OutlookNeutral
This morning CPLA reported its 3Q09 EPS of $0.57, well above our estimate and consensus of $0.51, as a result of stronger-than-expected enrollment growth coupled with impressive efficiencies in instructional and marketing costs. We believe CPLA results underline the positive industry backdrop as student interest is abundant, government student loans have been accessible, and pricing increases are sticking.
Enrollments and operating leverage were impressive. Enrollments grew 28% y/y to 30,738, and revenues grew 28% y/y, both above company's guidance. Operating margin expanded ~524 bps y/y to 17.4%, also above our estimates and guidance, primarily due to efficiencies in instructional and marketing costs. Other positives included a $10 million share repurchase and continuing profitability improvements in the bachelor’s level, due to scale.
Higher 4Q09 guidance and reiterated long-term growth goals. Strong 3Q09 performance led to healthy (better-than-expected) 4Q09 guidance and 5-6% higher full-year 2009 EPS guidance. As a result, we expect 200 bps y/y margin expansion in 4Q09 (to 23.6%) and raised our 4Q09 EPS by $0.07 to $0.85.
3Q09 negatives included a continuing (mostly expected) drag in revenue per learner. While 3Q09 revenue per learner grew 0.3% due to favorable colloquia timing, we expect 4Q09 revenue per learner to decline over 2% y/y due to fewer colloquia, mix shift, and lighter course loads. Other modest negatives included 30 bps y/y increase in bad debt (to 2.5%), still one of the lowest in the sector.
Education sector is out of favor. We recognize that education stocks have been out of favor since February due to 1) regulatory/legislative uncertainty and 2) sector rotation away from defensive stocks. We continue to believe that education stocks provide a good balance of growth-defensiveness in a still uncertain economy and will show healthy (albeit much decelerated) growth during an economic expansion due to secular drivers.
We remain Neutral. We raise our 2009 EPS estimate by $0.13 to $2.47, raise our 2010 EPS estimate by $0.15 to $3.12, and introduce 2011 EPS of $3.74. Following a 50%+ rally since May, shares of CPLA trade at 23x our 2010 EPS (vs. 15x for the sector). CPLA’s premium valuation reflects consistent execution and high growth. Our new 2010 price target of $85 (18% upside) suggests 23x our 2011 EPS, approximately inline with the current NTM multiple. We prefer companies with an efficiency turnaround (APOL) or more open-ended growth (STRA).