Strayer Education: Go Southwest, Young Man; 3Q09 Results/2010 Business Model Underline Consistency

Yesterday, STRA reported 3Q09 EPS of $1.21, well above our estimate of $1.14 and company’s guidance due to strong marketing efficiencies. Strayer’s 2010 business model (which baselines $9.30-$9.50 EPS for 2010) is above our previous estimates and consensus, suggesting an upward bias for full-year 2010 EPS. Strayer’s 2010 southwestern expansion to four more states (AR, LA, MS, TX) is consistent with the company’s contiguous geographic expansion growth strategy and opens up new markets for the company’s schools.
Growth story continues. Fall enrollment grew 22% y/y (vs. our 21% y/y), while new enrollments (starts) grew 20% y/y (vs. a “tough” comp of 29% last year). Enrollment growth moderately decelerated y/y, but looked healthy sequentially. Interestingly, classroom enrollments grew faster than online enrollments (23% y/y vs. 21% y/y) because of increased campus-based offerings, specifically those designed for new students.
Consistency in execution brings comfort. We are encouraged by STRA’s execution strength, as the company is on track with the 2009 campuses openings (11 campuses) and enhanced its plans to open 13 new campuses in 2010. New Strayer campuses produce measurable ~70% internal rate of return.
Positives included better-than-expected revenue per student growth (5.7% y/y vs. our 5.1% y/y), ~250 bps y/y leverage in selling and promotional expenses (to 24.0% of revenues vs. our 25.7%), and a ~$5 mn share repurchase. 3Q09 Operating margin expanded ~290 bps y/y to 23.8% of revenues (vs. our 22.5%). Other positives included a new $100 mn share repurchase program and increased dividend (from $2.00 to $3.00 per share). Negatives included a three-day rise in DSOs (to 15 days), 80 bps y/y increase bad debt expense (to 4.5% of revenues, inline with our estimate), and 37% y/y decline in 3Q09 free cash flow.
With the sector out of favor, STRA trades toward the low end of its historical P/E range. We raise our 2009 EPS by $0.07 to $7.57 to account for 3Q09 outperformance. We also raise 2010 EPS by $0.15 to $9.45 and introduce 2011 EPS of $11.25. Shares of STRA trade at 21x our 2010 EPS estimate, vs. a group average of 14x. We are comfortable with STRA’s premium valuation, as it reflects superior focus on quality and consistency, lower risk profile, and better control over its prospective growth compared with that of its peers. We establish a y-e 2010 price target of $260 (29% upside), about 23x our new 2011 EPS estimate, approximately in line with the current forward multiple.