Capella Education Upgraded - Analyst Blog

We recently upgraded our recommendation on Capella Education Company (CPLA), provider of online education, to 'Neutral' with a price target of $69.00. Earlier, we had an 'Underperform' rating on the stock.

Capella Education's strong focus on working adults and exclusive online education has enabled it to become a prominent player in the for-profit post-secondary education industry. The company's sustained efforts to expand educational programs helps it to boost enrollments, and in turn, the top line.

Total enrollment soared 25.7% year over year to 38,634. Graduate program enrollment rose 19.4% to approximately 30,000. Due to the surge in enrollment, the quarterly revenue of $105 million increased 25.7% from the prior-year quarter, and remained in line with the Zacks Consensus Estimate.

Capella Education has recorded strong revenue growth over the last four years. During 2005–2009, revenues grew at a CAGR of 22.4% driven by high student satisfaction and referral rates, increase in tuition fees and participation in Title IV programs. For fiscal 2010, the company expects revenue growth in the range of 26.5% to 28.5%.

However, we observe that the growth in enrollments in third-quarter 2010 has decelerated sequentially. After increasing 32.1% in the second quarter, the rate of growth in enrollment dropped to 25.7% in the third quarter. Capella Education now expects enrollment to rise within the range of 16% to 17% in the fourth quarter, reflecting a soft increase compared with previous quarters.

Currently, an uncertainty is looming over the education sector because of the regulation proposed by the Department of Education that may weigh upon students' enrollments and the company's profits.

Recently, 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 the use of student's grant.

The sector bellwether Apollo Group Inc. (APOL) also cautioned that enrollment in its first-quarter 2011 would drop by more than 40%, and withdrew its outlook for the fiscal year, citing an uncertain regulatory environment. 

Given the pros and cons, we prefer to be 'Neutral' on the stock. Capella Education holds Zacks #3 Rank, which translates into a short-term ‘Hold' recommendation, and correlates with our long-term view.

 
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