Not Buying APOL's Earnings Momentum

Apollo Group (APOL - commentary - Cramer's Take) is one of the largest private providers of higher education services. Through the University of Phoenix and other subsidiaries, Apollo serves more than 300,000 enrolled students at more than 100 campuses, using a mix of traditional and online educational services.

Over the last month, analysts have been increasing their earnings estimates for Apollo. For the August 2008 fiscal year, estimates have risen from $2.80 three months ago to $2.97 today. The estimates for 2009 have grown from $3.25 to $3.40 over the same period. As a result of this momentum in earnings, Apollo's Zacks rank was recently raised to 1, which puts the company among the top 5% in terms of earnings momentum.

Henry Mercer of Mercer Capital Advisors says in a Forbes.com transcript that he believes Apollo is worth playing, on the thesis that "a lot of people will be laid off and they'll be trying to improve their skills." But that makes an implicit assumption that those students will be able to pay their bills.

Last year, Apollo, ITT Educational (ESI - commentary - Cramer's Take) and Corinthian Colleges (COCO - commentary - Cramer's Take) all reported rising bad-debt expenses, and the trend has not abated.

Bad-debt expense at Apollo for the first quarter of 2008 as a percentage of revenue was 4.2%, compared with 3.5% a year ago. Management also identified "certain items that should have been reported or should have been classified as discounts or refunds, that is, as a reduction of revenue, as opposed to a charge to bad debt expense in prior quarters." This would have made the prior-year number 2.9%, so the deterioration is from 2.9% to 4.2%.

Apollo's associate's-degree programs are growing at a far faster rate than its bachelor's-degree program; this contributes to the bad-debt issues and may contradict Mercer's thesis that higher growth will be coming from professionals looking to enhance their skills.

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At the time of publication, Trent had no positions in stocks mentioned, although positions may change at any time.

William A. Trent, CFA, is a freelance equity analyst based in the New York metro area. He has been an equity analyst since 1996 and is co-author of Understanding and Evaluating Prospectuses, Offering Documents, and Proxy Statements. Under no circumstances does the information in this column represent a recommendation to buy or sell stocks. Trent appreciates your feedback; click here to send him an email.