In 2014 education provider Navitas was riding high. Mid-year, the stock soared above $7.50, placing it on a price-earnings ratio of 34. It was, as they say, ‘priced for perfection’.
Now it’s true that Navitas is a good business. It's also benefitting from some favourable and durable tailwinds, similar to those benefiting recent float IDP Education (see IDP Education’s ultimate test from 25 Nov 15 (Hold – $3.25)): Asia’s growing middle classes want a high-quality international tertiary education for their children.
Even better for Navitas, students pay their course fees upfront, meaning profits turn up as cash in the bank (a characteristic very different from Shine Corporate, as shareholders in that company recently discovered). Table 1 compares Navitas’s profits and free cash flow over the past five years. Strong cash flow generation means shareholders enjoy a current fully franked yield of 4.2%.
So if Navitas is such a great company, why did the stock fall more than 30% in July 2014?
Excellent long-term growth record
Valuation looks reasonable
But occasional disappointments likely
To answer that question you need to understand Navitas’s core business, University Programs. This division has partnered with 27 universities around the world to prepare students for degrees at those institutions. Navitas typically operates an on-campus curriculum for students which, should they pass, feeds them straight into the second year of a university degree.
It’s traditionally quite lucrative, with Navitas charging fees of more than $20,000 per student per year. In its traditional model, Navitas pays around 30% of its revenue out as royalties to partner universities. All up, the University Programs division generated revenue of $566m and earnings before interest, tax, depreciation and amortisation (EBITDA) of $140m in 2015.
|Net profit ()||80.7||73.1||74.6||82.0||91.4||401.8|
|Free cash flow ()||58.5||54.5||106.8||115.6||103.7||439.1|
|Source: Company reports|
In July 2014, Sydney’s Macquarie University, which had been outsourcing its student preparation programs to Navitas for 18 years, announced it would bring them back in-house. The end of this partnership shocked the market, leading some to question Navitas’s entire business model. However, the lucrative nature of operating student preparation programs – and, importantly, the ability to retain full control of education standards – means that some universities prefer to run them in-house. The University of Technology in Sydney, for instance, operates its own student programs through a wholly-owned company called Insearch.
Navitas now offers new or renewing universities two choices – the former royalty model, or a joint venture (that is, joint ownership of the college). Perhaps reflecting the lengthy negotiating process, only two universities have signed up to joint ventures so far. Others, such as the University of South Australia, recently preferred to renew under the existing royalty model (in its case for ten years).
Come and go
So it seems that some universities will come, and some will go – just the same as any business arrangement. While the loss of long-term partner Macquarie was undoubtedly disappointing, Navitas fulfils a need – bringing international students and universities together.
In the short term, the end of the Macquarie partnership from February 2016 means profits from Navitas’s University Programs’ division will fall during the current half year, as well as the first half of 2017. After a consistent rise in earnings over a long period – see Chart 1 – growth will stall in 2016. While earnings from University Programs will fall in 2016, Navitas’s two other divisions will take up the slack.
Neither of these two other businesses is quite as good as University Programs, however. They have lower margins – see Table 2 – reflecting less pricing power. SAE has been particularly problematic, but is finally showing signs of recovery.
SAE runs 54 colleges in 24 countries training students for careers in creative media, such as audio, film and animation. Navitas acquired SAE for $294m in 2010 but, despite strong revenue growth, the business has required significant restructuring. The benefits are only now showing up – underlying EBITDA grew 28% in the first half of 2016, but full-year earnings will struggle to match the $33m SAE generated before its acquisition.
Navitas’s final division, Professional and English Programs, operates a range of other colleges and programs. These include English language and literacy programs for migrants and refugees (including under government contract), and various other training courses and professional colleges. Navitas management seems to recognise that reputation is everything in education, so it has generally been immune from the problems that have dogged the vocational education sector.
|Prof. and English Programs||13.2%|
Professional and English Programs has also been performing well. Since 2012 EBITDA has more than doubled to $30m and earnings should rise again in 2016. With growth from SAE and Professional and English Programs offsetting the decline in University Programs, the company’s total 2016 EBITDA will approximate the $163m produced in 2015.
On that basis, Navitas doesn’t look particularly expensive. Its enterprise value to EBITDA multiple is a little over 11 times, fairly reasonable for a high quality company. On a free cash flow basis, Navitas is on a yield of 5.9%. And its forecast 2016 price-earnings ratio is 19, much lower than in 2014. These are pretty attractive numbers for a quality business with decent growth potential.
So what’s stopping us from upgrading? It’s a niggling feeling that the company might be subject to disappointments occasionally.
Disappointment could come from several sources. Universities other than Macquarie could take their programs back in-house. Governments around the world might tinker with student visa requirements – the UK is the latest government to increase restrictions. Or economic downturns in source markets like China or India could mean fewer students seek education abroad.
Perhaps Navitas’s most significant risk is reputational, however. If one of the company’s colleges was to be embroiled in a scandal, it could damage the entire brand. More particularly, if Navitas feeds too many academically weak students into university courses, both it and the university’s reputation will ultimately suffer. Navitas boasts that more than 90% of students progress to studying a degree at a partner university, but the incentives are clearly to pass as many as possible.
Perhaps we’re being too conservative, as the company’s long-term growth record speaks for itself. And it may be that we’ll continue to grow more comfortable over time, particularly if Navitas continues signing up universities internationally. However, occasional disappointments seem likely and may provide a buying opportunity.
For now, we’re setting our Buy price at $4.00, although with an ‘upward bias’. The stock is down 10% since we last covered it some years ago on 20 Mar 13 (Avoid – $5.21) but we’ve grown more comfortable since then. We’re upgrading a notch and will resume more regular coverage in the hope a buying opportunity appears. HOLD.