Analysis:As regulatory clouds clear, college stocks should rally

BANGALORE (Reuters) - Report card for U.S. for-profit education stocks: Likely to remain near the bottom of the class in the first half, but should do better as the year goes on, regulatory concerns ease and growth, while sluggish, returns.

The sector has been in freefall for nearly a year as investors took flight amid government moves to rein in massive aid to fund loans. Colleges came under fire for not properly preparing students for work and for loading them with debt.

A sector index almost halved between April and December, and most stocks have plumbed new lows in recent months. Over the same period, the Nasdaq rose 6 percent.

"We think these stocks have been beaten up beyond what they deserve and the pendulum is starting to swing in their favor," said Robert Auer, senior portfolio manager at SBAuer Funds, which owns shares in ITT Educational Services, Corinthian Colleges, DeVry and Career Education.

Auer reckons education stocks could gain 25 percent this year in a flat market, and more if the overall market performs well.

"In 2011, it may be one of the best groups you can buy as an industry relative to the market because they're so beat up," said Auer.

The sector trades at an average 9.5 times forecast earnings, while the broader S&P 500 trades at a multiple of more than 13, according to Thomson Reuters StarMine data.

Companies are aggressively buying back stock, indicating they think their shares are undervalued.

Sector bellwether Apollo Group, currently valued at $5.8 billion, spent almost $200 million last quarter buying back its shares and has authorized $600 million more for repurchase.

REGULATION ROCKS

Investor confidence has been rocked by regulatory measures that could dent growth at colleges -- just as they were poised to benefit from high U.S. unemployment. During tough economic times, adults flock to these colleges to retrain. Apollo alone has some 400,000 students enrolled at its University of Phoenix.

New rules, due in July, seek to make for-profit colleges more accountable for the $145 billion in federal aid they receive to fund student loans.

"I think we've seen the worst for the large majority of the stocks," said William Blair analyst Brandon Dobell, adding, however, that investors would likely hold off until there is more clarity on the so-called 'gainful employment' rule, which has proved controversial and has been an overhang on the sector.

The gainful employment rule, which should be finalized in the weeks ahead, will effectively tie federal aid to colleges proving they are doing a better job of preparing students for work. For many colleges, federal aid is their primary income.

Piper Jaffray analyst Peter Appert sees stocks remaining largely range-bound in the next few months while earnings and growth expectations are dialled back.

However, the back half of the year could see stock gains as annual comparisons get easier and companies adapt to the new regulatory landscape.

"The biggest sentiment I hear from investors is they just need to get more visibility on gainful employment," said Dobell at William Blair.

HOLD FOR NOW, BUY LATER

Among the leading stocks, analysts favor those that are less exposed to the tougher new regulations and look cheap.

Dobell said he would be comfortable owning American Public Education, Bridgepoint and Grand Canyon even without clarity on gainful employment.

Rahul Gorawara at Rivanna Capital, which has a stake in Bridgepoint, thinks the stock is close to the bottom.

"Others have more issues going on. That's where it's going to be harder to assess where the bottom is going to be as they are still cleaning up their practices," said Gorawara.

Apollo has initiated a university orientation program that roots out students who might not be able to pay back loans. This, and broad macroeconomic factors, triggered a drop of more than 40 percent in new student enrollments at the University of Phoenix in the winter term.

"No one has an orientation program that has the scope that Apollo has. No one is trying to fix their business like Apollo is," said Dobell, who rates the stock "outperform."

For-profit colleges, which boomed in the recession as the jobless sought retraining, are seeing fewer students knocking on their doors -- put off by bad press around the industry and partly as the colleges themselves adapt their business models to the new rules.

Auer, who holds one of the riskier stocks, Corinthian, said he would hold on to all his positions.

"If I didn't sell when they went down 20-40 percent, I'm not selling now. I'm waiting for it to come back."

(Reporting by A.Ananthalakshmi in Bangalore, Editing by Ian Geoghegan)