LOPE - Grand Canyon Education May Need To Consolidate Before The Next Move Up

Summary

• Company beats earnings and sales expectations in its fourth quarter.
• Cash flow & Liquid assets fell in fiscal 2022.
• Although we have a long-term technical breakout, caution is advised if buying into this up move.

Intro

We wrote about Grand Canyon Education, Inc. ( LOPE ) in August of last year when we stated that the stock was on the cusp of a sustained long-term move to the upside. Not long after we penned that August commentary, shares finally began to undergo the move we were expecting. In fact, shares now find themselves up approximately 38% over the past six months or so due to momentum in the stock gaining traction once we got the clear breakout out of the long-term symmetrical triangle as we see below. We did foresee a sizable move coming but did not foresee the magnitude of the move.

Technical patterns on long-term charts are more significant than their short-term counterparts. The reason being is that far more information is digested on long-term charts which means we can get a better read on investors' emotions throughout the given time period. The premise behind our bullishness in LOPE 6 months ago stemmed from the company's high gross margins, strong balance sheet, and very keen valuation at the time. In fact, strong profitability was witnessed once more in LOPE's recent Q4 numbers where we witnessed beats in both the company's earnings (Non-GAAP Earnings of $2.36 per share) as well as its sales ($258.7 million).

Followers of our work will be aware that we believe that growth rates (Or lack thereof) are many times overemphasized by the market in cheap oversold companies. We always favor valuation and core profitability metrics in out-of-favor stocks (such as we had with LOPE at the time). However, with LOPE as mentioned having rallied close to 40% over the past six months alone, the market will now become FAR more in tune with forward-looking growth rates in order to justify its new valuation.

Therefore, investors need to consistently look at cash-flow generation numbers as we discuss below as the market will take its cue from this as to whether sustained growth continues to lie ahead for LOPE.

Cash Flow Generation

Many times investors can get faked out by solely monitoring EPS numbers and their associated valuation multiples. If we look at fiscal 2022 numbers, for example, core EPS came in at $5.75 per share compared to $5.94 per share in the previous year. However, management has been buying back company stock relentlessly over the past couple of years with $800+ million of stock bought back in fiscal 2021 with $600+ million bought back the following year. These actions have obviously boosted profitability on an accounting basis but what about from a cash-flow basis?

In fiscal 2020, LOPE generated $220+ million in operating cash flow which resulted in $146 million of free cash flow. Immediately here, we see that the $600 million of share buybacks last year did not come from internally generated cash flow but rather from the company's cash balance. Suffice it to say, these buybacks (And associated boosting of EPS) cannot continue at their current scale.

Balance sheet cash last year came down by over $480 million which means Total cash & ST investments now come in at approximately $182 million. Although liquidity is still strong in LOP, more liquid assets on the balance sheet are always favorable for the following reason.

As investors, a long investment in LOPE today is only worth the future cash flow it generates going forward . If free cash flow numbers for example disappoint over the next 12 months, the value of the shares will drop as the market will begin to price in lower growth rates than originally envisioned. However, there are two areas that can essentially lessen the pain for an investor when a cash-flow generation comes in lower than expected.

1. If an investor can buy a company's present cash flows below average, this produces a margin of safety that protects the stock in times of volatility.
2. If there are ample cash & ST investments on the balance sheet which can essentially make up for the shortfall in cash flow in order to keep re-investment elevated.

At present, LOPE's trailing cash-flow multiple comes in at 16.35 and the price-to-cash multiple comes in at 19.87. The latter multiple here especially demonstrates here that strong growth is required going forward to keep on pushing the share price higher. Therefore, one would believe that the estimated 4% top-line growth and 7% bottom-line growth projections for fiscal 2023 would need to be at least met for shares to continue their trajectory higher.

Conclusion

Although we see LOPE returning to at least test its 2019 highs in this present up move, growth rates will now become under extra scrutiny as a result of the very strong rally since October of last year. Shares are going higher but how quickly this happens remains up for debate. We look forward to continued coverage.

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