LINC - Lincoln Educational Services Q3: Beat Raise Repeat

2023-11-07 15:37:34 ET

Summary

• We reiterate our 'Strong Buy' rating on LINC due to strong and continued earnings momentum and industry trends favoring upskilling.
• We have a better visibility on revenue growth and margin expansion potential as new course launches and new campuses mature.
• Despite the outperformance, the company still trades at a discount to its peer average and historical averages providing favorable risk reward for long term investors.

Investment Thesis

We had ascribed a 'Strong Buy' rating to Lincoln Educational Services Corporation ( LINC ) as a result of continued earnings outperformance and strong industry tailwinds as students and experienced professionals looking to upskill themselves focused on job-ready skills. In addition, further development of its hybrid model drives higher utilization and shift to alternative career segments which are affordable amidst potential increase in unemployment rate and high traditional tuition fees and strong growth prospects with new course launches as well as new university. The company continues to report robust earnings outperformance which sent the shares soaring ~10% on print. We reiterate our Strong Buy rating and ascribe a target price of $12.5 (at 20x Fwd P/E at a slight premium to its historical average and peer average) due to its strong outperformance and better visibility on growth and margin expansion in the near term.

Strong Revenue Growth

The company reported a strong Q3 on November 6th with total revenues of ~$100 mn, up over 10% YoY ahead of the consensus expectations pegged at ~$95 mn. The consensus beat was driven by strong student starts which grew by over 7% YoY post a 18% student start growth in the previous quarter. The student start growth was driven by a 7.6% growth in Transportation and Skilled trades while Healthcare starts grew 5.8% which led to average student population growing by 3% driving top line growth. The increase in student starts was primarily organic driven with the growth coming from its traditional courses as the launch of its recent courses was delayed due to longer wait times in regulatory approvals. In addition, average revenue per student grew by over 7% driven by continued increase in its utilization of the hybrid platform Lincoln 10.0 along with pricing actions. The continued growth in student starts is also driven by the renewed focus on job-ready skills compared to high cost traditional college.

"...certainly the current generation is thinking much more speculatively about college. And so I think there are more people interested in doing what we do, and I think more people are seeing value in working with their hands."

- Scott Shaw, President and CEO, Lincoln Educational Services

Stable Margin Profile in Core Ops

Gross margins remained stable at 56.7%, up marginally by 20 bps YoY as a result of higher instructional expenses due to increased salaries as a result of higher student population and improving retention along with a jump in books and tool expenses and higher utility expenses. SG&A expenses deleveraged by 350 bps YoY primarily on account of continued investments in marketing to create awareness to drive higher student starts which is typically higher in H2 due to seasonality along with a jump in performance-based incentives. Adj. EBITDA margins for campus operations declined by 150 bps YoY to 14.5% while higher corporate expenses and decline in transitional services segment further contributed to the overall decline in consolidated margins by 200 bps at 6.1%.

Beat, Raise, Repeat

The company reported GAAP EPS of $0.07 which came in ahead of the consensus expectations of $0.04 driven by strong top line growth and stable margin profile. Balance sheet position also continues to be strong with a total of $70 mn in cash balance with no debt outstanding, even accounting for the planned investments in Nashville and Atlanta campus along with the completion of its sale and leaseback arrangement in Levittown.

Management revised their guidance upwards and now expects 2023 revenues to be $372.5 mn at the midpoint (vs. $365 mn guided in the previous quarter and $360 mn at the end of Q1) and Adj. EBITDA is expected to be $25 mn at the midpoint (vs. $24 mn guided in previous quarter and $23 mn at the start of Q2) and Adj. Net income expected to be $12 mn (vs. $11.5 mn previously) driven by continued earnings momentum. This implies Q4 revenue growth of ~8% YoY and an Adj. EBITDA margin of 14.7%, down by 260 bps as a result of higher facility and instructional expenses and SG&A deleverage due to an increase in marketing spending.

2024 Outlook and Beyond

Management noted that it is contemplating tuition price increases of 2-5% across programs that have strong demand which could particularly be within the Automotives and Trades business. In addition, we expect student start to continue growing by high single digits for 2024 driven by strength in current courses along with planned launch of its Atlanta campus in the first half along with 10 new replication programs to be launched in 2024 would enable the company to drive a low-double digit revenue growth. The company further is looking to expand its Philadelphia campus to a new campus in Levittown which is expected to be operational in 2025. The current Philadelphia campus can house only 250 students and provides only automotive courses while the new campus will provide about 600 students and courses beyond automotive in HVAC, welding and electrical. The new campus is expected to be EBITDA accretive year 3 onwards (similar to Atlanta campus).

We expect gross margins to improve going forward as a result of lapping favorable base along with continued improvement in its hybrid model Lincoln 10.0. Marketing expenses are likely to remain in line with current year as the company makes further investments in driving awareness, however, would be partially offset by operating losses in the new campuses. We expect the company to return to low teens margin in the near future along with better visibility on driving double-digit revenue growth as a result of increasing uptake of its existing courses, new campuses and course launches and growing hybrid share.

Valuation

Despite the continued earnings momentum as well as near 10% jump in stock price on the print, the company trades at 15.4x at a discount to its long-term average of ~18.0x as well as its peer average of ~17.6x. We believe given the potential for margin expansion as well as continued operational outperformance driving earnings growth, new campus and course launches warrant a premium. We ascribe a 15% premium to its peer average and ascribe a target PE multiple of ~20x Fwd P/E and reiterate our Strong Buy rating with a target price of $12.5.

Risks to Rating

Risks to rating include:

1) LINC operates in a highly regulated education sector which is heavily dependent on federal funding and Title IV programs. Any change in regulation or its ineligibility to receive funding could have an adverse impact on student starts.

2) LINC operates in a highly competitive sector which includes traditional private and public colleges as well as universities and other proprietary schools along with Edtech companies.

3) Its inability to improve its utilization of Lincoln 10.0 can lead to lower than expected margin upside potential.

4) The company's inability to provide new courses for job-ready skills based on current job market trends can hamper enrollment.

Final Thoughts

We believe LINC has consistently outperformed with strong operational performance which drove its shares higher by almost 10% on its recent earnings release. The company continues to take progressive steps with the planned new campuses in 2024 and 2025 along with new course launches which will continue to drive student growth. In addition, tuition increases have remained modest compared to 2019 and while it is expected to moderate further, we believe its offering of providing job-ready skills would continue to resonate with the students amidst an increasingly challenging job market and rising unemployment. Reiterate our Strong Buy rating and ascribe a target price of $12.5 (at 20x Fwd P/E).

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