LINC - Lincoln Educational: Unemployment Spike Is What's Needed For A Sustained Rally

2023-06-02 12:00:53 ET

Summary

• Lincoln Educational Services Corporation's shares have underperformed the S&P index, returning approximately 5.6% since November last year.
• The company's Q1 earnings report showed a 7% increase in top-line revenues and a 6%+ increase in student starts, but significant investment is still needed for growth.
• Lincoln's current trajectory suggests a breakout above the $7.50 to $8 level is unlikely, leading to a "Hold" rating for now.

Intro

We wrote about Lincoln Educational Services Corporation ( LINC ) back in November of last year when we reiterated our bullish stance on the stock. Since that piece, shares have returned approximately 5.6% which actually means it has underperformed (opportunity cost) the S&P index (12.27%) over the same time frame. Suffice it to say, given current inflation rates continue to hover around the mid-single digit range in the US, investors need to be mindful of how their nominal returns stack up against the 'real returns' of their positions.

We state this because of the following. If we pull up a technical chart of Lincoln, we see that shares continue to trade in a pretty tight rangebound manner which has been the norm for the best part of three years now. Whilst these patterns can work for long-term dividend growth investors (as faster compounding can take place as a result of the stable share price), Lincoln does not pay a dividend which means real returns over the past 3 years or so in this play have been negative for the majority of investors.

Although, shares have built momentum in recent weeks due to the company's encouraging Q1 numbers announced earlier this month, the longer the multi-year consolidation continues, the more difficult it will be for Lincoln shares to register a breakout. We estimate there is approximately another 15% of capital gains to be realized for investors if shares can test that multi-year resistance level ($7.50 approximately) in due course. How long this takes to happen is anyone's guess but the right question to ask is if the company at present is fundamentally strong enough to be able to register a lasting breakout when indeed overhead resistance is tested. Lincoln's recent Q1 earnings report and associated trends can give us insights into this endeavor.

Q1 Earnings

The encouraging trends in Lincoln's first quarter were the almost 7% increase in top-line revenues along with the 6%+ increase in 'student starts' which came in at 3440 at the end of the quarter. Earnings revisions have also been dialed up in recent months as growth initiatives continue to gain traction. The CEO went through how the new hybrid learning model, the centralization of financial aid, fresh program launches and the Atlanta location startup will lead to a much improved Lincoln over time. Full-year guidance was also increased on the earnings call where top-line sales now come in at approximately $360 million below.

From a 'potential' standpoint, Lincoln has many catalysts which could lead to above-average growth. Demand right across the board both from students as well as corporations demonstrates the 'skills shortage' in many areas where government bodies are also looking to Lincoln for solutions to this problem. The underlying theme though of the report was the significant investment that still needed to be done both in existing campuses (new programs) and in new campuses going forward. Although these investments will undoubtedly lead to growth, how much this growth is going to cost remains unknown at this stage. Remember, Lincoln Educational does not have the privilege of being able to book customers for life like in other sectors which is why 'student starts' always must be performing at a better run-rate than students who ultimately finish their programs.

Aggressive Growth Strategies

Therefore, taking the above into account and despite Lincoln's strong balance sheet, I see Lincoln tapping some form of credit going forward especially if it wants to execute its growth strategy in a timely fashion. The reason being is that the company's profitability is not strong enough at present to fund these initiatives and we can really see this in Lincoln's cash-flow numbers.

For example, if we take Lincoln's free cash flow of $3.8 million over the past four quarters and divide this number by the number of shares outstanding (31.34 million), we get free cash/flow per share of $0.12. Subsequently, if we divide Lincoln's free cash flow per share ($0.12) into Lincoln's current share price of $6.53, we get a price-to-free-cash-flow ratio of 53.87.

So what does this metric tell us? Well, it essentially tells us the cost of $1 of free cash flow. Anything over 35 in my book is high which is why I believe Lincoln will need to find capital shortly in order to fund its growth initiatives.

Conclusion

To sum up, given Lincoln's present trajectory, we see shares continuing their multi-year consolidation where a breakout above the $7.50 to $8 level seems unlikely. This premise though could change on a dime if unemployment were to rise sharply which would improve demand on the front-end for Lincoln's courses. Reverting back to a 'Hold' rating for now.

For further details see: