May 4, 2017

DV is not as cheap as traditional analysis suggests, with UAFRS EPS showing slow growth going forward


  • DV’s EPS’ will grow by just 1% in the next four quarters, not by 100% like as-reported metrics suggest
  • After making the appropriate UAFRS adjustments, EPS’ growth does not suggest DV is a value-pick, but instead could be a value-trap
  • DV’s profitability is materially distorted by accounting for stock options and operating leases under GAAP

 

DeVry Education Group, Inc. (DV) is expected to release Q3 2017 as-reported earnings of $0.63 per share after the bell today (5/4), representing significant 22% shrinkage over $0.81 levels generated during the same period last year. However, full-year expectations are much more optimistic, and are for EPS growth from $1.27 in the four quarters ended Q2 2017 to $2.69 over the next year, a 112% growth rate.  Growing optimism surrounding the firm has driving material stock price appreciation, with DV shares up over 100% in the past year, and up over 20% since the beginning of 2017, as investors have flocked to what appears to be a cheap company with massive growth.

However, after making appropriate adjustments under Uniform Accounting Financial Reporting Standards (UAFRS), it is apparent that profitability at DV is stalling, and valuations are not nearly as cheap as they appear, suggesting investors have grown too positive on the name as of late.

Specifically, under UAFRS, while Adjusted EPS (EPS’) is greater than as-reported EPS, it is actually expected to remain flat in the next four quarters, not grow by 100%+.  The firm is expected to see EPS’ shrink in Q3 2017, to $0.74 levels from $0.86 in the same period last year, and full year expectations are only marginally more positive, for growth from $3.11 in the last four quarters, to $3.14 in the next four.  Moreover, after making the requisite adjustments, it is apparent valuations are more expensive than investors may realize, suggesting the firm is not an interesting value name, but instead fairly valued at best.

dv1-20170504

The quarterly results show a similar trend, with EPS’ remaining fairly poor, and not growing at a rate even near what as-reported metrics suggest.  Given weaker-than-reported profitability trends, the firm is not trading at a discount, and is instead fairly valued at best.

dv2-20170504

UAFRS, Uniform Adjusted Financial Reporting Standards, call for removal of distortions from issues like the treatment of operating leases and stock option expenses. Once removed, it is apparent that EPS’ is likely to remain flat, not grow aggressively, and is therefore likely fairly valued, not trading at a discount.

UAFRS vs. As-Reported EPS

Investors make major decisions about which companies to own based on quarterly company earnings, the most common metric mentioned in traditional corporate investment analysis.

However, more often than not, the earnings that companies report in any given quarter can swing wildly and lead investors to completely wrong conclusions, because GAAP and IFRS rules force management to report results in ways that are not representative of the real operating performance of the business.

While there is a case to be made that some management teams can use “creative accounting” to adjust numbers, the research would show that more often than not, the real problem is with the accounting rules themselves, not management’s use of them.

Impact of Adjustments from GAAP to UAFRS

There are several adjustments required to make earnings representative of a firm’s true cash flows. For DV, the most material are related to operating leases and stock options.

DV’s operating lease expense is material. The decision management makes between investing in capex and investing in a lease is not a decision between an expense and an investment, but rather a decision in how management wants to finance their investments. If they would rather spend cash up front for the asset, they will spend capex. However, if they want to spread the cost of the asset over several years, they will instead choose to lease the asset. That said, as-reported accounting statements treat one as an investment, and the other as an expense that does not impact the balance sheet.

Meanwhile, stock option expenses are treated as an operating expense to the company in accounting statements, when it is actually a way for the company to give employees an ownership stake in the company, it is a financing decision if you will. As such, this non-cash expense should be treated as dilution to equity holders and another claim against the Enterprise Value of the firm, as opposed to it being treated as an annual expense. This is especially true as, unless the company uses cash to buy shares (to suppress dilution for equity holders from the option grants being exercised), there is no cash impact on the company.

UAFRS-reporting adjusts for these traditional accounting distortions by treating all operating leases as an investing cash flow and rebucketing stock option expenses into the enterprise value of the firm. These simple reclassifications remove a tremendous amount of accounting noise related to investment activities and improves investors understanding of the operating earnings of a business.

Below, we have included in tabular form, all of the adjustments required to get from Net Income to UAFRS Adjusted Earnings:

dv3-20170504

Worse-than-reported profitability trends imply DV isn’t a value pick, but potentially a value trap

At current prices, DV is trading at a 13.7x as-reported forward P/E, suggesting the firm is trading well below corporate averages, and is still cheap when considering expected growth rates, even after the run in share prices in the past year.  However, after making the requisite adjustments, it is apparent that DV is actually more expensive, and considering expected growth rates, is fairly valued at best.

Specifically, the firm is actually trading at a 16.3x UAFRS-based P/E (P/E’), which is only slightly below corporate averages. Given modest expected growth rates, this suggests a firm that is actually fairly valued at best, and should the firm fail to improve growth past expected levels, investors may find themselves holding a value trap, rather than a cheaply-acquired asset.

By using Uniform Adjusted Financial Reporting Standards (UAFRS), investors see a cleaner picture that distorted GAAP and IFRS metrics cannot show. By standardizing financial reporting consistently across time and across companies, corporate performance and valuation metrics improve dramatically. Comparability of a company’s earnings over time, trends in corporate profitability and comparability in earnings power and earnings growth across close competitors and different sectors becomes far more relevant and reliable.

To find out more about DeVry Education Group, Inc. and how their performance and market expectations compare to peers, click here to access the open beta of the Valens Research database.

Our Chief Investment Strategist, Joel Litman, chairs the Valens Research Committee, which is responsible for this article. Professor Litman is regarded globally for his expertise in financial statement analysis, fundamental research, and particularly Uniform Accounting, UAFRS.