Description

Thesis

At $17, Universal Technical Institute (UTI) stock is an attractive risk reward investment. UTI is in the early stages of a turnaround that is not fully discounted by the market. With higher capacity utilization rates, the company is capable of earning $1.70 to $2.00. The company is showing promising signs of progress in its operating metrics. As earnings begin to come through, analysts will raise their earnings estimates, highlighting the significant valuation discount to other for profit companies in the United States.

Capitalization

UTI has a market cap of $433 mm and a net cash position of $81 mm.

Description

UTI is the leading provider of post-secondary education for students seeking careers as professional automotive, diesel, collision repair, motorcycle and marine technicians. UTI’s undergraduate enrollment is 14,941 full-time students. The company works closely with leading OEMs such as: Audi, Honda, BMW, Cummins, Daimler, Ford, Mercedes, Mercury Marine, Nissan, Suzuki, Porsche, Yamaha and Volkswagen. Tuition ranges from approximately $17,750 to $40,650 per program, depending on the nature and length of the program.

UTI is the market leader in mechanic training with more than 2x the students of WyoTech or Lincoln Educational. In addition, the company has a market leading job placement rate. According to management, its placement rate for 2007 and 2006 was 91%. The high job placement rate helps both attract students and assist students in receiving financing.

Market size and opportunity

The $325 billion post-secondary market is growing 1-2% annually. For profit career colleges have 10% of the market and are growing 8-14% annually.

The market for qualified service technicians is large and growing. The need for technicians is due to a variety of factors, including technological advancements, a continued increase in the number of automobiles, trucks, motorcycles and boats in service, as well as an aging and retiring workforce that generally requires training to keep up with technological advancements and maintain its technical competency. According to the US Dept. of Labor, there will be an average of approx. 43,600 new job openings annually for new entrants from 2006 to 2016 in the fields UTI serves.

In response to concerns regarding the rapid decline in the number of new cars sold and potential dealership consolidation, management stated that demand for technicians is more closely correlated to the number of vehicles on the road and their age.  Though automotive service demand is cyclical, it is less cyclical than new car sales.  Further, service and parts generate more than 80% of operating profits at dealerships and are therefore likely to remain a key focus for dealerships, according to the company. According to the Bureau of Labor Statistics, only 30% of auto technicians work at dealers.

Additionally, there is a strong student value proposition for UTI’s program. According to management, the mean earnings for a high school graduate is $23,428 compared to $41,140 for an auto technician. A historical analysis indicates demand for education and enrollments ramp as unemployment rises, as intuitively the opportunity cost falls.

Investment opportunity

UTI is a countercyclical investment with significant potential to increase earnings power. The company’s operating margins have fallen to 3% from nearly 20% in FY2004 due to decreased capacity utilization. As a result, earnings have fallen to $0.32 per share in FY2008 from $1.26 per share in FY2005. Three issues contributed to the decreased utilization. One, UTI increased available seats by 35% since FY2004. Two, low unemployment rates negatively impacted student recruitment efforts. Three, internal execution missteps in the areas of marketing, lead generation, and sales force practices, limited growth.

Given the fixed cost model, margins were significantly pressured. Capacity utilization fell by more than 10 percentage points. UTI is now making a turn towards improved profitability and improved operating metrics. The company can achieve a mid-teens operating margin as it boosts capacity utilization.

A 15% operating margin translates into $1.85 of EPS. The education industry is trading at 20x next year earnings. The 5-yr average multiple is 26x. Applying a 20x multiple on $1.85 is $37. This is a 30% compounded return over the next three years.

The company is beginning to show evidence of a turnaround with two consecutive quarters of starts growth. Increased unemployment will continue to help starts and enrollment growth over the next several quarters. This should lead to improved capacity utilization rates and, in turn, operating margins as the company leverages its fixed and SG&A costs. Utilization rates have fallen from the 80%+ range in 2004 to 60% recently. The table below demonstrates the impact of capacity utilization rates on profitability.

Progress in the most recent quarter

• Since Jan 2008, UTI implemented a new national advertising campaign and revamped web strategy. This has significantly improved lead generation. During Q4 2008, UTI generated 33% more leads as compared to the prior year. The company’s cost per lead decreased 33% from Q4 2007.
• Advertising spend in the quarter was 7.3% of net revenues compared to 8.5% last year.
• Student contract growth was 28% compared to Q4 2007.
• 5% start growth compared to last year. This is now two consecutive quarters of starts growth and the highest starts number in 2+ years.

Management expects year-over-year starts growth in the high single to low double digit range for the full fiscal year. With this, the company expects to return to double digit operating margins in the fourth quarter of FY 2009.

Risks

The primary risks relate to student loan financing and management execution. UTI’s countercyclical nature should help offset some execution risk as unemployment rates become a tailwind rather than a headwind. With respect to student sources of funding, UTI generates 72% of its net revenues from federal student financial aid programs (Title IV). There have been several positive legislative actions in recent months to assist students with financing needs and close the “gap” between tuition rates and Title IV loans. Students are eligible for approx. $14,000 of government aid per year.

Catalyst