This article is a reprint of my February 19, 2008 RealMoney column

Apollo Group (APOL) is one of the largest private providers of higher education services. Through the University of Phoenix and other subsidiaries, Apollo serves more than 300,000 enrolled students at more than 100 campuses, using a mix of traditional and online educational services.

Over the last month, analysts have been increasing their earnings estimates for Apollo. For the August 2008 fiscal year, estimates have risen from $2.80 three months ago to $2.97 today. The estimates for 2009 have grown from $3.25 to $3.40 over the same period. As a result of this momentum in earnings, Apollo’s Zacks rank was recently upped to 1, which puts the company among the top 5% in terms of earnings momentum.

Byron Wien thinks Apollo is worth playing on the thesis that “a lot of people will be laid off and they’ll be trying to improve their skills.” But that makes an implicit assumption that those students will be able to pay their bills. Last year, Apollo, ITT Educational (ESI) and Corinthian Colleges (COCO) all reported rising bad debt expenses, and the trend has not abated.

Bad debt expense for the first quarter of 2008 as a percentage of revenue was 4.2% compared to 3.5% a year ago. Management also identified “certain items that should have been reported or should have been classified as discounts or refunds, that is, as a reduction of revenue, as opposed to a charge to bad debt expense in prior quarters.” This would have made the prior year number 2.9%, so the deterioration is from 2.9% to 4.2%.

Apollo’s associates degree programs are growing at a far faster rate than their bachelor’s degree program, which contributes to the bad debt issues and may contradict Wien’s thesis that higher growth will be coming from professionals looking to enhance their skills.

As to those rising earnings estimates, it’s hard to put too much faith in them when I see their quality. The accrual ratio, which measures the difference between cash earnings and accounting earnings, ideally should hover around zero. Apollo’s is all over the map, and the trend appears to be getting worse.

Source: Zacks Research Wizard, compiled by William A. Trent

At 23x current year earnings and 13.3x book value (compared to an industry average of 3.5) Apollo hardly looks cheap by traditional valuation measures. Apollo’s free cash flow over the last 12 months was $540 million, which amounts to a 4.9% free cash flow yield. Although the paltry Treasury yields currently available result in a favorable comparison, I think there are other names with similar cash flow yield and growth profile but with higher earnings quality.

On the conference call, management noted that “during the first quarter, we didn’t repurchase any of our Class A stock. As I just discussed, with the creation of Apollo Global, our potentially deep pipeline has grown significantly and we are busy evaluating the best use of our capital to create long-term value for our shareholders.” Could that be code for, “the stock is too expensive right now?”

I’m no technician, but Apollo has dropped through several moving averages recently and what looked like decent support at $70. If it drops through the 200-day (currently around $64-65) all bets could be off.

Disclosures: None

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Corinthian Colleges (COCO) reported earnings:

Comparing the third quarter of fiscal 2007 with the same quarter of the prior year:

* Net revenue was $250.5 million versus $250.3 million.

* Total student population was 68,175 versus 69,403.

* Total student starts were 24,457 versus 24,647.

* Operating income was $18.6 million compared with operating income of $19.8 million. Excluding severance expenses of $1.2 million, Q3 07 operating income was $19.8 million, flat with the same quarter of the prior year.

* Net income was $12.0 million compared with $14.7 million.

* Diluted earnings per share were $0.14 versus $0.17, in line with the Company’s previous guidance of $0.14 - $0.16. Excluding severance expenses of $0.01 per share, diluted earnings per share were $0.15 in Q3 07.

Analysts were expecting the company to earn $0.14 on $253 million in revenue. COCO’s decline in enrollments contrasts with some of its peers, such as Small Cap Watch List (Track at Marketocracy) and Mid Cap Watch List (Track at Marketocracy) member Apollo Group (APOL) or Large Cap Watch List (Track at Marketocracy) member ITT Educational Services (ESI). However, it does share a less favorable metric with those peers:

Educational services expenses were 56.7% of revenue in Q3 07 versus 55.1% in Q3 06. The increase was mainly the result of higher occupancy and bad debt expenses. Bad debt expense was 4.8% of revenue in Q3 07 versus 4.0% in Q3 06.

The company issued EPS guidance of $0.12-$0.13 for its fourth quarter, which ends in June. The consensus expectation had been for $0.14.