Rating Update: Stock Rating B-Positive (7/19/19)-Nelnet Inc. (NNI).

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BUSINESS

Nelnet, Inc. provides education related products and services, and loan asset management services worldwide. The company’s Loan Systems and Servicing segment is involved in loan servicing activities, such as loan conversion, application processing, borrower updates, customer service, payment processing, due diligence procedures, funds management reconciliation, and claim processing activities for student loan portfolio and third-party clients. This segment also provides software and data center, default aversion tracking, claim processing, and post-default collection services, as well as borrower and loan updates for guarantee agencies, and contact center solutions; and licenses student loan servicing software to third-party student loan holders and servicers.
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INVESTMENT RATING

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With future capital returns forecasted to fall short of the cost of capital, NNI is expected to be a modest Value Eraser.

Nelnet has a current Value Trend Rating of B (Positive).
The Value Trend Rating reflects contradictory signals from PTR’s two proprietary measures of a stock’s attractiveness. Nelnet has a slightly negative Appreciation Score of 35 but a good Power Rating of 84, leading to the Positive Value Trend Rating.

Nelnet’s stock is selling above targeted value. The current stock price of $60.25 compares to targeted value 12 months forward of $56.
This moderately low appreciation potential results in an appreciation score of 35 (65% of the universe has greater appreciation potential.)
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Nelnet has a Power Rating of 84. (This good Power Rating indicates that Nelnet has a better chance of achieving attractive investment performance over the near to intermediate term than all but 16% of companies in the universe.)
Factors contributing to this good Power Rating include: the recent trend in Nelnet’s earnings estimates has been extremely favorable; is in a strong phase current; and recent price action has been favorable.

INVESTMENT PROFILE

Nelnet’s financial strength is high. Financial strength rating is 81.
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Relative to the S&P 500 Composite, Nelnet Inc. has moderate Value characteristics; its appeal is likely to be to Income-oriented investors; the perception is that NNI is normal risk. Relative weaknesses include: low forecasted profitability, high financial leverage, and low historical growth. Nelnet’s valuation is low: moderate dividend yield, low P/E ratio, and low price/book ratio. NNI has unusually low market capitalization.

CURRENT SIGNALS

Nelnet’s current operations are eroding. Return on equity is falling, reflecting: declining pretax margin; and falling leverage.

Nelnet’s current technical position is very strong. The stock price is in a 4.7 month up move. The stock has appreciated 30.9% from its prior low. The stock price is above its 200 day moving average which is in an uptrend.

ALERTS

Extremely important negative changes in investment behavior have recently occurred for Nelnet Inc. (NYSE: NNI): negative upside/downside volume developed, and its shorter term price trend turned down.
The stock is currently rated B.
Nelnet Inc. (NYSE: NNI) stock closed at $0.34 on 7/19/19 after a major increase of 17.4%. Trading volume in this advance was normal. The stock has been strong relative to the market over the last nine months and has risen 2.4% during the last week.

CASH FLOW

In 2018, Nelnet generated a very significant increase in cash of +$250.3 million (+27%). Sources of cash were much larger than uses. Cash generated from 2018 EBITDA totalled +$983.4 million. Non-operating sources contributed +$60.1 million (+6% of EBITDA). Cash taxes consumed -$58.8 million (-6% of EBITDA). Re-investment in the business amounted to -$853.7 million (-87% of EBITDA). On a net basis, debt investors provided +$192.3 million (+20% of EBITDA) while equity investors pulled out -$73.0 million (-7% of EBITDA).
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Nelnet’s Non-operating Income, %EBITDA has exhibited a very small overall uptrend over the period. This improvement was accompanied by a similar trend for the Nelnet Inc. Peer Group. In most years, Nelnet was in the top quartile. Currently, Nelnet is upper quartile at +6% of EBITDA (+$60.1 million).

Nelnet’s Cash Taxes, %EBITDA has exhibited a very small overall uptrend over the period. This improvement was accompanied by stability for the Nelnet Inc. Peer Group. In most years, Nelnet was in the third quartile and top quartile. Currently, Nelnet is upper quartile at -6% of EBITDA (-$58.8 million).

Nelnet’s Business Re-investment, %EBITDA has enjoyed a volatile overall uptrend over the period. This improvement was accompanied by an opposite trend for the Nelnet Inc. Peer Group. (Since 2016 Business Re-investment, %EBITDA has experienced a very sharp decline.) In most years, Nelnet was in the third quartile and top quartile. Currently, Nelnet is slightly below median at -87% of EBITDA (-$853.7 million).

Nelnet’s Debt Investors, %EBITDA has experienced a volatile overall downtrend over the period. This downtrend was accompanied by an opposite trend for the Nelnet Inc. Peer Group. (Since 2016 Debt Investors, %EBITDA has experienced a very sharp recovery.) In most years, Nelnet was in the lower quartile and second quartile. Currently, Nelnet is slightly above median at +20% of EBITDA (+$192.3 million).

Nelnet’s Equity Investors, %EBITDA has experienced a downtrend over the period. This downtrend was accompanied by an opposite trend for the Nelnet Inc. Peer Group. In most years, Nelnet was in the third quartile and second quartile. Currently, Nelnet is slightly above median at -7% of EBITDA (-$73.0 million).

Nelnet’s Change in Cash, %EBITDA has exhibited little to no overall change over the period. This stability was accompanied by a downtrend for the Nelnet Inc. Peer Group. In most years, Nelnet was in the second quartile and top quartile. Currently, Nelnet is at the upper quartile at +25% of EBITDA (+$250.3 million).
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Nelnet’s Cash, %Revenue has exhibited little to no overall change over the period. This stability was accompanied by a downtrend for the Nelnet Inc. Peer Group. (Since 2013 Cash, %Revenue has experienced a very sharp decline.) In most years, Nelnet was in the second quartile. Currently, Nelnet is substantially above median at +71%.

PROFITABILITY

Nelnet’s return on equity has eroded very significantly since 2009.
A major analytical focus for NNI is a small negative trend in pretax operating return a significantly augmented by very strong negative trend in non-operating factors.
The productivity of Nelnet’s assets rose over the full period 2009-2019: asset turnover has enjoyed a very strong overall uptrend that accelerated very sharply after the 2015 level.
More than offsetting this trend, however, pretax margin experienced a very strong overall downtrend that accelerated very sharply from the 2013 level.
Non-operating factors (income taxes and financial leverage) had a significant negative influence on return on equity.
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Nelnet’s return on equity is lower quartile (6.7%) for the four quarters ended March, 2019.
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Operating performance (pretax return on assets) is lower quartile (0.8%) reflecting asset turnover that is upper quartile (0.07X) and lower quartile pretax margin (10.8%).
Tax “keep” rate (income tax management) is at median (81.8%) resulting in after tax return on assets that is lower quartile.
Financial leverage (leverage) is upper quartile (10.63X).

GROWTH RATES

Overall, Nelnet’s growth rate has slowed very considerably in recent years.
Nelnet’s historical income statement growth and balance sheet growth have diverged. Revenue growth has exceeded asset growth; earnings growth has fallen short of equity growth.

Annual revenue growth has been 7.9% per year.

Total asset growth has been 1.9% per year. (More recently it has been -2.6%.)

Annual E.P.S. growth has been 5.1% per year.

Equity growth has been 14.8% per year. (More recently it has been 7.9%.)
No consensus growth rate forecast is available for Nelnet.
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Relative to the Nelnet Inc. Peer Group, Nelnet’s historical growth measures are erratic. Revenue growth (7.9%) has been upper quartile. Equity growth (14.8%) has been upper quartile. Total asset growth (1.9%) has been at the lower quartile. E.P.S. growth (5.1%) has been lower quartile.

Consensus growth forecast is unavailable.
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PRICE HISTORY

Over the full time period, Nelnet’s stock price performance has been variable and superior. Between September, 2008 and July, 2019, Nelnet’s stock price rose +324%; relative to the market, this was a +66% gain. Significant price moves during the period: 1) September, 2011 – November, 2013: +140%; and 2) April, 2009 – December, 2010: +293%.
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TOTAL INVESTMENT RETURNS

Current annual total return performance of 2.6% is below median relative to the S&P 500 Composite.
In addition to being below median relative to S&P 500 Composite, current annual total return performance through June, 2019 of 2.6% is upper quartile relative to Nelnet Inc. Peer Group.

Current 5-year total return performance of 8.7% is below median relative to the S&P 500 Composite.
Through June, 2019, with below median current 5-year total return of 8.7% relative to S&P 500 Composite, Nelnet’s total return performance is below median relative to Nelnet Inc. Peer Group.
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VALUATION BENCHMARKS

Relative to S&P 500 Composite, NNI’s overall valuation is normal. The highest factor, the ratio of enterprise value/revenue, is upper quartile. Ratio of enterprise value/earnings before interest and taxes is at the upper quartile. Ratio of enterprise value/assets is at the lower quartile. Price/earnings ratio is lower quartile. The lowest factor, the price/equity ratio, is lower quartile.
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Nelnet has a major value gap compared to the median valuation. For NNI to achieve median valuation, its current ratio of enterprise value/revenue would have to fall from the current level of 12.78X to 5.13X. If NNI’s ratio of enterprise value/revenue were to fall to 5.13X, its stock price would be lower by $-475 to $-414.
For NNI to fall to lower quartile valuation relative to the Nelnet Inc. Peer Group, its current ratio of enterprise value/revenue would have to fall from the current level of 12.78X to 2.57X. If NNI’s ratio of enterprise value/revenue were to fall to 2.57X, its stock price would decline by $-633 from the current level of $60.

VALUE TARGETS

With future capital returns forecasted to fall short of the cost of capital, NNI is expected to be a modest Value Eraser.
Nelnet’s current Price Target of $58 is little changed from the current price of $60.25.
This moderately low appreciation potential results in an appreciation score of 35 (65% of the universe has greater appreciation potential.)
Notwithstanding this moderately low Appreciation Score of 35, the high Power Rating of 84 results in an Value Trend Rating of B.
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Nelnet’s current Price Target is $58 (+17% from the 2018 Target of $49 but -4% from the 07/19/19 price of $60.25). This slight rise in the Target is the result of a +17% increase in the equity base and a +0% change in the price/equity multiple. None of the Value Drivers has an impact on the price/equity multiple. The forecasted increase in growth has no impact on the multiple. The forecasted increase in cost of equity also has no impact and the decline in return on equity didn’t either.
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PTR’s return on equity forecast is 6.5% — in line with our recent forecasts. Forecasted return on equity suffered a dramatic, steady decline between 2010 and 2018. The current forecast is significantly below the 2010 peak of 20%.

PTR’s growth forecast is 12.0% — slightly above our recent forecasts. Forecasted growth enjoyed a dramatic, erratic increase between 2010 and 2018. The current forecast is significantly above the 2012 low of 2%.

PTR’s cost of equity forecast is 9.1% — in line with recent levels. Forecasted cost of equity enjoyed a dramatic, steady decline between 2010 and 2018. The current forecast is below the 2010 peak of 12.0%.
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At Nelnet’s current price of $60.25, investors are placing a positive value of $4 on its future investments. This view is not supported by the company’s most recent performance that reflected a growth rate of 8.0% per year, and a return on equity of 7.8% versus a cost of equity of 8.7%.
PTR’s 2020 Price Target of $58 is based on these forecasts and reflects an estimated value of existing assets of $68 and a value of future investments of $-10.

About John Lafferty 44922 Articles
During his career, John has developed valuation and stock rating methodologies, managed institutional portfolios and mutual funds, and provided equity research to institutional investors on thousands of companies. He has been Director of Research at PTR since its inception in 2004.

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