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The Biggest “Fake” Stock Rise of 2014?

What an extraordinary couple of weeks it’s been for ITT Educational Services, Inc. (ESI)…

On Monday, October 13, shares closed at $4.30.

Last Friday (October 17), they closed at $9.19 – up 65% over the previous day’s price and 96% higher for the week.

This past Monday, the stock soared by another 38% to close at $12.68. More than 7.9 million shares traded hands, compared to the average daily volume of 1.4 million.

Since October 13, the stock is up around 120%.

So what’s driving such a sudden, blistering rise?

Is This Rise for Real?

The surge happened amid news that Bank of America (BAC) raised its target price on ITT to $8 from its original estimate of $7.

The chart below shows the price movement of ITT shares… which Bank of America still rates as “underperform.”

ITT Educational Services' Rollercoaster Two Weeks

But is the sudden price spike enough to ease investors’ fears that this provider of post-secondary degree programs will continue to earn a failing grade?

While many investors may be tempted to believe that the exploding stock price means the company has finally turned the corner, unfortunately, the facts don’t bear this out…

Truth be told, the catalyst for the increase is more than likely short-sellers covering their positions. These investors were caught unaware when the badly mismanaged company announced a $90-million letter of credit that effectively mitigated the company’s lack of liquidity.

Now, in addition to temporarily solving a liquidity issue, the letter also eliminates potential sanctions by the Department of Education, which requires ESI to maintain an $80-million letter of credit.

But this doesn’t mean the company has moved away from the regulatory abyss. Far from it…

The SEC Comes Knocking…

On September 19, the SEC sent ITT Educational Services a notice of potential civil action against the college. The filing suggests that a cease-and-desist order and/or fines are possible, due to the company’s failure to submit 2013 year-end financial statements.

It’s believed that the SEC is looking at the college’s troubled PEAKS program, which was used to increase the amount of private money available for students to pay tuition.

The company’s lack of disclosure on its losses from the program is holding up the reporting of its financial results. But the school faces projected student loan defaults of more than 59%.

And this is just the tip of the iceberg…

The foul state of the company’s overall financial position is readily apparent…

Balance Sheet Diagnosis: Sick!

In its last quarterly earnings report…

  • ITT’s net income plunged 22%, compared to the same quarter a year ago. EPS slumped by more than 19.5%, a decline that’s accelerated for two years now.
  • In a sign of the company’s mismanagement, return on equity measures minus 22.2%, significantly lower than a year ago.
  • Operating cash flow fell to $60.1 million – a 30.5% decline versus the same quarter last year.

Even incorporating the stock’s recent huge rise, it’s still down 71% year to date.

The only positive news for ITT is that new student enrollment only fell by 8.1% for its second quarter and by 9.5% for its third quarter.

How is this good news?

Well, it seems the college was expecting new student enrollment for the period to decline by 10% to 15%!

So that’s okay, then!

This only serves to highlight the school’s ongoing fundamental problems. So don’t be fooled by the stock’s recent spike. In virtually every category of investment analysis, ITT gets a failing grade. And its murky regulatory issues make this stock one to avoid.

Richard Robinson

Richard Robinson

, Ph.D., Equities Analyst

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