Chegg (NYSE:CHGG), which provides online education tools to students, recently reported disappointing third-quarter results, and the company is facing very steep macro challenges. Despite the sharp decline of CHGG stock, its valuation remains elevated, given the firm’s growth outlook, its macro issues and the relatively low barriers to entry in its sector.
In light of all of these points, I recommend that investors sell the shares.
Disappointing Q3 Results and a Huge Guidance Cut
Chegg’s Q3 sales rose only 11.6% from a year ago and came in meaningfully below analysts’ average estimate. What’s more, the company provided Q4 top-line guidance of $194 million to $196 million, versus analysts’ previous outlook of $241.6 million.
Chegg lowered its 2021 top-line guidance to $762 million to $764 million from $805 to $815 million previously The firm cut its 2021 EBITDA outlook, excluding certain items, to $255 million to $257 million from $295 million to $300 million
CEO Daniel Rosensweig blamed the Q3 miss and guidance cuts primarily on temporary, (dare I say “transitory?”) declining attendance at colleges amid the tight labor market. But as I’ll explain in the next session, that phenomenon could be less temporary than the CEO is predicting, and the company is facing another, huge macro problem that he did not highlight.
Macro Issues
As I mentioned, Chegg’s CEO highlighted lower attendance at colleges as the company’s major problem. Specifically, the company said in an SEC filing:
Higher Education revenue was down 7% as growth in international courseware, including Canada and the UK, was more than offset by a 9% decline in US Higher Education Courseware. While no market data for the full back to school period is available as yet, Pearson’s internal analysis indicates a decline in enrolments, particularly in community colleges, following a surge in COVID-19 infections in the key back to school period, and a strengthening of the US labour market.
Rosensweig said, “We believe this is a post-pandemic impact that will affect this school year but is not sustainable for higher education long term.”
That statement reminds me of Fed Chairman Jay Powell’s frequent assertions over the course of this year that accelerating inflation would prove to be “transitory.” In recent testimony before a Congressional committee, he stopped using the word and, by indicating that the Fed would likely speed up the reductions of its bond purchases, tacitly acknowledged that it had previously moved too slowly to counter the inflation threat.
So it’s clear that the chairman’s use of the word “transitory” proved to be much more transitory than the inflation itself.
Likewise, Chegg is indicating that the trend away from higher education will be temporary, but it could easily prove to be wrong about that. In other words, the trend could easily last two, five, or even 10 years.
After all, most U.S. colleges do cost ridiculous amounts of money now. And Silicon Valley, which often sets the trend for the rest of the country, does not view college degrees as extremely important (Bill Gates, Steve Jobs, and Mark Zuckerberg all famously dropped out of college). Finally, the trend of strong wage growth could easily last a few years, also making colleges less appealing during that time.
But there’s more. Chegg has another big macro issue. Specifically, there’s a great deal of evidence that the parents of K-12 students were quite unhappy with the results of online learning during the pandemic.
For example, MSNBC recently reported that, “As early as June 2020, following a nightmarish spring of remote learning, polling began to indicate that parents were fed up.” And MSNBC quoted the New York Times as reporting that, ““Parents angry over how schools have operated during the pandemic span the political spectrum, from lifelong liberal Democrats to activist Trump supporters.”
So for K-12 students, online education has gotten a bad reputation. As a result, I think that many parents of those students will be very reluctant to spend significant amounts of money on Chegg’s products going forward.
Also worth noting is that the online education sector does not have very high barriers to entry. I don’t believe that it would be very difficult for existing or new companies to hire some writers and teachers, develop educational materials, and start selling them online.
Valuation and the Bottom Line on CHGG Stock
CHGG stock is currently changing hands for 23x analysts average 2022 earnings per share estimate of $1.23. That’s not exorbitant. But as analysts become more aware of Chegg’s macro challenges, I expect their 2022 EPS estimates to fall meaningfully, causing the forward P/E multiple to rise significantly.
Further, even with the current mean EPS outlook, the company’s EPS is only expected to creep up 3% next year. Given these points, along with the company’s tough macro challenges, CHGG stock remains extremely overvalued.
On the date of publication, Larry Ramer did not have (either directly or indirectly) any positions in the securities mentioned in this article.
Larry Ramer has conducted research and written articles on U.S. stocks for 14 years. He has been employed by The Fly and Israel’s largest business newspaper, Globes. Larry began writing columns for InvestorPlace in 2015. Among his highly successful, contrarian picks have been Plug Power, solar stocks, and Ford. You can reach him on StockTwits at @larryramer.