Competition Limits Pricing Power, But Enrollment Continues To Climb

Following the pandemic's financial hit, Brazilian education companies have been overhauling their business models to increase enrollment by providing tuition discounts to newly enrolled students, opening more online learning centers, and offering a greater number of online courses.

Since 2019, the number of learning centers among the three companies that we rate, YDUQS Participacoes S.A. (YDUQS; brAAA/Stable/--), Cogna Educacao S.A (Cogna; brAA+/Stable/--), and Vitru Brasil Empreendimentos, Participacoes e Comercio S.A. (Vitru; brAA-/Stable/--), shot up by 200%, outpacing the increase in their enrollment of more than 150%. This has heightened competition in the sector, curtailing pricing power. Nevertheless, we believe growth prospects for the sector are favorable because of a substantial pool of prospective students that companies can tap by offering remote courses.

The accelerating shift toward online education, along with the shrinking share of students taking on-campus courses that command higher tuitions, caused education companies' revenue growth to slow in 2022. However, lower tuitions for online education, coupled with the sector's post-pandemic recovery, have enabled companies to boost student enrollment in the past two years. At the same time, a larger student body enrolled in online learning could increase loan delinquencies and lower tuition offerings amid high competition.

Online Learning Can Result In Higher Student Delinquencies, But Stronger Margins

The education sector has undergone substantial changes stemming from the pandemic-induced interruption. Online course offering has surged, not because of higher enrollment, but thanks to lower tuition rates. According to the 2021 Higher Education Census, the shift to online learning has been occurring since 2015, which the pandemic intensified.

Education companies have increased investments to expand their online learning curriculum, mainly because it generates higher margins stemming from the lower cost structure. However, given higher dropout rates among remote students and the increasing competition in the sector, companies are prompted to reduce tuition rates to boost enrollment, raising the already high student-loan delinquency rates.

In response, the largest education companies have increased sharply provisions for doubtful accounts, especially during the pandemic years of 2020 and 2021. EBITDA margin volatility has increased, but continuing focus on receivables collection, and cost-structure streamlining have enabled a gradual recovery in profitability in the past two years. We expect companies' margins to reach pre-pandemic levels in 2024, as learning centers mature, dropout rates fall, and tuition fees are adjusted to inflation.

The Premium Curriculum Segment Is Lucrative, But Presents Limitations

The premium curriculum segment typically refers to medical courses, one of the most profitable in the sector. Aside from commanding higher tuition fees, given robust demand for such courses, the premium segment has lower dropout and loan-delinquency rates than other curriculum segments.

Since 2013, education companies can only expand the medical student enrollment through the Mais Médicos governmental program, posing limitations. The program's objectives are to send doctors to regions where there is a shortage or absence of medical staff. On Oct. 4, 2023, the program authorized private education companies to offer about 5,700 new slots for medical courses.

Rated education companies have been posting higher margins and stable cash flow from this segment, stemming from higher student enrollment due to the maturation of existing slots and lower dropouts, resulting in increasing tuition fees.

The Share Of Government-Subsidized Loans Is Likely To Remain Low

The Student Financing Fund (FIES), the federal government's program that provides loans to low-income students, has run into increasing setbacks in recent years. Access to FIES loans has tightened following changes to the program, which resulted from a significant increase in student-loan delinquencies. Between 2015 and 2022, the number of students enrolling in undergraduate courses at two of the largest private education companies in Brazil, YDUQS and Cogna, through FIES loans plummeted about 93%.

To mitigate this impact, some companies have created their own financing programs. YDUQS established the Estácio Payment Program (PAR) in 2017, and Cogna started the Private Student Payment Program (PEP) in 2015. However, the PAR funded less than 0.5% of loans in 2022, and the PEP was discontinued by Cogna in 2021 given the high loan-delinquency rate in prior years.

Given restrictions on FIES that sharply decreased the number of students with such loans, and the high delinquency rates in loans offered by private education companies, we don't expect a significant growth in students enrolled under FIES or private financing programs in the next few years.

After Spiking In 2020-2022, The Sector's Leverage Started To Fall In 2023

Prior to the pandemic, the sector underwent major M&As, with significant levels of capital raised at attractive interest rates. The increase in companies' debt, coupled with lower EBITDA during the pandemic, raised sharply the sector's leverage in 2020. The average debt-to-EBITDA ratio of rated companies almost doubled from 3.4x in 2019 to 6.3x in 2020.

To adapt to shifting trends in higher education, some companies have deployed an 'asset-light' strategy. This included reducing the number of campuses and investing in digital platforms in order to increase market share and reduce costs. Although these changes raised cash flow, by the second quarter of 2023, credit lines linked to Certificates of Deposits (CDI) rate accounted for about 90% of the rated companies' funding, given low basic interest rates in 2019 and 2020. However, owing to the sharp rise in basic interest rates between 2022 and mid-2023, interest expenses soared, denting cash flow of many companies in the sector.

Given the continued rise in online student enrollment, the capacity of online learning centers to handle larger number of students, and decreasing interest rates, we believe companies' cash flow will improve, enabling the partial repayment of debt. As a result, we project a reduction in the average debt-to-EBITDA ratio to 3.7x in 2023 from 4.8x in 2022, with a further gradual decrease in the next two years. Furthermore, we do not anticipate large-scale acquisitions in the sector, given currently high debt among companies. Instead, we forecast smaller acquisitions, primarily of technology companies in order to enhance digital education platforms.

The Sector Is Starting To Recover

The COVID-19 pandemic, high inflation and interest rates, and low economic growth caused a shift in service offerings—including a sharp rise in online learning--among Brazilian education companies. We believe that companies have started recovering in 2023 thanks to higher student enrollment, mostly for online learning. As a result, we expect higher cash generation in the next few years, enabling companies to partly repay debt accumulated over the past few years.

Despite these favorable trends, the bulk of students enrolled at for-profit education companies is from the low-income slice of the population, which is susceptible to economic downturns. However, in our view, after the pandemic-induced economic shock, companies are better prepared to face future downcycles. We believe that the share of online learning can keep expanding during the economic slump, given that online student tuitions are 70% lower than those of on-campus among rated companies.