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We recently downgraded our recommendation on Universal Technical Institute, Inc. (UTI - Analyst Report) to Underperform with a price target of $13.00. Earlier, we had a Neutral view on the stock.

What Triggers the Move?

We are currently bearish on Universal Technical, the provider of postsecondary technical education. The for-profit education institute is witnessing a fall in average undergraduate full-time student enrollment, although it did report better-than-expected third-quarter 2011 results.

The company saw earnings of 27 cents a share coming ahead of the Zacks Consensus Estimate of 21 cents, and climbing 8% from 25 cents earned in the prior-year quarter. However, waning student enrollment is a major concern for the company as its revenue generating ability depends on active enrollments.

Regulations Weighing Upon Enrollment

Management hinted that the regulation proposed by the Department of Education is weighing upon student enrollment. The educational institute, which provides professional automotive, diesel, collision repair, motorcycle and marine programs, said that average undergraduate full-time enrollment dropped 3.8% in the third quarter, following an increase of 3.3% in the previous quarter. Student starts plummeted 32.5% to 2,700.

The Department of Education proposed that an educational program could qualify for Title IV funds, only if it helps in achieving gainful employment, which includes the criteria of loan repayment rate and debt-to-income ratios. The company derives a major portion of its revenues from Title IV –– the federal student financial aid programs.

The institutions are under the scanner due to the rise in the default rate of student loans, and are now being asked to submit information relating to recruitment procedures and the use of student’s grant.

Gloomy Outlook

Universal Technical warned that enrollment of new students for the fourth quarter and fiscal 2011 will be below the earlier periods, and consequently result in low single-digit revenue growth for the year.

Capella Education Company’s (CPLA - Analyst Report) is similar. We observe that Capella is witnessing a fall in enrollment. After increasing 7.3% in first-quarter 2011, total active enrollment slipped 1.5% in the second quarter. Capella now expects total enrollment to fall by 6% to 8% in third-quarter 2011.

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