TAL - New Oriental Education: A Focus On Upcoming Earnings

2023-04-09 06:09:10 ET

Summary

• New Oriental Education & Technology Group is a China-based education and tuition ADR with operations in mainland China.
• The company reports earnings on Wednesday 19 April before market open.
• We unpack historical price action and data-feeds for the benefit of earnings traders.

Introduction

New Oriental Education & Technology Group (EDU) makes up part of a once high-flying flock of China-based ADRs serving up tuition to the nation’s vast population of students and pupils. Fellow technology firm TAL Education Group (TAL) was one of our most successful short calls following detailed analysis of the underlying business and financial statements.

A government crackdown banning online tutoring companies from making profits provided a catalyst for a collapse in this group of Chinese online education ADRs, including New Oriental Education & Technology Group that we will review today.

Rather than take a more long-term macro-overview of EDU’s earnings prospects, financial statement quality and investability, this here is a focus on upcoming earnings due before market open on Wednesday 19 April. The post’s objectives are to provide analytical near-term trading insights for earnings plays like ones employed for our portfolio of risky assets.

It is worth highlighting that despite the sizable recovery in the underlying firm’s equity price, this is not a long-term holding we would retain given sizable risks linked to Chinese ADRs, geopolitical tensions, and a general lack of transparent financial data.

In summary, this is a detailed statistical analysis on upcoming earnings used to develop derivative-driven trading strategies while we maintain a neutral outlook on the firm’s prospects.

Despite a more recent momentous rise, both EDU & TAL collapsed over the past 5 years following a crackdown on profit making by the Chinese government.

New Oriental Education & Technology Group provides private tutoring in the People’s Republic of China. The company offers test preparation courses for students studying foreign languages or taking on entrance exams using a mix of classroom based and online learning technologies. The China-based tuition firm presently generates sales of $2.5B, trades at 27x forward earnings and has a market cap of $6.5B.

Historical Earnings Data

New Oriental Education & Technology Group will present its earnings for Q3, 2023 on Wednesday 19 April before market open. Revenue estimates for the period range from $702.8M to $719.M – a 16% increase from the same period last year.

Revenue growth estimates are expected to come in around 14% to 17%. Despite being included in the consumer discretionary sector, it is worth noting that education and student tuition touts economic characteristics perhaps stickier given parents’ reluctance to sacrifice educational opportunities for their children even despite an economic downturn.

Hitting revenue expectations appears to make up a meaningful part of the impact on immediate price action – on a like-for-like basis, Q3 FY22 saw a -6.3% drawdown on a huge revenue miss ($1.2B estimate v $614M actual) despite an EPS surprise of $1.36 per share. Over statistical observations dating back to 2013, there has only been one time when a revenue miss eventuated in positive stock price action (+4.4% Q1 FY15)

Overall, it appears both revenues and guidance play a meaningful role in immediate stock price behavior, perhaps more so than earnings per share. Given the high growth nature of the stock, it's plausible that traders pardon an earnings miss more than a revision in sales.

Stock price performance over the last 9 quarterly earnings.

The two-week run up towards earnings has generally been a successful time for traders to lean into the equity – during this period, average returns totaled +5.1% with a slightly upwards bias. 56% of observations were positive with a median return during the two-week run into earnings hitting +6.2%. The outliers were big, particularly to the upside – the maximum positive return during this period was +22.5% (Q2 FY22) while the maximum negative return was solely -8.2% (Q1 FY22). All in, the run up to earnings has generally been positive with some sizable up moves.

The earnings move has been a little harder to call – the past 9 quarters have seen more negative observations (56%) but they remain more muted than explosive upside ones. It has somewhat skewed the data, delivering an average return of +1.2% but a median one of -3%. The +28.3% (Q1 FY22) move has pulled the data to the upside – interestingly this swift assault to the North was also during a two-week run where price action was overtly negative. The biggest negative return for earnings was -12% registered during the last quarter (Q2 FY22)

Price action in the following days and weeks has been resoundingly positive, regardless of a negative or positive earnings move on the very day of earnings. One week later, the stock price is up 67% of the time, with a median return of +6.3%. During that same period, the maximum positive return was +34.9% and the maximum negative return was -3.8% - an ideal setting for call buyers looking to take advantage of the implied volatility crush post earnings by loading up on cheap calls and riding the price action for the next 7 days. Looking at the historical data, buying call options after earnings has been announced has been an extremely successful trade.

Implied Moves & IV Crush

Implied moves priced in by options markets have consistently been around the +/-10% mark – the biggest absolute implied move was +/-13% (Q3 FY20) with the lowest one +/-5.9% (Q1 FY20).

Implied earnings moves for EDU range around +/- 10%.

82% of the time those moves have been overestimated with real absolute average moves totaling +/-6.3%. On a median basis, real absolute moves came in at +/-5.7%, the big outlier being the explosive +28.3% to the upside registered during the past quarter’s earnings.

Actual earnings moves have been around the 6% mark with an explosive upside outlier.

A quick glimpse of the expected earnings move v actual earnings move chart highlights a relatively constant over-estimation of price moves in EDU equity during the earnings periods. Data since 2014 emphasizes that price action is more biased to the upside, with the stock moving upwards 55.9% of the time. The worst price return during earnings was in the last quarter – the stock price collapsed -12% v an implied move of +/- 9.5%.

Expected Earnings Move v Actual Earnings Move.

Surprisingly, implied volatility for 30-day at the money options appears not to recede very much post earnings. EDU’s last earnings implied volatility (IV30) going into earnings was 74.7, which dropped to 69.6 after announcement – albeit a modest reduction in volatility of -7%. On average, the implied volatility crush in options was 13% making volatility plays using options markets somewhat questionable.

Options Strategies

EDU’s historical price action data provides a few interesting opportunities for options traders looking to capitalize on price movements. A simple 25 delta long call has provided above average returns on the run up to the even on the back of relatively positive price action. 60% of the time, purchasing an at-the-money call has led to +103.4% returns on the value of the option if held 2 weeks before and closed the day before earnings.

A range of options strategies have provided interesting results when trading earnings.

Given the comparably positive price action after earnings as observed earlier, a simple long stock only or at-the-money long call provides for an interesting trade. 2 at-the-money calls can provide a defined risk position while replicating (100 deltas) price action in the equity. At ZMK Capital, we believe this may provide the most compelling after-the-event trade, given limitations in IV crush and irregular but meaningful outsized upwards moves.

Historically, the best earnings strategy over the past 10 observations includes a win rate of 90% and a Sharpe ratio of 0.75.

Final Thoughts

EDU’s upcoming earnings provides an attractive opportunity for earnings traders to capitalize on price-action. Historically, we have seen the stock price relatively range bound, holding +/-10% roughly 82% of the time.

Implied volatility crush has not been sizable enough for short vol strategies but set-ups exist post-earnings as the stock moves up during the two week period following the event most of the time.

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