TAL - New Oriental Education: From Near Extinction To Stellar Turnaround

Summary

• Less than two years ago New Oriental was fighting for survival and their share price collapsed to multi-year lows.
• The company has successfully restructured their business to comply with new regulations and appears to be on track for solid earnings growth.
• Competition and regulatory risks may limit their growth prospects.

Chinese edtech company New Oriental Education (EDU) has delivered an impressive performance for the first six months of FY 2023, benefiting their market value which has increased by triple digits over the past year. There are reasons to be optimistic about the company’s prospects going forward.

Back in the black and likely on track for consistent profitability

After the Chinese government decimated the country’s K-12 online tutoring industry with their Double Reduction policy introduced in mid-2021, the survival of many players including New Oriental whose business largely depended on K-12 after school tutoring services were called into question. The company sank into the red for the first time in years and its share price plunged to multi-year lows.

Fast forward less than two years later and New Oriental appears to be roaring back. For the six months ended November 2022 revenues reached USD 1.4 billion (compared with USD 1.97 billion the same period in 2021). Profitability however improved considerably with net income attributable to shareholders’ jumping to USD 66.7 million for the period compared with a loss of USD 875.9 million in the same period in 2021. Their stellar turnaround helped New Oriental’s share price jump nearly 250% over the past year, a stunning performance for a company that less than two years ago was fighting for survival..

New Oriental’s turnaround could just be in the early innings. Their non-academic education and remaining traditional education business (which accounts for about 40%-45% of revenues, and at 20%-25% segment profit margin is one of the biggest profit contributors) is benefiting from growing demand for extra-curricular activities and enrichment education such as (chess, robotics, and public speaking) driven by the Chinese government’s effort to transition towards a holistic, ‘rounded’ education. The division has been seeing strong traction already, with enrollments reaching 447,000 students during the quarter ended November 2022, up from 297,000 the previous quarter. There is enormous room for further growth; the total number of urban primary school students in China (urban students are likely to better afford enrichment education courses and not surprisingly New Oriental’s strategy so far focuses on penetrating this geographic region with the top 10 cities in China contributing to about 60% of the business’s revenue) amounts to nearly 40 million students while the number of students in urban junior high schools amounts to around 18 million.

Meanwhile their eCommerce business (a livestream ecommerce channel named ‘Oriental Selection’ maintained on Douyin i.e., the Chinese version of TikTok) operated by their subsidiary Koolearn is growing in leaps and bounds; for the first six months of their fiscal year, Koolearn recorded a mammoth 590% YoY increase in revenues which exceeded CNY 2 billion during the period while net profits skyrocketed 638% YoY reaching CNY 585 million compared with a net loss of CNY 108 million the same period the previous year. Contributing around 30% of New Oriental’s revenues, this business is the company’s second-biggest and the division’s 25% profit margin makes it as profitable as New Oriental’s biggest business - traditional learning and non-academic tutoring - and is more profitable than New Oriental’s other remaining education-related businesses i.e., overseas test prep and overseas study consulting (which accounts for about 25% of revenues and has a profit margin of around 10%), and college and adult education (which accounts for around 6% of revenues but is barely breaking even).

The division’s growth streak could be just the beginning; Oriental Selection which so far has largely focused on selling agricultural produce (much of which originates from rural China where most of the country’s farms and orchards are located), could benefit from a growing trend of digitalization of the country’s fresh produce supply chain. China is the world’s biggest eCommerce market but like most countries worldwide, China’s fresh produce industry is among the last retail segments to transition to online channels. But with China being one of the most mature eCommerce markets, fresh produce could be the next frontier for digitization through eCommerce over the coming years; fresh produce eCommerce penetration in China is projected to increase to 16% by 2024, from around 10% in 2021.

For a country with the world’s biggest population, and one of the world’s biggest fresh produce consumers on a per capita and absolute basis (China is the world’s biggest consumer of fruits , and is among the world’s biggest consumers of fruits and vegetables on a per capita basis) the agriculture eCommerce opportunity is enormous. New Oriental’s agriculture focus also ties well with the Chinese government’s ‘Common Prosperity’ program which aims to increase incomes among low-income households, which includes farmers and rural residents.

New Oriental’s overseas study consulting business should benefit from growing demand for overseas education among Chinese students in the medium term as rising incomes among a bigger proportion of the population. China is the world’s largest source market for overseas education but just about 700,000 Chinese students currently study overseas, a fraction of the roughly 10 million students enrolled in undergraduate degree programs across China.

Risks

Possible further regulatory tightening

The possibility of further regulatory tightening cannot be ruled out. After imposing the ‘Double Reduction’ policy in mid-2021, the Chinese government issued a new guideline in December 2022 governing non-academic tutoring programs outside school.

Possible peaking of interest in overseas education

While overseas education remains popular among Chinese students today, there are views that as China improves their education standards, and the salary premium tied to overseas degrees shrinks, overseas education demand from Chinese students could peak in the coming years, potentially impacting revenues for overseas consulting and test prep courses. A 2022 analysis by international consultancy firm Oliver Wyman expects the total number of Chinese students in overseas higher education degree programs to peak within five years. Overseas test prep and study consulting is New Oriental’s third biggest revenue generator accounting for about 25% of revenues and the second-most profitable business with margins of 10% and hence the impact could be significant.

Competitive risks

New Oriental is not the only player venturing into enrichment education and livestream eCommerce as part of their restructuring efforts (rival TAL Education ( TAL ) is a notable player with implementing the same strategies ). Higher competitive pressures may limit revenue and earnings growth prospects. It is worth pointing out however that New Oriental is one of the most well known education players in the country, and they could benefit from a first mover advantage in the livestream eCommerce space over rivals such as TAL Education who entered the arena after New Oriental.

Conclusion

With a forward P/E of 37, a market value that is about 2 times higher than their shareholders' equity and with their earnings having a long runway for growth, New Oriental may be viewed as a buy for some or a hold for others.

Analysts are generally bullish on the stock.

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