TAL - TAL Education Group: Elevated Expectations

2023-09-29 09:52:00 ET

Summary

• TAL Education Group's share price has done well in recent months, thanks to its Q1 results beat and favorable AI-related developments.
• However, the downside risk associated with TAL Education potentially reporting below-expectations results going forward has become more significant.
• A Hold rating for TAL Education Group is maintained; expectations for TAL Education are elevated, implying that positives have been priced into its shares.

Elevator Pitch

I have a Hold rating awarded to TAL Education Group ( TAL ) shares. TAL's stock price has already gone up significantly in the past few months, and elevated expectations increase the risk of a potential results miss for TAL. As such, my decision is to retain my existing Hold rating for the sock.

Above-Expectation Results And AI Tailwinds Led To Share Price Outperformance

TAL Education's stock price rose by +47.4% (source: Seeking Alpha price data) since my earlier July 20, 2023 update was published.

In particular, it is worth noting that TAL Education's shares went up by +24.4% and +12.4% on July 28, 2023 and September 27, 2023, respectively. The company's share price surge on July 28 this year is most likely attributable to its better-than-expected quarterly financial results, while there has been excitement about TAL Education's new AI offerings in recent times.

Earlier, I previewed TAL Education's financial performance for the first quarter of FY 2024 (March 1, 2023 to May 31, 2023) in my late-July write-up. I was expecting TAL Education to report in-line financial numbers for Q1 FY 2024, but the company delivered a positive surprise with respect to its most recent quarterly results.

TAL Education delivered positive YoY top-line expansion for the first time in eight quarters, as its revenue increased by +22.9% YoY to $275.4 million in Q1 FY 2024. The actual first quarter revenue for TAL Education turned out to be +2.3% higher than the sell-side's consensus projection of $269.1 million. Moreover, TAL Education's Q1 FY 2024 headline net loss attributable to shareholders amounting to -$45.0 million was much narrower than the analysts' consensus estimate of -$57.0 million (source: S&P Capital IQ ).

The increase in TAL Education's revenue for the most recent quarter was driven by "the steady growth of learning services" and "the release of new products within the content solutions business" as per its management commentary at the Q1 FY 2024 results call .

On the other hand, good expense control allowed TAL Education to register narrower-than-expected losses in Q1 FY 2024. The company's G&A (General & Administrative) costs, adjusted for share-based compensation, declined by -6.5% YoY in the first quarter of the current fiscal year.

Separately, the market appears to be impressed by TAL's new AI solutions. TAL Education's shares were up by +32.0% in the last one month.

Gizmochina , a website focused on Chinese technology products, published an article on August 24, 2023, mentioning that TAL Education recently "launched the public beta testing of its innovative mathematical large model, MathGPT," which is "China's first large (language) model tailored for mathematics."

Sell-side research firm, China Renaissance Securities , also recently issued a research report (not publicly available) on September 26, 2023 noting that TAL Education launched a "new app Xuexiaoban" that utilizes MathGPT to "provide customized solutions" for mathematics.

At its first quarter results briefing, TAL Education previously shared that the company is "working towards a rollout of AI products in the future."

However, I am of the opinion that TAL Education's excellent share price run might be halted, if the company's future financial performance doesn't meet the market's elevated expectations following its Q1 beat and AI developments.

Eyes On Learning Center Network Expansion And Content Solutions Business' Growth

TAL Education is expected to reveal the company's Q2 FY 2024 (June 1, 2023 to August 31, 2023) towards the end of October . The sell-side analysts have raised their expectations of TAL's Q2 FY 2024 and full-year FY 2024 significantly in recent months, and this leaves room for disappointment.

In the past three months, 13 of the 15 analysts increased their fiscal 2024 revenue forecast for TAL Education. Specifically, the consensus FY 2024 top-line estimate for was revised upwards by +8.6% in this time period.

However, TAL's cautious approach toward the expansion of its learning center network might put a cap on the revenue growth potential for the company's learning services business. The Learning Services and Content Solutions segments accounted for three-quarters and one-quarter of TAL Education's revenue, respectively, for Q1 FY 2024. Within the Learning Services segment, TAL's enrichment learning business was the outperformer, with YoY revenue expansion above +10% in the most recent quarter.

TAL Education's comments at its Q1 FY 2024 results meeting indicate that the company might take a conservative stance with respect to adding new learning centers to support the growth of the enrichment learning business. TAL specifically mentioned that "we will expand our learning centers at a steady pace to ensure a smooth and balanced growth." The company also cautioned that "we don't necessarily expect to see the same level of increase (in new learning centers) at this pace every single quarter from now on." As a reference, TAL Education added around 30 new learning centers in Q1 FY 2024 to increase its total number of learning centers to 200, which isn't the rate of learning center network expansion to be expected for subsequent quarters.

On the other hand, the market's consensus Q2 FY 2024 normalized EPS projection for TAL Education was raised by a very significant +79.0% in the recent month.

In the preceding section, I touched on TAL Education's declining G&A expenses in YoY terms for the recent quarter. While TAL is doing a great job in optimizing G&A costs, its profitability could be under pressure due to the growth of the company's Content Solutions segment.

The Content Solutions segment's key growth driver is its learning devices, such as its "new smart learning pad product, xPad" which I touched on with my July 20, 2023 article. The learning devices business is likely to depress TAL Education's overall profitability in the near term for two reasons. Firstly, the learning devices business is more "asset-heavy" than the services-based enrichment learning business, so the former will have a lower profit margin than the latter. In other words, TAL's overall profitability could be hurt by a less-than-favorable sales mix. Secondly, the learning devices business is still in the early innings of growth, which demands a larger amount of investments to support the introduction of new products.

Concluding Thoughts

I am impressed with TAL Education Group's above-expectations Q1 FY 2024 financial performance and the company's new AI offerings. On the flip side, the market has become overly bullish on TAL as evidenced by the recent changes in consensus forecasts for the stock. Therefore, I think that a Hold rating for TAL Education is justified.

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