2023-05-08 13:04:54 ET
Summary
- TAL Education Group's current valuations are appealing following the recent pullback in its share price, and the company intends to continue buying back its own shares, which is expected to be value-accretive.
- However, TAL Education's financial performance in the new fiscal year (FY 2024) might disappoint the market due to an unfavorable sales mix and a high level of investments.
- My rating for TAL Education Group remains as a Hold, as I think that there are reasons justifying the stock's depressed valuations.
Elevator Pitch
I continue to rate TAL Education Group ( TAL ) shares as a Hold. I previously reviewed TAL's share price performance between late-2022 and early-2023 with my earlier February 21, 2023 update for the company.
My latest article for TAL Education assesses whether the stock is a potential investment candidate in view of its valuations and prospects. My analysis leads me to the conclusion that TAL isn't a good investment opportunity, as its shares are cheap for good reasons. TAL Education is still in investment mode, and fast top line growth might come at the expense of weaker profitability due to a less favorable revenue mix. In that case, I retain a Hold rating for TAL Education Group stock.
TAL Education's Share Price And Valuations
TAL Education Group shares have fallen by -17.0% (source: Seeking Alpha price data) since my prior February 21, 2023 article was published. During this time period, the broader market as represented by the S&P 500 (SP500) went up by +3.5%. TAL Education's recent share price weakness have brought the stock's valuations down to more attractive levels.
The market currently values TAL at 7.8 times consensus forward fiscal 2025 (March 1, 2024 to February 28, 2025) ex-net cash normalized P/E as per S&P Capital IQ's valuation data. TAL Education's ex-net cash P/E multiple is calculated by dividing TAL's market capitalization adjusted for its net cash balance of $3 billion by its consensus forward normalized earnings. TAL Education also trades at undemanding consensus forward FY 2025 EV/EBITDA and Enterprise Value-to-Revenue multiples of 3.6 times and 0.61 times, respectively.
It is encouraging to note that TAL Education has the intention of engaging in value-accretive share buybacks to address the issue relating to the undervaluation of the company's shares.
When TAL announced its Q4 FY 2023 and full-year FY 2023 results on April 27, the company disclosed that it will push back the expiry date of its current share buyback plan by one year to April 30, 2024. TAL has approximately $737 million remaining from its current share repurchase authorization, after buying back 2.3% of its shares in fiscal 2023. At the company's FY 2023 results call , TAL Education assured investors that it will "continue to seek opportunities to generate return for our shareholders through our share buyback program." TAL's management comments at the recent results briefing indicate that the company is very likely going to continue repurchasing its own shares in the next one year.
But I am of the view that TAL is trading at low valuation multiples for valid reasons as detailed in the subsequent section.
I Expect TAL's FY 2024 Results To Fall Short Of The Market's Expectations
As per consensus financial data sourced from S&P Capital IQ , the analysts see TAL Education's revenue growing by +20.4% to $1,228 million in FY 2024 (YE February). The sell-side expects TAL to turn around from a non-GAAP adjusted net loss of -$27 million in FY 2023 to generate a positive normalized net income of $26 million for the current fiscal year.
In my opinion, the market is too optimistic about TAL's FY 2024 prospects.
I think that there are two key factors which could lead to lower than expected earnings for TAL Education this year.
One key factor is the unfavorable change in revenue mix.
TAL Education revealed at its FY 2023 results briefing that learning services, content solutions, and other revenues accounted for approximately 75%, 15%, and 10% of the company's top line, respectively for the most recent fiscal year. In my mid-November 2022 update for TAL, I had referred to the company's content solutions segment as a new business which was established at the beginning of the prior fiscal year (FY 2023) and had no sales contribution for fiscal 2022. Therefore, it is natural to assume that TAL Education's content solutions business will be the fastest growing segment for the company in FY 2023.
But the rapid top line growth for TAL's content solutions segment has a negative impact on its overall profitability profile. The key sales growth driver of TAL Education's content solutions business is smart devices. TAL acknowledged at its 2023 investor briefing that smart devices are in the "pretty early stages" of development with a focus on "optimizing the functionality" of the products, when asked a question on "what is the impact to our margin" relating to the revenue growth for this product category. As such, it is safe to say that TAL Education's content solutions business, which includes the smart devices product category, is very likely to be loss-making for the foreseeable future. Therefore, TAL Education's profit margin should take a hit, as revenue contribution from the unprofitable content solutions segment increases over time.
Another key factor is TAL Education's stance on investments to explore new growth opportunities. At the company's most recent fiscal year earnings call, TAL mentioned that it intends to allocate capital to "overseas learning services" and "new technologies."
It is understandable that TAL has interest in expanding the company's presence in foreign markets outside of Mainland China. Venturing abroad will increase the size of TAL Education's addressable market and extend the company's growth runway. Separately, foreign markets expansion will also reduce TAL's exposure to regulatory risks relating to the Chinese education sector.
Also, the rise of generative AI (Artificial Intelligence) throws up both opportunities (potential introduction new products and services related to AI) and risks (threat of new entrants) for education companies like TAL. This makes it necessary for TAL Education to set aside part of its cash and excess capital for investments in AI-related technologies.
In a nutshell, TAL Education's actual fiscal 2024 earnings might turn out to be lower than what analysts are currently expecting, taking into account the changes to revenue mix and larger than expected investments.
Concluding Thoughts
There are downside risks relating to TAL Education Group's future earnings based on an assessment of the company's future top line mix and capital investment focus. This explains why TAL Education Group deserves a valuation discount, so TAL's current valuations are fair, justifying a Hold investment rating.
For further details see:
TAL Education Stock Is Cheap For Good Reasons