Article / 17 April 2015 at 4:14 GMT

Earnings Preview: Can New Oriental Education address slowing growth?

China Watcher / Shanghai
China
  • Adult English class sizes have declined as language fluency improves
  • NOE saw a strong pickup in enrollment after a disappointing first quarter
  • NOE is focusing on mobile online learning driven by investment in R&D

By Neil Flynn

Earnings season for China’s US listed firms is set to begin on Tuesday, as the country’s largest private education firm New Oriental Education is set to report earnings before the market opens on April 21. The firm has endured a difficult 12 months after confusion over planned reforms to China’s university entrance exam caused parents and students to delay their enrollment to New Oriental’s programs. However, with the confusion settled, the firm will be looking to see growing enrollments reverse the trend of declining revenue growth. These are the four key points that investors should pay attention to during the release of the fiscal third quarter earnings and the subsequent conference call.

Will slowing revenue growth be addressed?

New Oriental Education’s business is very seasonal, with the largest enrolment and revenue figures posted in the fiscal first quarter, when the school year begins, and whilst the second quarter posts the smallest figures, the third and fourth quarters see growth in both revenue and enrollment as the end of year exams approach.

This makes quarter-on-quarter growth metrics essentially meaningless, but year-on-year growth has been displaying a notable slowdown. The fiscal second quarter seemed to buck this trend, as it posted 13.4% yoy growth, compared to just 1.4% yoy growth in the first quarter, but it should be considered that this is due to the university entrance (Gaokao) exam confusion.

Because parents and students were unsure as to the planned reforms to the Gaokao, they delayed their enrolment to New Oriental’s programs, and therefore the fiscal first quarter saw a notable decline in revenue and enrolment growth. Because of this, the parents and students who would have enrolled in the first quarter drove the stronger growth in the second quarter, and whilst the second quarter looked promising, the third quarter should give an indication as to whether the slower growth is an ongoing concern for the firm. 

New Oriental's Revenue History
Source: New Oriental Education  

Due to the late timing of the Chinese New Year, the firm implemented shorter class hours in order to fill in two terms of courses within the winter break, and this will likely have hurt the ASP. Nevertheless, the firm has seen continued strong growth in the overseas test prep and consulting businesses, which achieved 16% annually, whilst the VIP class business saw revenue growth of 18% annually in the fiscal first quarter.

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 NOE will be hoping enrollment growth can drive revenues for the fiscal year. Photo: iStock

This growth has been important for New Oriental because the adult English classes have been seeing declining enrollments, as the overall level of adult English in China has improved. Over the past few years, we have seen that margins have remained reasonably stable, and the firm should be expecting that both the customer loyalty program and the O2O strategy should boost this in the long run.

New Oriental's Margins
Source: New Oriental Education

Can student enrollment growth be maintained?

As with the revenue growth in the second quarter, New Oriental saw a strong pickup in enrollment after a disappointing first quarter. The middle school U-Can business saw an increase in student enrollment of around 40%, but the firm has seen delays in the revamp of its grade school POP Kids platform and this has affected enrollment growth.

The firm had therefore reduced marketing campaigns for the program because it wanted to the wait until the release of the new platform. However, this delay occurred over the seasonally strong fiscal first quarter, and the firm will be hoping that POP Kids enrollment growth can drive revenues throughout the rest of the fiscal year, as the program has yet to be fully rolled out.

This was evident in the second quarter, as POP Kids enrollment exceeded 13% compared to the firm average of 10%. Management has stated that the newly revamped POP Kids program will likely see the K-12 after school tutoring business lead revenue and enrollment growth.  

New Oriental's Student Enrolment
Source: New Oriental Education 

Customer loyalty program

The firm launched a new customer loyalty program during the middle of the second quarter that has resulted in deferred revenue of around $4.1m, which will be recognised within two years without additional expenses associated with such revenues. The idea is that when a student pays for academic subjects tutoring or test prep classes, they can earn points that are worth between 2% and 5% of the total spending, and these points can be used to pay for the tuition fees over the next two years. Whilst this temporarily dampens revenues, the deferred revenues will be recognised when the points are either spent or expire after two years. 

The implementation of this program is partially due to growing competition in the industry. In yesterday’s trade view, I alluded to how the larger firms are expanding into Tier 2 and 3 cities as local competition is significantly weaker in terms of financial strength and course quality. However, as this continues, rivals such as TAL Education will be in direct competition with New Oriental Education, and the new customer loyalty program will likely help to maintain enrolment growth. Management should give commentary in the conference call about the progress of the customer loyalty program.

Technological developments

New Oriental Education is focusing on mobile internet online learning that will be driven by significant investment in R&D. One such strategy is the O2O integration, which allows for online self-learning in collaboration with classroom learning. There were around 172,700 registrations to the Koo.cn live broadcast open platform in the second quarter, 12m downloads of the DONUT mobile learning game series, and 818,200 users of the Le Ci English language vocabulary training app. 

I have been bullish on the collaboration with tech giant Tencent, and the two firms have released an English learning app called uDA. It has yet to be completely launched across Tencent’s platforms because they are waiting to add maths modules, which should be completed soon. The plan for both firms is to add learning content for all subjects on the Gaokao exam, and given Tencent’s user base of over a billion people, New Oriental should be set to see stronger enrollment growth as a result of the collaboration.

The firm will be looking at business partnerships and M&A throughout the calendar year in order to build a market leading presence in O2O and mobile learning. Rival TAL Education has been making strong progress through investments, and New Oriental should be looking for investments in content in order to compete.

Earnings history

New Oriental has a reasonably consistent history of beating EPS consensus, whilst its reported revenue has a chequered history of beating consensus. However, the market reaction to New Oriental’s earnings is typically negative, both over one day and three days after the earnings release.

The New Oriental May $24 straddle has a mid price of $2.37 on the screen, which suggests that between now and the expiry on the 15th May, the market is expecting a 9.9% move. Wall Street is currently expecting EPS of $0.22 and revenues of $284.75m. This revenue consensus is inline with the firm’s guidance range of $279.8m and $290m.

New Oriental's Earnings History
Source: New Oriental Education  - Create your own charts with SaxoTrader. Click here to learn more

-- Edited by Adam Courtenay

Neil Flynn is a portfolio manager at Alcuin Asset Management. Follow Neil or post your comment below to engage with Saxo Bank's social trading platform.

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