Article / 14 January 2015 at 1:50 GMT

Earnings preview: hopes of turnaround for New Oriental Education

China Watcher / Shanghai
China
  • Exam reforms and platform rollouts hurt New Oriental's revenues in 2014
  • New Oriental will have to explain why if strong enrolment growth hasn’t returned
  • Lower demand for adult English learning and competition for children's classes may hurt New Oriental's core revenues

By Neil Flynn

With Alcoa kicking off earnings season with a beat, my focus turns to education provider New Oriental Education, which tends to be the first Chinese firm to report earnings. The firm will report their fiscal year second quarter earnings on January 20 before the opening of the market.

In the previous quarter, CEO Louis Hseih said that the firm would implement its third development strategy called ‘Optimise The Market’ in the firm’s fiscal 2015. This follows its earlier ‘Occupy The Market’ and ‘Harvest The Market’ strategies. However, for this to be successful, there are certain key points that need to be addressed.


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A generation has studied in native English-speaking countries or picked up English through Western media exposure, curbing demand for adult English classes in China. Photo: Thinkstock
 


After the GaoKao debacle, are students returning?

During the firm’s 2014 fiscal fourth quarter, a sharp decline in the number of students enrolling in the English courses and summer camps was announced, because it was rumoured that the Chinese government would change the requirements and format of the GaoKao (university entrance exam) English test. Whilst this trepidation by students and their parents was understandable, the year-on-year decline for English summer camp and dormitory enrolments in the fiscal fourth quarter was 25% and 30% in the fiscal first quarter.

However, as management discussed in the fiscal first quarter conference call, the reforms to the GaoKao English exam were made in September, which should mean that the firm has seen a whole quarter of strong enrolment growth, because the customers that delayed their enrolment finally have clarity on the GaoKao exam. 

Wait for the POP Kids platform over

Revenues for the firm’s 5 year to 12 year old education service, called POP Kids, have been falling because it is being revamped to integrate a new O2O platform. The delays to the rollout of the new platform have seen the firm lower marketing expenses for the existing platform.

This has had an understandable effect on the POP Kids revenue, but given that management stated that the rollout would be complete during the fiscal year second quarter, investors should expect to see higher enrolment growth along with heavier marketing expenditure.

Partnership with Tencent

On December 8, New Oriental released its highly anticipated English learning app uDa. The previous two earnings releases have seen the disappointment over worsening user base metrics curbed by the anticipation of the uDa release, and investors will be looking to see initial user figures and further discussion on the strategy with Tencent. However, it’s worth noting that because New Oriental’s fiscal second quarter began in August and ended in November, revenues from the app won’t be given.

The release of the app should help to boost English course enrolment figures, because it helps users to test their English level. As we are six months from the end of year exams, enrolment figures tend to increase by the end of the second quarter and into the third and fourth quarters.

New kids on the block

English classes have been a core revenue driver for New Oriental, because both children and adults have needed to learn the language. But nowadays, particularly in larger cities, the English level of professional workers is adequate enough to not require classes. Not only does China have a generation of workers that has studied abroad in native English-speaking countries, but also a generation that has been exposed to western media and cultures, which require English to experience. Therefore while half of New Oriental’s core market for English language classes is declining, the children and student market is becoming evermore competitive. 

In December I wrote a report about the once-popular social media site Renren, which aims to hang on to its loyal student user base by offering both payment financing and online education platforms. In addition, the live video streaming platform YY launched its own education platform, called 100.com, at the start of 2014.

The online education market is heavily fragmented, with even the biggest firms in the industry like New Oriental only holding a market share of less than 5%. This has seen a lot of new startup firms enter the market that have been receiving heavy investment from funding rounds. While two of New Oriental’s co-founders have been funding a start up called 17Zuoye, which focuses on primary and middle school tutoring, New Oriental’s biggest rival TAL Education has invested in over 30 online education startups during the year.

Investors should be looking for New Oriental to invest in the industry, before consolidation sees TAL Education take a commanding share of the market.

Earnings history

Whilst New Oriental has a reasonably consistent record of beating the EPS consensus for the quarter, the standard reaction in the share price is to decline. However, the rollout of the new POP Kids O2O platform and the release of the Tencent English app should boost the share price, should they both meet the expectations of shareholders.

New Oriental's earnings history


New Oriental's Earnings History









Source: New Oriental Investor Relations, Yahoo Finance

This earnings release will be very important for New Oriental Education, as investors stomached the slowing growth in fiscal year 2014 because of extenuating circumstances. However, these have all seemingly being resolved, so management should have no excuses if growth in revenues and user enrolment haven’t returned.


– Edited by Robert Ryan


Neil Flynn is head equity analyst at Chinese Investors. Follow Neil or post your comment below to engage with Saxo Bank's social trading platform.


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