Article / 21 January 2015 at 1:41 GMT

Earnings Preview: TAL Education spreads its tentacles

China Watcher / Shanghai
  • TAL found that tier 2 and 3 cities provided strong revenue growth for the small class business
  • TAL Education acquired a stake of Guokr for $15m, a mobile and web based community used to teach students about science and technology
  • The company has an impressive record of almost always beating consensus for both EPS and revenues

By Neil Flynn

TAL Education is set to announce its fiscal 2015 third quarter results tomorrow. The firm is actively diversifying its revenues away from Beijing and Shanghai, and is expanding its market age range to tap into the lucrative university student market. Investors will look to see that this continues as TAL Education grows its market share in the heavily fragmented education market in China.

Will small classes continue to replace declining one-on-one class revenues?

As one-on-one class revenue growth slows, it is being replaced by strong growth in small class revenues, which grew 38% during the second quarter. The business segment contributed 82% of the firm’s revenues during the quarter, compared to 78% a year ago. One-on-one class revenue contribution declined over the year from 19% to 15%, as students favoured the cheaper and more social group class environment.

This is perhaps expected as the firm diversifies its revenues away from Beijing and Shanghai, which have long been the major revenue localities for TAL Education. As these two markets reach saturation, TAL has expanded its presence in other cities. Generally speaking, tier 1 cities such as Beijing and Shanghai are the wealthiest, and as tier 2 and 3 cities provided strong revenue growth for the small class business throughout the second quarter, growth was much slower in the one-on-one class business.

This is likely to continue because as TAL Education enters new cities, it will find that the local competition will only offer small and large classes, as one-on-one classes are too expensive for these consumers. Therefore I expect that TAL Education will focus more of its marketing campaigns on its small classes, in order to take students away from local competitors. In the earnings report, I expect to see that revenue contribution from small classes has increased further on a sequential basis at the expense of one-on-one classes.

 Nanjing: One of the Tier 2 cities now being focused on by TAL Education. Photo: Thinkstock

Will tier 2 and 3 cities continue to drive growth?

Whilst Beijing and Shanghai are the two major cities in China, the competition in the education market is fierce, and the revenue growth that firms like TAL Education have seen over the past few years is slowing as the markets become saturated. Therefore the current source of revenue growth is coming from Tier 2 and 3 cities. For TAL Education’s small class business, 48% of revenues came from cities other than Beijing and Shanghai in the second quarter, compared to just 35% a year ago. This is because competition in cities such as Nanjing, Hangzhou and Chongqing, all of which have populations exceeding 8 million, is lower than in Beijing and Shanghai. Rivals to TAL in these cities are most likely to be local firms who can’t compete with its content and technological quality, which is why small class revenues from these cities saw triple digit growth in the second quarter.

Another aspect to the growth in tier 2 and 3 cities is that the average level of English in these cities is lower than in Beijing and Shanghai. Therefore whilst revenue growth from English classes in Beijing and Shanghai is slowing, there are still growth opportunities in other cities.

Investment In Guokr

In December, TAL Education acquired a stake of Guokr for $15m. Guokr is a mobile and web based community used to teach students about science and technology. Guokr uses its Massive Online Open Course (MOOC) to provide a ‘play and learn’ platform for students, which differentiates it from the standard classroom and online course business models. Guokr works with content providers such as Coursera and top universities around the world to offer Chinese language content, and the platform has since become popular with high school students, university students and recent graduates.

I expect that this will be a very good investment for TAL Education in the long run, because Guokr has two important assets: quality content and a strong user base. The third quarter conference should see management discussing the integration strategy between the two services. 

Has the investment Minerva opened up the university market?

In the second quarter conference call, management discussed the $80m investment in the Minerva Project. This is a ‘hybrid university’, where students will spend time living in cities around the world, and attend classes online. In addition to the investment in Guokr, this shows that TAL Education is making strong progress in acquiring quality content, which presumably will become available to students in Chinese, and more importantly, the firm is targeting the relatively untapped university student online education market. I expect that this will become a major business area for TAL Education because online education firms are finding that the English language training market is saturated, particularly in the mega cities. Therefore by investing in the university student market, TAL Education not only has new potential user base of millions of students, but the firm can educate students from pre school to university and post graduation. 

Earnings history

Current analyst consensus is for EPS of $0.17 and revenues of $97.66m, and whilst this would be a sequential decline, the second quarter typically sees the highest EPS and revenues. The average year-on-year revenue growth over the 14 quarter time frame is 35% whilst the average year on year EPS growth is 59%. If TAL Education results are inline with consensus, then the year on year growth in revenues and EPS will be 32.9% and -10.5% respectively.

Earnings And Revenue History
Source: TAL Education  

TAL Education has an impressive record of almost always beating consensus for both EPS and revenues over the past three years. However, the share price reaction over a one-day and three-day is uncorrelated to this, as investors focus more on the management conference call.

Earnings History
Source: TAL Education, Yahoo Finance

-- Edited by Adam Courtenay

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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