Article / 22 April 2015 at 5:47 GMT

Earnings review: New Oriental Education back on track

China Watcher / Shanghai
China
  • New Oriental Education announced consensus-beating results for third quarter
  • K-12 after-school tutoring continued as key revenue driver, up 22% year-on-year
  • POP Kids platform gross revenue grew 7% and enrolments grew 16% y-o-y

By Neil Flynn

New Oriental Education announced consensus-beating results for the fiscal third quarter, and investors were relatively pleased, as the share price ended the day up 2.63%. Along with strong headline results, the firm is showing growth in its revamped POP Kids platform, whose rollout has suffered delays in prior quarters, and there continues to be strong adoption figures for the English language learning apps Le Ci, and the Tencent collaboration uDA. 

Headline results are promising

New Oriental reported revenues of $287.7m and non-GAAP diluted EPADS of $0.29, which both beat analysts’ consensus of $284.76m and $0.22, respectively. The K-12 all subjects after-school tutoring business continued to be the firm’s key revenue driver, growing 22% year on year, and contributing almost 50% to total revenues in the quarter, up from 41% in the second quarter. Within K-12, U-Can middle school and high school after-school tutoring saw gross revenue growth of 29%, whilst the year on year slowdown in enrolment growth to 12.4% was due to the late timing of the Chinese New Year, and will likely be seen in the fourth quarter. 

New Oriental's Revenue History
Source: New Oriental Education Investor Relations

I discussed in my earnings preview last week that the profit margins have been coming under pressure as the firm funds its O2O strategy. However, we should start to see growing profit margins going forward, because the online investment spending is set to decline in the next fiscal year. In addition, New Oriental has released its new O2O platforms whilst keeping ASP growth relatively low in order to gain market share. Once a good market share has been attained, the firm will begin to increase ASPs, which will help to boost earnings going forward.

New Oriental's Earnings History
Source: New Oriental Education Investor Relations  

The firm saw total student enrolments in subject tutoring and test preparation courses of 603,000, which only amounted to negligible growth of 100 students from a year ago. In addition, the fiscal third quarter typically sees the second highest enrolment figures, after the first quarter, but there was a sequential decline of 3%.

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 NEO typically sees a boost in enrolments after the Chinese New Year. Photo: iStock

The firm has stated that this is due to the late timing of the Chinese New Year, which was in the middle of February, compared to its typical timing of the end of January. The firm typically sees a boost in enrolments after the Chinese New Year for the Spring classes, but because the festival coincided with the end of the fiscal quarter, these enrolments have been recorded in the fiscal fourth quarter instead. In the first six weeks of the fourth quarter, the firm has already seen a 35.8% increase in enrolments and 43% increase in cash receipts compared to a year ago, and this is due to the late timing of the Chinese New Year.

New Oriental's Student Enrolment
Source: New Oriental Education Investor Relations

The revamped POP kids Is performing well

The revamp of the POP Kids platform has suffered delays throughout the fiscal year, but as the rollout of the new platform is almost complete, the firm is already seeing strong performance. Gross revenue grew 7% and enrolments grew 16% year on year, and the platform has earned positive feedback from the firm’s network of schools.

In addition, the platform continues to see strong growth in the first six weeks of the fourth quarter, with over 30% growth in enrolments and almost 40% growth in cash receipts year on year. It should be noted that due to the planned revamp, the firm reduced marketing expenditure on the previous POP Kids platform last year, and hence saw a decline in enrolments and revenues.

Due to the ongoing rollout, the firm is less focused on increasing ASPs, as gaining market share is more important. For 2015, the ASP for POP Kids increased by only 5%, and the increase for 2016 will be slightly more, with the eventual target of 10% year on year ASP growth.

Building a strong user base for English learning apps

Several years ago, adult English language classes were significant revenue drivers for private education firms such as New Oriental, but revenue contribution has declined because the average level of adult English in China has improved. Previously, the firm was capitalising on a huge demographic of adults that wanted to learn English, but had very little previous exposure to the language through school education, media content, native speaking friends and colleagues, and overseas university education. New Oriental has rethought its English strategy, and has integrated it into its mobile platforms.

As part of the second level of the firm’s O2O strategy, New Oriental launched the Le Ci English language vocabulary training app for smartphones and tablets, and had over 1,146,300 users by the end of the third quarter. This represented sequential growth of over 40%. I have been bullish on the potential of New Oriental’s collaboration with tech giant Tencent, and the release of the English learning app uDA.

The strategy is to expand this from just English into all of the subjects in the university entrance exam (Gaokao). Therefore, because uDA currently only covers English and a bit of mathematics, promotion for the app has been muted. However, this indicates that there is strong potential for user growth and student enrolment growth. New Oriental will be tapping into Tencent’s huge user base, and integrating into its market leading mobile ecosystem. 

There is strong potential for these English learning apps, because as the user base continues to show strong growth, it introduces students into the New Oriental ecosystem, from where they can be monetised by the firm. In addition, particularly with the uDA app, I would expect that New Oriental would look to increase monetisation through premium content, and advertisements, as is standard on Tencent’s platforms.

Further investments should be expected

As of February 28, the firm had $411m in cash and equivalents on the balance sheet, declining from $451m at the end of the fiscal second quarter. The firm has made it clear that it is committed to investing this cash and buying back more shares. As with prior quarters, the investment focus will be on the firm’s O2O strategy, but as core platforms have been revamped, I expect that the firm will acquire minority stakes in education firms that complement the services within New Oriental’s ecosystem. 

The firm expanded its presence in existing markets during the third quarter, and added a net of nine schools and learning centres, which gives a total of 722. The firm is looking to open between five and ten new learning centres during the fourth quarter, and will look for further growth opportunities in three to four new cities in the fiscal year 2016. 

During the quarter, the firm invested around $8.5m in online education, and the full year figure is expected to reach between $30m and $35m. The firm’s pure online learning platform Koolearn.com has been very successful, and generated net revenues of $10.2m in the third quarter, representing annual growth of 39%.

Registered users grew over 200% annually, and the cumulative total number of registered users has now reached over 10.3m. The O2O strategy expansion saw the launch of the U-Can Visible Progress Teaching system in September, which is now in 40 cities, and should reach 50 by the end of the fiscal year. In addition, O2O is a key part of the revamped POP Kids English learning program, which is now in 35 cities.

The O2O domestic test prep platform has received positive feedback, and this will be expanded into overseas test prep courses by the end of the fourth quarter. The overseas test prep will be a key revenue driver for New Oriental in the coming years, because not only has there been a big increase in the number of Chinese students attending overseas universities over the past decade, but we are now seeing parents sending their children to overseas institutions much younger, which allows New Oriental to expand their overseas test prep to high school exams such as SATs and A-Levels. 

Looking ahead

This has been a strong quarter from New Oriental, and after the problems of enrolment delays during the summer, the firm looks to have emerged on a strong path. The investment in its online education and O2O strategies looks to have peaked, and the rollouts of the improved platforms have been gaining positive feedback.

The only disappointment was the slower than expected enrolment growth for the quarter, but as the firm explained, this is merely a timing issue, and the enrolment for spring classes that is usually recorded in the fiscal third quarter will be recorded in the fourth quarter instead. The fiscal year 2016 should see stronger profit margins and the firm begins to grow its ASPs and online education investment decreases.

-- Edited by Susan McDonald and 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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