Strategic trade
Trade view / 16 April 2015 at 4:12 GMT

TAL Education gets the benefit of rival’s earnings

China Watcher / Shanghai
China
Instrument: EDU:xnys
Price target:
Market price:
Background

Earnings season for US-listed Chinese firms typically begins with the two big education firms New Oriental Education and TAL Education, as their fiscal quarter ends a month before the standard calendar quarter. Tomorrow I will release an in-depth preview of New Oriental’s fiscal third quarter earnings, but ahead of the release on April 21, investors can benefit from the event by trading New Oriental Education’s major rival TAL Education.

TAL Education saw growing expenses in the fiscal third quarter as the firm funds its growth initiatives with investments into online education startups, such as Guokr. The firm also made an investment in Minerva, which is a hybrid university that allows students to study in several different countries to gain more of an international experience. TAL’s expansion into university education is promising, and I expect that Guokr’s huge content library will be used to improve Minerva’s content quality. 

In the fourth quarter, investors should expect to see further news on these investments, and how the firm’s expansion into Tier 2 and 3 cities has been performing. These students are a key demographic for TAL because in the major Tier 1 cities, the education market is highly competitive, but in Tier 2 and 3 cities, the market is less competitive, and the only rivals are typically smaller local firms, meaning that TAL Education has a strong competitive advantage over these rivals. At the end of the fiscal third quarter, the firm had cash and equivalents of $526.4m, so we should see further investment activity over the coming quarters.

I believe that both TAL and New Oriental Education need to make further investments into the industry, because as both expand into more rural areas, the quality of content will be integral to growth. TAL’s investment in Guokr, with its MOOC (Massive Online Open Course) content library, should help to boost its market share as it expands throughout China.

However, New Oriental’s collaboration with tech giant Tencent is a major positive driver, and TAL will need to find similar collaborations in order to compete. Tencent has a social network user base of over a billion people, as well as market leading technological capabilities. We have also seen smaller rival Xueda Education partner with Qihoo, so while TAL will likely make further investments in smaller technology companies, partnering with a larger tech firm is likely to be inevitable.

Given that the two firms are close rivals, their share prices are highly correlated, and apart from recent volatility from New Oriental in April, this relationship has held strong throughout 2015. Therefore the release of New Oriental Education’s earnings on April 21 should give investors a good insight into what TAL will likely report on April 28.

TAL and New Oriental monthly share price performance
TAL and New Oriental's share prices
Source: Google Finance - Create your own charts with SaxoTrader. Click here to learn more 

Management and risk description

There are two key risk factors for this trade view. Firstly, New Oriental Education posts its fiscal third quarter earnings on Tuesday April 21st, and then TAL Education posts its fiscal fourth quarter results on Tuesday April 28. Both these events could cause volatility for the trade, and should New Oriental’s earnings disappoint investors, TAL’s share price would likely react negatively. 

Parameters

Entry: $35.75

Stop: $32

Target: $38

Duration: Two months


— Edited by Adam Courtenay

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