Another explosion! Can New Oriental still be "chickened" up by parents?

$New Oriental EDU & Tech(EDU.US) On January 21st, Beijing time, the U.S. stock market released its performance for the second quarter of the fiscal year 2025, corresponding to the off-peak operating conditions from September to November 2024.

This performance review still focuses on the education business:

1. Concerns that triggered a huge shock in the financial report - Can the high prosperity of non-academic subjects continue?

It was originally thought that the study abroad business would be under pressure, but in fact, the study abroad revenue performed well. However, the new business faced challenges, with a year-on-year growth rate of 42.6% in the second quarter, which was below the company's guidance and market expectations of over 50%.

Since its transformation, New Oriental has included new businesses such as quality education, learning machines, and camp education, which have become the pillars of revenue growth and also support New Oriental's valuation. In a high prosperity environment, the market is willing to assign high valuations.

However, alongside market expectations, there are also some concerns. On one hand, there are policy issues (the boundary between non-academic and academic subjects is blurred for some institutions, and there are also high-paying "chicken baby" situations, which slightly conflict with the goals of the "double reduction" policy), while the actual policy environment remains stable, trending from tight to loose; on the other hand, supply is increasing. In addition to the Ministry of Education steadily issuing non-academic licenses (Dolphin calculates an annual growth rate of 5%), the stable policy environment has led to the prevalence of small black classes, which has also squeezed some demand.

Dolphin is also paying attention to these two issues. Last quarter, the rapid decline in the growth rate of non-academic enrollments at New Oriental has raised our alert. Looking at the second quarter, although there was a significant seasonal increase, considering the management's mention of the distortion in year-on-year growth due to time cycles last quarter, Dolphin believes that based on the cumulative growth rate over two consecutive quarters, the Q2 growth rate is also in a slowing channel.

Moreover, the company's revenue guidance for the core learning business in Q3 (year-on-year growth of 18-21%) is also lower than the expectations of foreign investment banks (year-on-year growth of around 25%). This undoubtedly further exacerbates market concerns about the rapid slowdown in demand for new businesses and the growth pressure brought by the release of industry supply.

2. Old businesses are not as weak as imagined, but the growth pressure of study abroad has not disappeared

As for the old businesses outside of the new ones, the growth performance is quite good, at least meeting market expectations:

The study abroad business, which lowered its guidance last quarter, saw exam training and consulting grow by 21% and 31%, respectively, exceeding the company's guidance of over 20%. Adult English grew by 35%, also slightly higher than the company's guidance of over 30%.

However, Dolphin believes that from a qualitative perspective, the pressure of slowing growth in the study abroad business still exists. On one hand, the demand released during the pandemic has gradually diminished; on the other hand, under macro pressure, the payment ability of the target customer group has been affected, and the demand for studying abroad due to employment pressure is also beginning to cool down as the cost-effectiveness decreasesIn addition, during Trump's term, geopolitical risks have increased. For example, earlier this year, some American universities also suspended their exchange and cooperation with Chinese universities, which will suppress some study abroad demand.

3. Off-season + mismatch period + impact of Dong Yuhui's divestment, short-term profit pressure

In the second quarter, operating profit fell by 10% year-on-year, and the profit margin dropped to 1.9%. This was mainly due to the combination of off-season, production mismatch (newly established schools have not yet started enrollment and operation, but marketing, textbook procurement, and faculty investment expenses have already begun to be recognized) and the impact of Dong Yuhui's divestment.

This point is not a major concern for Dolphin Jun; if business growth can be ensured, then profit improvement is a natural outcome. The second quarter financial report did not disclose the number of new learning centers established, but based on data from institutional research, New Oriental's production and expansion have been steadily accelerating in the second quarter and up to now in November and December.

Regarding the pace of production, the company has already provided guidance for the fiscal year 2025 last quarter—capacity is expected to grow by 25%, averaging about 6% per quarter, which is higher than the expansion pace of 20%/15% for fiscal years 2024/2023.

As for the short-term profit pressure, the management has already taken some preventive measures last quarter. With the new schools starting operations in the second half of the year and utilization rates increasing, profit margins are expected to gradually recover.

4. Can shareholder returns be maintained?

New Oriental has a substantial amount of cash on hand, and its business model of collecting tuition fees in advance means that its cash flow is generally not a major concern. As of the end of November, the company's cash + short-term investments totaled $4.8 billion. After excluding deferred revenue of $1.96 billion mainly from advance tuition fees, the net cash available for discretionary use is $2.8 billion.

As of yesterday, January 20, management has repurchased a total of 11.2 million ADRs, spending $540 million. This calculates to 1.4 million shares repurchased this quarter at an average repurchase price of $60.

Based on the annualized repurchase scale from the average of Q1 and Q2, it is approximately $500 million (implying the company continues to extend repurchases and expand the current quota). Therefore, with a market value of $8.5 billion after a pre-market drop of 15%, the return rate is 5.8%. If we add the special dividend of $100 million issued this year, the total shareholder return is 7%. To some extent, as long as the management stabilizes this dividend rhythm, the current valuation can be considered a "dividend floor."

5. Overview of financial indicators

Dolphin Jun's Viewpoint

New business is the core growth highlight and valuation pillar for New Oriental, especially the quality education and training within the new business. Therefore, every financial report from New Oriental is essentially about observing the logical changes in quality education and training.

Last quarter, Dolphin Jun had some doubts about the rapid slowdown in the growth rate of enrollments in quality education and training. However, the company subsequently expressed confidence in the demand's prosperity and provided relatively stable high growth guidance, which alleviated some of our concerns.A stable or tightening policy environment, after more than two years of industry prosperity, is actually both beneficial and detrimental to New Oriental. The good news is that it can eliminate some major policy hammers, allowing the company to operate and expand normally. The downside is that it may also breed unlicensed small black classes, crowding out potential demand. Therefore, as the overall supply in the industry accelerates, and with the continuously severe macro environment, the company's original growth expectations will be affected when they actually materialize.

Of course, the current competitive environment is still not comparable to that of 2021, so it is not appropriate to overly anticipate intense competition. Meanwhile, for New Oriental, the current "slowdown" actually carries expectations of marginal improvement—new schools planned for the second half of fiscal year 2024 are expected to start operations in the second half of fiscal year 2025, likely reflecting gradual revenue growth support in Q3 and Q4.

However, with a weak Q3 guidance, we can only hope that the new capacity mentioned above will mainly materialize in Q4, but attention should also be paid to how management breaks down the growth guidance for each segment during the conference call. If the growth expectations for new businesses in Q3 are also somewhat suppressed (especially the growth rates of quality education and learning machines), then we need to further listen to management's explanations for the underlying reasons, whether it is due to changes in the pace of new school operations. Non-demand and competitive reasons can be temporarily forgiven; otherwise, the valuation of new businesses may need to be adjusted downwards.

Finally, regarding valuation, for a company like New Oriental Group with a complex business structure, the market generally adopts a Sum of the Parts (SOTP) valuation based on the business guidance provided by the company, which is relatively favorable compared to the dismal Chinese concept stocks. Otherwise, based on New Oriental's current profit levels, the P/E would be relatively high. However, since Dongfang Zhenxuan has frequently encountered governance issues and changes in the market environment, some funds have also adopted a group-wide P/E valuation for New Oriental.

Currently, after a pre-market plunge of 15%, the $8.5 billion valuation implies an EV/NOPAT of 16x for FY26, essentially falling within the valuation range for Chinese concept stocks. Although there is still pressure on short-term performance, this valuation is not considered high, especially since revenue growth is expected to rebound to over 20% with the new learning initiatives coming online. If share buybacks can continue to exceed expectations at the pace of the previous two quarters, then further downside potential will also be relatively limited.

(Note: New Oriental's financial report only discloses part of the business performance, with most operational conditions and guidance revealed during the earnings conference call and small-scale institutional meetings, so the content of the upcoming conference call is relatively important. Dolphin will update in the comments section later.)

The following is a detailed commentary

1. Has education taken another break?

In the second quarter of fiscal year 2025, New Oriental achieved total revenue of USD 1.039 billion, a year-on-year increase of 19%, with a growth rate of 20% in RMB terms. Among them, the core education revenue, excluding the live streaming business, was USD 894 million, slightly above the upper end of the company's guidance range.

The company's revenue guidance for Q3 core learning business is in the range of USD 1.007 to 1.033 billion, implying a growth rate of 18% to 21%, lower than the 25% growth expectation of leading institutions.

The situation of the segmented businesses was partly disclosed in the conference call and partly in small institutional meetings. Dolphin Jun currently provides split estimates, and specific data will be clarified in the comments section later:

Study abroad training and consulting grew by 21% and 31%, respectively, with the company's guidance being 20%+, and market expectations were not high due to the downward adjustment of guidance in the previous quarter.

Adult English grew by 35%, also performing well, slightly above the company's guidance of 30%+.

However, the new business, which has been regarded as a growth pillar after the transformation, only achieved a year-on-year growth rate of 42.6% in the second quarter, failing to meet both the company's guidance of 50% and the market expectation of 50%+.

In the second quarter, the number of enrollments in non-subject education was 994,000, although there was a significant increase compared to the previous quarter. However, considering the management's previous mention of the issue of year-on-year growth distortion due to time cycles, Dolphin Jun looks at the cumulative growth rate over two consecutive quarters, and the growth rates in the first and second quarters are also in a slowing trend.

The number of subscriptions for learning machines was 261,000, a slight drop from 323,000 in the previous quarter, but industry demand remains relatively high, with peers' shipment volumes and online active users continuing to rise during the same period.

2. Short-term Profit Pressure

Last year, leading companies such as New Oriental and TAL Education announced plans to accelerate expansion, indicating that the investment phase in quality education is far from over. Although the second quarter is typically a slow season, New Oriental's expansion pace has not slowed down, with increased team and operational expenses accompanying the capacity expansion.

In addition, the expansion of the elderly cultural tourism business (Q2 revenue growth of 233%, primarily leading to a significant increase in marketing expenses) and the impact of Dong Yuhui's divestiture have undoubtedly increased short-term profit pressure.

Ultimately, the operating profit for Q2 was less than $20 million, with a profit margin of only 1.9%. The management had already issued a warning last quarter, but the market is also more willing to see revenue maintain high growth; otherwise, it will scrutinize profitability more closely.

3. "Dividend Floor" After the Plunge

In the second quarter, the operating net inflow was $313 million, a slight year-on-year increase of 4%. The new expenses from team and operational costs due to capacity expansion dragged down profits, thereby affecting cash flow. Capital expenditures in Q2 were $60 million, resulting in a free cash flow of $253 million for Q2 2025, slightly lower than the same period last year.

As of the end of November 2024, the company had $4.8 billion in net cash on its balance sheet (cash + deposits + short-term investments), excluding deferred revenue of $1.9 billion (mostly tuition fees, which are subject to special regulation and cannot be freely used), leaving nearly $2.8 billion in cash that can be freely allocated.

As of yesterday, January 20, management had repurchased a total of 11.2 million ADRs, spending $540 million. This calculates to 1.4 million shares repurchased this quarter at an average repurchase price of $60.

Based on the annualized repurchase scale from Q1 and Q2 averages, it is approximately $500 million (implying the company continues to extend repurchases and expand the current quota). Given the market value of $8.5 billion after a 15% drop before the market opened, the return rate is 5.8%. If we add the special dividend of $100 million issued this year, the total shareholder return reaches 7%. To some extent, as long as management stabilizes this dividend rhythm, the current valuation can be considered a "dividend floor."

Dolphin "New Oriental" Historical Articles:

Financial Reports

October 23, 2024: New Oriental: Pressure in the Off-Season, We Believe We Will Rebound in the Second Half of the Year (1Q25FY Conference Call Summary)

October 23, 2024: Turmoil at New Oriental: Without Dong Yuhui, Will Education Collapse?

August 1, 2024: New Oriental: Optimistic About Profit Margin Improvement Trend Without Focusing on Dongfang Zhenxuan (4Q24FY Conference Call)

July 31, 2024: New Oriental: Live Streaming at the Forefront, Education is Thriving

April 24, 2024: New Oriental: Improved Resource Utilization, Increased Expansion Targets (3Q24FY Conference Call)

April 24, 2024: New Oriental: Live Streaming Drags Down Profits, Education Supports the Foundation Again

January 25, 2024 Conference Call: New Oriental: Education Demand is Booming, But We Don't Want to Expand Too Quickly, Profit Margin First (2Q24FY Conference Call)

January 25, 2024 Financial Report Commentary: [New Oriental: Enjoying the "Blooming and Fruiting Period"] (https://longportapp.com/zh-CN/topics/11328724?invite-code=032064)

October 27, 2023 Conference Call: New Oriental: Actively Expanding, Demand is Stronger Than Previously Expected (1Q24FY Performance Meeting Summary)October 27, 2023 Financial Report Review: "Education is the True Face of New Oriental"

July 28, 2023 Conference Call: "New Oriental: Education Demand is Very Strong (4Q23FY Conference Call Summary)"

July 26, 2023 Financial Report Review: "New Oriental: The Reversal Logic of Old and New Businesses is Gradually Being Realized"

April 20, 2023 Conference Call: "New Oriental: The Repair is Not Yet Complete, Growth is Still Ahead (3Q23FY Conference Call Summary)"

April 19, 2023 Financial Report Review: "New Oriental: How Many More Surprises are Needed to Restore Market Confidence?"

January 18, 2023 Conference Call: "New Oriental: While Increasing Investment, More Concerned About Group Profitability (FY2Q23 Conference Call Summary)"

January 17, 2023 Financial Report Review: "New Oriental: After Making Money from Live Streaming, Old Business Returns to Investment"

In-depth

April 4, 2023: "Cash Builds a Strong Bottom, Dong Yuhui Can't Control New Oriental"

January 13, 2023: "With Dong Yuhui on the Spring Festival Gala, Can New Oriental Still Rely on Education for the Future?"

Hot Comments

July 26, 2024: "Dong Yuhui's Departure Crashes New Oriental, Who is the Real Victim?"Risk Disclosure and Disclaimer for this Article: Dolphin Research Disclaimer and General Disclosure