New Oriental: Old business reinvested after earning money from live broadcasting

Hi everyone, I'm Dolphin Analyst!

Before the US stock market opened at Beijing time on January 17, 2023, $New Oriental.US revealed its Q2 performance for the months of September to November 2022.

Firstly, it should be noted that due to the low point in the RMB exchange rate for FY2Q23, the performance in terms of USD valuation is slightly better when calculating YoY growth rate.

Secondly, after the education market shook, there are not many institutions that continue to track New Oriental. Therefore, looking at the expected difference alone is not very significant. It is recommended to focus on the company's outlook for this year's business and strategic direction.

1. On the revenue side, including the next quarter guidance, all exceeded expectations, and the proportion of online business has reached nearly 30% due to the explosion of live broadcast e-commerce.

2. On the profit side, the main difference in expectation is the gross profit margin, which was weaker than the market expectation at 47%. It is recommended to pay attention to the answers of management during the conference call, and Dolphin will also issue conference notes as soon as possible.

However, Dolphin believes that there are short-term factors here. Some fixed expenses for the K9 business adjustment and the initial investment in newly established schools will definitely affect the gross profit margin until the admission rate climbs to a certain level.

1. There were a total of 706 schools and learning centers in the group at the end of the quarter, an increase of 2 compared to the previous quarter. The number of non-academic counseling admissions increased from 297,000 in the previous quarter to 477,000 in Q2.

2. The company's key strategies this year are undoubtedly live broadcast e-commerce first, followed by study abroad, which are the two businesses that management discussed the most in the Q2 financial report.

** (1) Oriental Selection ** began airing at the end of 2021, but did not gain a lot of heat until early June 2022. In the previous quarter's financial report, the proportion of online business revenue has soared from 5% to 15%, and in Q2, the GMV of Oriental Selection MV reached RMB 4.8 billion, exceeding market expectations (~RMB 3.6 billion). As there is "no buying volume, no anchor sharing," Dolphin expects that the realization rate of live broadcast shopping can reach 16%.

(2) Study abroad business is more about the expectation of further repair after the national gate is opened. After the study abroad consulting business began to recover significantly in the last quarter, overseas study preparatory business also grew by 17% in Q2.

** (3) In addition,** Dolphin believes that the sharp increase in admissions of non-academic counseling may also be a positive signal. Combined with the net increase in the total number of group schools and learning centers, it indicates that the impact of the K9 double-reduction policy is basically close to the end, while the non-academic counseling admission demand is relatively strong.

As Dolphin said in the previous article on New Oriental's depth, the educational demand of individual households will not disappear because of the policy's introduction, but will rather be transferred. In this market, which is the cake of non-academic quality education, New Oriental is expected to accelerate the concentration ratio with its brand strength for a long time. Dolphin Analyst's View

As the industry policy comes to an end, the old business is expected to recover after the epidemic lockdown, and the new business with lower policy risk, especially the knowledge-sharing live streaming e-commerce with excellent business models and the wide-ranging non-disciplinary training, will have smooth business progress in the short term and potential growth in the long term. Therefore, the investment logic of New Oriental's "crisis reversal" is relatively clear.

However, the core issue is whether the current valuation has fully priced in the above-mentioned positives. Dolphin Analyst believes that, based on market expectations, the current pricing is mainly for the recovery of the old business and the short-term growth expectation of the new business. However, the longer-term ideal expectation for the new business has not been priced in completely.

Especially in Dolphin Analyst's view, the non-disciplinary coaching and the intelligent teaching equipment in the in-depth article entitled "Can New Oriental Rely on Education with Dong Yuhui's Spring Festival Gala?" are a high-growth story with high certainty for New Oriental, but they need step-by-step operation and realization to dispel doubts.

Moreover, judging from the valuation level (PE) corresponding to the market performance expectations for 2023, the current valuation is not high, but is in line with the historical valuation Centrum. However, under the "crisis reversal" logic, this does not match the high valuation generally corresponding to optimistic sentiment. This indicates that the current market funds still have doubts and concerns about the education and training industry.

In this situation, the calculation of new business growth space is particularly crucial for the current market value of New Oriental. Only when there is considerable growth elasticity space and the current market value has a relatively ideal valuation expectation with a high safety cushion, can the market bias be eliminated in the short term. In the in-depth research of New Oriental, Dolphin Analyst we will focus on this issue, so stay tuned.

Specific Interpretation of this Quarterly Financial Report

1. Super Revenue Expectations, Business Adjustment Approaching Its End

In the second quarter ending in November 2022, New Oriental achieved total revenue of US$638 million, a year-on-year decrease of 3%. The second quarter coincided with the low point of the RMB against the US dollar, which dragged down the performance data. Excluding the impact of exchange rate, the income denominated in RMB officially rebounded, with a year-on-year growth of 8%.

Due to policy impacts, the number of schools and learning centers closed down has been gradually slowing down by quarter. This quarter has also "hit the bottom and rebounded," with a net increase of 2 schools and learning centers in the second quarter, totaling 708. On the one hand, it indicates that the handling of K9 offline courses is approaching the end, and on the other hand, it can also roughly predict the good progress of new business.

Looking at the prepayment of tuition fees from deferred income, deferred income in the second quarter was USD 1.139 billion, an increase of USD 0.126 billion compared to the previous quarter, and a growth acceleration compared to the same period. Looking again at the revenue situation, although the second quarter is the off-season and the outbreak of epidemics has occurred in many parts of the country, the single-quarter revenue has not decreased much compared to the previous quarter.

II. Segmented business: live e-commerce leads, study abroad rebounds

After significant changes in operations, the disclosure scope of segmented business of New Oriental has also changed. First, looking at specific product services, the biggest change before and after the policy is that the K9 subject coaching business has been completely withdrawn, but new businesses such as K12 non-academic training, smart learning products and camp study have been introduced, as well as the innovative model of combining knowledge sharing with live e-commerce.

In the "Subsidiary Operations" section of the New Oriental annual report, it is divided into two categories: "Educational Services" and "Other, including books". However, management will highlight the business situation with significant changes in the current period. They generally disclose data and information according to the following merging/splitting criteria:

1. K12 extracurricular education (after closing K9, only high school subject training and K12 quality education remain)

2. Overseas business (test preparation and study abroad consulting)

3. Adult and college courses (domestic test preparation, adult English, and small languages)

4. Online courses (New Oriental Online)

5. Other businesses

In addition, as new businesses promoted by New Oriental gradually contribute more and more to income after the implementation of policies, a segment called "New Business" composed of three sub-items: K12 non-academic training, smart learning products, and study trips will also periodically disclose their revenue proportion.

Dolphin Analyst attempted to break down the operating situation of each quarter according to the above criteria based on historical financial reports, conference calls, and surveys (not an accurate value, only a reference to change trends).

Looking at the changes in the revenue share of different businesses, online business contribution ratio significantly increased in the second quarter. As for the old business situation disclosed by management, overseas test preparation and study abroad consulting increased by 17% and 14%, respectively, while adult training and domestic college student test preparation decreased by 9% compared to the same period last year. K9 Business Operations and New School Investment or Decrease in Gross Profit Margin

After passing through the FY2Q22 performance bottom, with the acceleration of campus closures, the company's profitability level is also rapidly recovering. Starting from FY4Q22, the gross profit margin further accelerated its improvement to the level before the double reduction policy, and also benefited from the contribution of live e-commerce revenue with high gross profit (no anchor sharing, higher gross profit of self-operated products) in the overall group. In 1Q23, the gross profit margin continued to approach the historical high level with the sustained popularity of Dongfang Zhenxuan.

Although the sales expense ratio has fluctuated in the four quarters due to the enrollment season, it has remained in the range of 10%-15%. Historically, the management expense ratio has also been relatively stable, but after the policy was introduced, due to the closure of schools, the handling of teaching equipment, and the downsizing of the teacher team, short-term expenses such as provision for impairment losses, compensation payments, etc. were relatively high, causing the expense ratio to fluctuate significantly.

However, since the first quarter of 2023, the short-term fluctuation in the expense ratio caused by business adjustments has begun to ease, and due to the more private nature of Dongfang Zhenxuan, its live e-commerce revenue is relatively restrained in buying volume while contributing to high gross profit. Therefore, the gross profit margin and operating profit have been simultaneously optimized and increased in 1Q23.

The gross profit margin in the second quarter did not continue the trend of improvement in the first quarter, and it fell to 47.7% on a month-on-month basis. The gross profit margin of the online business, including live broadcasts, was 47%, which indicates that the gross profit margin of the old business is also similar, but there is still a gap compared with the historical equilibrium. The market has higher expectations for the improvement of the gross profit margin in this quarter, so this expectation gap may be of more concern to the market.

Dolphin Analyst believes that the decline in the gross profit margin here has accidental factors.

1. On the one hand, due to reasons such as off-season and the repeated outbreaks of the epidemic, the opening of offline courses was affected, which in turn reduced the recognition of revenue for the period.

2. On the other hand, the company established two new schools this quarter, and basic infrastructure investment is needed in the early stage. During the uphill stage of the enrollment rate of new schools, the rental and labor costs added by the newly established schools will drag down the repair of the gross profit margin in the short term.

Live e-commerce business can not only help New Oriental quickly get out of the trough and improve cash flow in the short term, but also become a new business growth engine in the long run. This form of knowledge sharing through live streaming has a more advantageous profit model, and also has the potential to feed the offline education and training business through online traffic, increase user stickiness, and greatly improve the unhealthy business model of the original education and training business of huge buying traffic. This will improve the overall profitability of the group.

Dolphin Analyst expects the operating profit margin of live streaming e-commerce business to reach a steady state of 25-30%, which is significantly higher than the steady state of 10-15% of the original offline education and training business. If the online business revenue contribution can reach 30%, it means that the long-term steady state operating profit margin of the entire group is expected to approach 20%.

Dolphin ("New Oriental") historical article:

Depth

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

Risk disclosure and statement for this article: Dolphin Disclaimer and General Disclosure