New Oriental: Live Streaming Weighs on Profits, Relying on Education for Financial Support

$New Oriental EDU & Tech(EDU.US) New Oriental EDU & Tech released its performance for the third quarter of the 2024 fiscal year before the U.S. stock market on April 24th Beijing time, corresponding to the three months from December 23 to the end of February this year. The overall performance compared to expectations has both good and bad aspects. On one hand, there is high business growth, but on the other hand, it also confirms the market's concern before the financial report—short-term profit weakening, which is also a reason for the stock price pressure in the past month.

1. Decline in gross profit margin, burden on Dongfang Zhenxuan: Similar to the guidance in the previous quarter, the performance of the company in the third quarter vividly reflects the current strong countercyclical demand for education. However, market expectations are also not low. Dolphin Jun expects the performance of the education business to be inline or slightly above expectations.

However, Dongfang Zhenxuan, due to its own business adjustments (tilting traffic to low-margin 1P business, as well as the increase in investment in the new account "Traveling with Hui" and additional external revenue sharing), clearly dragged down the overall gross profit margin level of the group. Although the contribution of live streaming to the group's valuation is not high, accounting for about 10%, the market may also be concerned about whether the decline in gross profit margin indicates a slowdown in the demand for educational services (decreased equipment utilization). This requires further clarification based on the revenue breakdown of specific business segments by the management during the conference call.

2. Accelerated expansion, implied overwhelming demand for education: New Oriental has always provided detailed and comprehensive guidance on performance expectations, but Dolphin Jun believes that the most forward-looking core indicator is actually only one, "the company's planned expansion speed".

In the education market where supply is less than demand, pricing power is in the hands of the remaining leading players. In other words, at the current stage, New Oriental's performance growth will rely more on the expansion pace actively chosen by the company. Over the past year, considering the group's profitability and regulatory environment, the management's pace of school expansion has been more conservative rather than aggressive. Therefore, we assume that the current expansion speed has not affected the overall equipment utilization rate.

In the previous quarter, the company's guidance for annual expansion growth rate was 20%. Generally speaking, a 20% expansion rate, considering factors such as equipment reuse and course price increases, corresponds to a revenue growth rate of over 30%. In the previous quarter, the number of schools and learning centers was 843, with a year-on-year growth rate of 19%, while in Q3 it reached 911, with a year-on-year growth of 27%, significantly exceeding market expectations.

The accelerated growth in the number of schools indicates an increase in the company's confidence in current and future education demand from a marginal change perspective.

3. Good guidance, short-term disturbances do not change the long-term trend: The expansion speed more reflects the medium-term growth trend in the next 1-3 years. In the short term, due to the base disturbance caused by the epidemic and the seasonal effects, the direct guidance of the core indicators by the management is also important Company's revenue guidance for the next quarter is in the range of 1.1-1.3 billion US dollars, implying a year-on-year growth rate of 34% in RMB terms, slightly exceeding market expectations. Pay attention to the company's profit margin in Q4 and whether there will be an upward adjustment to the full-year revenue and profit.

4. Stable revenue growth: Although deferred revenue declined quarter-on-quarter in Q3, it was mainly due to seasonal effects. Calculated based on deferred revenue, the revenue growth for the quarter, in RMB terms, was 46% year-on-year, slightly lower than the 47% in Q2 but overall maintaining a stable recovery trend.

5. Focus on the explanation for the slowdown in the growth of enrollment in quality education: Apart from the unexpected weakening of gross profit margin in overall performance, there is another operational indicator that Dolphin Jun is not satisfied with, which is the enrollment of 355,000 non-academic education students in this quarter, with a year-on-year growth rate of 63%. Compared to the 65% growth rate in Q2, Q3 saw a decline instead of growth on a low base. It is necessary to hear the management's explanation, whether there was interference from the late Chinese New Year holiday and the popularity of cultural tourism.

Dolphin Jun's viewpoint:

Although the fundamentals are strong, during a significant rebound period for Chinese stocks in the past month, the stock price of New Oriental did not perform well, mainly due to the drag on the group's profit margin from Oriental Selection. Looking at the trend, it is expected that Q4 will continue to be troubled by this issue.

In fact, Dolphin Jun has always emphasized that currently, although Oriental Selection contributes over 20% of the group's revenue, due to its poor business model (low profitability) and high uncertainties in the future (such as star anchor departures and moral risks, competition substitution, supply chain management, etc.), we tend not to have high expectations for the valuation of live streaming, and even directly exclude it from the valuation.

Under Dolphin Jun's neutral expectations, the valuation after excluding the live streaming business is $15 billion (including $4.7 billion in net cash). In the previous quarter's financial report review, Dolphin Jun suggested not to chase the rise but to look for opportunities to "get on board" during a "crisis moment," if the market overprices the profit decline brought by live streaming, then we believe that such a "crisis moment" is approaching.

Regarding the operational performance of segmented businesses, management generally provides relatively detailed disclosures during the conference call, so it is recommended to pay attention.

Key points of the financial report:

1. Mixed results in the third quarter compared to expectations

In terms of revenue, new businesses (quality education, learning machines) in the third quarter still maintained a high growth rate of 73%, while old businesses such as study abroad and adult education continued to accelerate, with the study abroad business surpassing pre-pandemic levels. The overall revenue in the third quarter reached $1.21 billion, a 60% year-on-year growth, and a 68% year-on-year growth in RMB terms, significantly exceeding market expectations.

Gross profit margin has seen a significant decline, but it is highly likely not due to weakening demand for education, but rather due to issues with Oriental Selection. In terms of expenses, marketing and administrative expenses increased year-on-year in the third quarter, but revenue expansion outpaced this growth, leading to an overall optimization of the expense ratio to a historically favorable level. Ultimately, the operating profit for the quarter was 113 million, with a profit margin of 9.4%.

2. Revenue guidance slightly exceeds expectations, focus on more business details to be disclosed during the conference call

The company's revenue guidance for the next quarter is in the range of 1.1 to 1.13 billion US dollars, with a year-on-year growth rate of 28% to 31%. Compared to the previous quarter, there is a noticeable decline, mainly due to the disappearance of the low base effect brought about by the epidemic.

Looking at deferred revenue, there has been a seasonal decline compared to the previous year, which to some extent also represents the normalization of business fluctuations after the weakening of the low base effect. Therefore, the subsequent revenue growth rate is expected to slow down significantly.

As a management team with a long-established presence and rich experience in the industry, 68 learning centers/schools were expanded in the third quarter, accelerating from the previous quarter. In addition, the management team has raised the expansion target for the 2024 fiscal year from 20% to 30%.

Although the expected revenue growth rate will slow down significantly, Dolphin believes that since the decision was made to accelerate expansion, it indicates that the company still sees more positive signals for the future and a more stable policy environment.

3. New businesses continue to grow rapidly, while existing businesses impressively exceed expectations

Regarding the performance of segmented businesses:

(1) In terms of our most closely watched new businesses (quality education, learning devices, camp study tours, elderly cultural tourism, etc.), the growth rate in the third quarter has slightly rebounded, reaching a high year-on-year growth rate of 73%. However, the total number of registrations in the third quarter was 355,000, which, due to the low base effect from the previous year, actually saw a slowdown in growth. It is recommended to pay attention to the management's explanation, whether there was disruption due to the Spring Festival holiday, or if demand was released earlier in the previous quarter According to the guidance, it is expected that in the full fiscal year of 2024, new business will still be the main driving force for growth, with a year-on-year growth of over 70%.

(2) The growth logic of old business: the epidemic dividend is weakening, but there is still the logic of market share improvement

The year-on-year growth rate of study abroad preparation business is 53%, and the year-on-year growth of study abroad consulting business is 26%. It is expected that the overall study abroad business in 2024FY can continue to maintain a growth rate of around 30%. The growth of the study abroad business is also driven by the increased demand brought by more people choosing to study abroad for further education due to lower-than-expected employment.

Furthermore, adult English/college student English preparation business has been rebounding since the previous quarter, with a 53% year-on-year growth in Q3, also benefiting from the low base dividend during the peak of the epidemic.

4. Operating cash flow declined year-on-year, with few repurchases

This quarter saw increased investment, with capital expenditures increasing by nearly $40 million compared to the previous quarter. Although the quarterly profit was good, the net operating cash flow was only $110 million year-on-year, significantly lower than $190 million last year. As a result, the free cash flow in 3Q24 was only $29 million. It is important to pay attention to the company's explanation for this, whether it is due to the repayment cycle, significant investment in related operating activities, leading to the decline. As of the end of February 2024, the company had a net cash balance of $4.7 billion, mainly composed of cash and short-term investments.

Apart from using this cash for school expansion and equipment purchases, the company also used part of it for stock repurchases. However, similar to the previous quarter, the company's stock price remained strong in the third quarter, so the management did not have many repurchase actions. As of April 23 before the financial report was released, in this round of repurchase plan, the company has repurchased a cumulative total of 6 million shares, consuming $195 million.

End

Dolphin "New Oriental" Historical Articles:

Financial Report

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

January 25, 2024 Financial Report Review "New Oriental: Enjoying the "Fruition Period""

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

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

July 26, 2023 Financial Report Review "New Oriental: The reversal logic of new and old businesses is gradually being realized" (link)

April 20, 2023 Conference Call "New Oriental: Repair is not over yet, growth is still to come (3Q23FY Conference Call Summary)" (link)

April 19, 2023 Financial Report Review "New Oriental: How many more times of exceeding expectations are needed to regain market faith?" (link)

January 18, 2023 Conference Call "New Oriental: Increasing investment while focusing more on group profit margin (FY2Q23 Conference Call Summary)" (link)

January 17, 2023 Financial Report Review "New Oriental: After making money from live streaming, old businesses return to investment" (link)

In-depth

April 4, 2023 "Cash builds a solid foundation, Dong Yuhui can't control New Oriental" (link)

January 13, 2023 "Dong Yuhui joins the Spring Festival Gala, can New Oriental still rely on education in the future?" (link)

Risk Disclosure and Statement of this article: Dolphin Investment Research Disclaimer and General Disclosure