New Oriental Emerges from Carnage of Education Cleanup

Key Takeaways:

• New Oriental Education returned to profitability in its latest reporting quarter, as its revenue declines continued to ease
• The company’s new business mix after China banned K-12 tutoring in core curriculum areas includes non-academic tutoring and study abroad services

By Doug Young

Despite making earlier headlines with its creative new foray into livestreaming e-commerce, the latest quarterly results from New Oriental Education and Technology Group Inc. EDU show the company’s future still lies squarely in its core education area. The company excited investors with a return to profitability in its latest quarter through August as many of its new services posted solid growth, indicating the worst was behind it following a year of turmoil.

“The company has now entered a stage of starting a fresh page, exploring new opportunity with greater flexibility and strong cash flows. We’re confident in the sustainable profitability of all our remaining key business, as well as the growth and prospects of our new initiatives,” said Yang Zhihui, who also uses the English name Stephen, on the company’s investor call. He added the company expects to achieve profitability for its entire current fiscal year that runs through next May.

Investors applauded the latest report by bidding up New Oriental’s New York-listed shares by 28% on Wednesday. The company’s Hong Kong-listed shares followed with a similar 23% gain in early Thursday trade. Shares of New Oriental’s Hong Kong-listed Koolearn (1797.HK) online unit, which runs its new e-commerce initiative, were up by a milder 15% in early Thursday trade.

New Oriental is one of the few U.S.-listed Chinese stocks that can boast gains for 2022, with its shares up about 45% year-to-date. But those gains only came after the company’s stock tanked last year, along with most other companies from China’s private education sector. Even after this year’s gains, New Oriental’s shares still trade at about one-sixth their peak levels from February 2021.

The past year has been a brutal one for China’s formerly vibrant field of private companies offering after-school tutoring services to K-12 students. China formally banned such services around a year ago in a bid to ease the pressure on its students, leading to sharp revenue declines for New Oriental and its peers.

As year-ago comparisons become less brutal more than a year after the new restrictions took effect, we can expect to see smaller revenue declines for companies like New Oriental. Reflecting that, the company said it expects to post revenue of $601.4 million to $619.2 million in its current fiscal quarter that runs through November, down about 7% year-on-year. That would represent a huge improvement over the 43% decline in its just-reported quarter through August, and a 57% decline in the quarter before that.

So, could this mark the start of a new beginning for the company? Investors seem to think so, at least based on its current valuation. New Oriental trades at a high forward price-to-earnings (P/E) ratio of 70, though that figure will quickly come down as its profits improve. On a price-to-sales (P/S) basis, it still trades at a relatively mediocre ratio of 1.1. But anything above 1 is generally good for U.S.-listed Chinese firms these days, and the figure still beats rivals TAL Education TAL and Gaotu Techedu GOTU, which trade at P/S ratios of 0.7 and 0.4, respectively.

New business mix

With all that big-picture information as background, we’ll spend the second half of this review with a deeper dive into New Oriental’s latest results, starting with what its new business mix looks like in the post-shakeup world.

The company still derives the biggest single piece of its revenue, about 40%, from its traditional and new businesses targeting K-12 students, which include test preparation, non-academic tutoring and study tours.

The other two big contributors are online, whose biggest piece appears to be the e-commerce initiative we’ve written about previously, featuring teachers hawking agricultural goods to consumers using livestreaming; and services related to students considering overseas study, including overseas test preparation and overseas study consulting. Each of those areas contribute between 20% and 30% of total revenue.

On an overall basis, the company posted revenue of $744.8 million in its latest quarter, which we previously noted was down 43% year-on-year. A sizable proportion of that came from new businesses that have only been rolled out over the last year, led by non-academic tutoring services that now have 297,000 enrollments in over 60 cities.

The company has mentioned a number of non-education initiatives in the past year during its transition, covering everything from e-commerce to microchips. But with the exception of mentions of the e-commerce initiative, called Dong Fang Zhen Xuan, the company hasn’t provided any updates on any of the other moves, indicating they probably have yet to make any meaningful revenue contribution.

The company’s operating costs fell by 48% to $667 million in its latest quarter, largely the result of the massive closure of facilities and layoffs in response to the K-12 after-school tutoring ban. Following that, New Oriental said it now has just 706 schools and learning centers around China, less than half the 1,556 it had a year earlier.

The company also looks quite healthy in terms of cash flow, which rose to a positive $185.2 million in the latest quarter from just $29.3 million in the previous quarter and a negative figure in the quarter before that. As a result, the company’s cash and short-term investments ticked up slightly to $4.3 billion at the end of August from $4.2 billion three months earlier.

New Oriental’s bottom line was also back in the black after falling into the red in the previous two quarters. The company reported a net profit of $66 million, up 9% year-on-year, though its non-GAAP profit, which includes items like share-based compensation, fell 25% to $84 million.

Analysts from Citigroup, UBS and BofA Securities were among the group asking questions on the company’s latest investor call, showing the investment community hasn’t given up on New Oriental just yet. At the end of the day, education will always be a lucrative business in China due to the strong value the culture places on self-improvement. The trick for New Oriental and its peers will be finding ways to offer products and services that cater to that focus while avoiding the unpredictable hand of Chinese regulators.