We expect a better 2H19E with YoY rev/adj. NP growth of 24%/117% YoY because (1) revenue growth of small group tutoring is recovering and (2) loss-making online education business has been divested.
- Satisfactory student admission in 2H19E. Due to regulatory impact, YoY revenue growth for small group tutoring moderated from 33% in 2H18 to 22% in 1H19. That said, as regulatory impact faded, we expect YoY revenue growth to recover from 20% in 1H19 to 24% in 2H19E, and 2H19E full class rate to improve from 62.5% in 1H19.
- Loss-making online education business divested. The Company has been investing R&D and advertising for online small group tutoring and recorded RMB34mn expenses in 1H19, which eroded 4.0ppt OPM in 1H19. This business will rely on heavy investment to obtain online users traffic, which would put pressure on the Company’s financial performance in short term. The Company has lowered its stake from 60% to 30% by introducing external investment in Aug to achieve balance for profitability. We expect overall OPM to improve significantly in 2H19E.
- Education center expansion plan unchanged. Though net openings was 18 in 1H19 (mainly in major cities in Greater Bay Area), management maintains its target of adding 40-50 centers in FY19E and 150 centers in 2018-2020E. According to Frost & Sullivan, number of students enrolled in K12 after-school tutoring in Guangdong was 5.5mn in 2018, only representing 28% of Guangdong’s K12 formal education student number. Such penetration rate is lower than tier 1 cities’ 62.9% in 2017. We think there is still large room for the Company to penetrate its school network.
- 1H19 after tax profit fell 9%. Revenue rose 20% to RMB867mn, driven by 12% growth of tutoring hours and 7% tuition fee growth. GPM dropped 0.9ppt to 41.4% due to opening and renovation of new education centers. After tax profit fell 9% to RMB75mn due to after tax loss of RMB26mn incurred for online small group tutoring, RMB10mn reduced fair value gain on investments and RMB8mn cost for adoption of new IFRS 16.
- Maintain Buy but lowered TP. We revised down FY19/20/21E adj. net profit by 21%/5%/3% to reflect lower student enrollment, IFRS 16 impact and loss in online education. Our TP is changed from HK$3.72 to HK$3.41, representing 13.0x FY20E P/E, which is still at 20% discount to sector average but rolled forward. Valuation is undemanding as net cash and investments totaled RMB1.15bn as 30 Jun 2019, equivalent to 74% of market cap. Catalysts: (1) better-than-expected student enrollment; (2) M&A. Risks: (1) fierce competition; (2) teacher cost pressure; (3) government policies.
