China Educator New Oriental Cuts Class To Get An 'A'

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When it was rapidly expanding tutoring programs across China, this ambitious education firm called its strategy "occupy the market."

NowNew Oriental Education & Technology Group ( EDU ) is in what it calls "harvest" mode, cutting back marginal learning centers, and staff, to improve margins and profitability.

Since the firm's so-called "harvest the market" strategy began nearly a year ago, New Oriental has closed more than 70 learning centers and cut about 3,600 employees, or more than 10% of its staff.

The strategy has borne fruit. The operating margin in the fourth quarter ended May 31 jumped to 10.2% from 5.8% a year earlier. Earnings rose 80% to 18 cents a share, the best growth rate in six quarters.

Though earnings for the full year were still up only 2%, the slowest pace in years, analysts expect the "harvest" program to bear more rewards in the current fiscal year. In a poll by Thomson Reuters, earnings are seen rising 51% to $1.31 a share.

But revenue is forecast to grow at half that rate, 21% to $1.16 billion, the slowest in the last decade. Even during the global recession, revenue grew 40% to 50% a year.

"By U.S. standards it's slowing from astronomical growth to just very fast growth," said Wells Fargo analyst Trace Urdan.

Emphasis On English

Beijing-based New Oriental prepares Chinese students for tough entrance exams to the country's top universities or for study abroad, mainly in the U.S. It specializes in English-language courses and test preparation.

Its 700 learning centers in 50 cities enrolled around 2.5 million students in fiscal 2013.

Students in tutoring programs range from early grade school to college age. Most are high-school students taking after-school classes.

"These are supplemental classes privately paid by parents to give students an edge as they prepare for high-stakes exams," Urdan said. "Parents and grandparents will sacrifice to give their children (the chance) to be accepted in one of China's elite universities or, alternatively, to study in the U.S."

New Oriental has been shifting to smaller classroom sizes. Parents pay more but demand is strong for what is viewed as higher quality learning, Urdan says.

"Their bread and butter has been giant lecture classes with entertaining lecturers. But they've been able to crank up the price points by offering smaller and smaller class sizes," Urdan said.

Analysts at T.H. Capital estimate that small-class enrollment made up about 60% of New Oriental's total courses offered in the last quarter, up from 32% a year earlier. They note that fees range from $2,000 to $8,000 per course in small classrooms vs. less than $1,000 for large classes.

"While the shift from big class to smaller-sized class could lead to slower growth in enrollments, the higher (price) could offset the negative impact and drive revenue growth," T.H. Capital analysts Tian Hou, Jack Yang and Gina Chen wrote in a research report.

New Oriental competes with many other for-profit education companies that tutor students in China, such asTAL Education ( XRS ),Xueda Education Group ( XUE ) andChina Distance Education Holdings ( DL ).

Urdan says New Oriental is the market leader "by far."

Last year New Oriental was rocked by questions from well-known Chinese-stock short seller Carson Block of Muddy Waters Research over ownership of some of its schools and how they were accounted for in financial reports.

The company's stock plummeted on July 18, 2012, to a multi-year low of $9.50 but an SEC investigation later found no wrongdoing. Shares have since climbed to around $25, but they're still below their earlier high.

"There is still this overhang on small-cap Chinese stocks and (New Oriental)," Urdan said.

Stock Buyback

In the aftermath of the Muddy Waters' attack last July, New Oriental's management initiated a $33 million share buyback program "to demonstrate confidence in our company." Between late April and June of this year, the firm bought back $50 million in shares. And in July, the board approved a special cash dividend of 35 cents per ADS, a 17% increase from last year's dividend, to be paid on Oct. 7.

Other issues have surfaced, though not due to any allegations of wrongdoing. New Oriental noted in its July 23 quarterly report that local competition was "intensifying," especially in large cities such as Beijing and Shanghai.

But in an Aug. 20 research note following a meeting with management, Oppenheimer analyst Ella Ji said that New Oriental's Beijing operation has "bounced back," with revenue growing 30%. Its Shanghai school "appears to be lagging expectations," however.

T.H. Capital analysts expect enrollment in fiscal 2014 to grow 6%, up from 2013's 5.7% growth rate, and average revenue per student to rise 18.7%. In the May-ended fourth quarter, student enrollment grew 6% from the earlier year to around 559,000 students.

New Oriental hasn't yet reported results for the first quarter ended Aug. 31. But management has forecast revenue growth of 16% to 21% for it, lower than normal to reflect the firm's "harvest" program.

The company said it closed 73 underperforming centers in fiscal 2013 and that it had no openings in the first quarter through July 22, compared with 89 centers opened in Q1 of 2013.

In a conference call, Chief Financial Officer Tung-Jung Hsieh said the company might open 20 to 50 centers starting in October or November to brace for an expected surge in demand in the second half of the fiscal year.

Though management, in its guidance on July 23, said that it might be impacted by a slowing Chinese economy, it said high-end teaching services are more resilient than other discretionary categories.

China's economy seems to have been improving in recent weeks, in that it's no longer slowing, according to Urdan. "We'll see when the company reports its next quarter if they agree," he said.



The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of The NASDAQ OMX Group, Inc.



This article appears in: Investing , Investing Ideas

Referenced Stocks: DL , EDU , XRS , XUE

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