New Oriental Education: Small Risk With Big Payoff

Summary

  • Chinese regulators are increasing restrictions on private, for-profit tutoring companies such as New Oriental Education & Technology Group Inc.
  • The country is increasingly tightening its grip on the tutoring sector.
  • China has banned “foreign curricula” prior to grade 9, which hurts New Oriental even more since it focuses on preparing Chinese students to study abroad.
  • This article focuses on the fundamentals and what the real value is versus the current share price.

New Oriental Education & Technology Group Inc. (EDU) has taken a hit in the first half of 2021. The Chinese online education stock plummeted 55.9% for the period. This is in large part due to not only the COVID-19 pandemic, but also increased regulation on private, for-profit tutoring in the country.

New Oriental has previously been focused on preparing Chinese students to study abroad. The COVID-19 travel restrictions have impacted the ability to capitalize on that particular sector. However, the company is also a major player in tutoring services, which have recently become subject to stricter regulations in China. The country is increasingly tightening its grip on the tutoring sector in an effort to ease pressure on school-aged children and reduce child-raising costs. The effect that this crackdown will have on New Oriental and the multi-billion-dollar private tutoring industry remains to be seen.

While current news stories, good or bad can sway our opinion about investing in a company, it’s good to analyze the fundamentals of the company and to see where it’s been in the past and in which direction it’s heading.

This article will focus on the long-term fundamentals of the company, which tend to give us a better picture of the company as a viable investment. I also analyze the value of the company versus the price and help you to determine if EDU is currently trading at a bargain price. I provide various situations which help estimate the company’s future returns. In closing, I will tell you my personal opinion about whether I’m interested in taking a position in this company and why.

Snapshot of the Company

A fast way for me to get an overall understanding of the condition of the business is to use the BTMA Stock Analyzer’s company rating score. It shows a score of around 73/100. Therefore, New Oriental Education & Technology Group is considered to be a good company to invest in, since 70 is the lowest good company score. EDU has high scores for 10 Year Price Per Share, Earnings per share, Ability to Recover from a Market Crash or Downturn, and Gross Margin Percent. It has a mediocre score for ROE. It has low scores for ROIC and PEG Ratio. A low PEG Ratio score indicates that the company may not be experiencing high growth consistently over the past 5 years. In summary, these findings show us that EDU seems to have above-average fundamentals.

Before jumping to conclusions, we’ll have to look closer into individual categories to see what’s going on.

(Source: BTMA Stock Analyzer )

Fundamentals

Let’s examine the price per share history first. In the chart below, we can see that price per share has been mostly consistent at increasing over the last 5 of 6 years, with the exception of 2021 where share price had declined. This decline may have been caused by a one-time event or possibly because of COVID’s effect on revenues. So, we’ll keep that in mind while doing our analysis.

Overall, share price average has grown by about 129.67% over the past 10 years or a Compound Annual Growth Rate of 9.68%. This is a decent return for many long-term hold investors.

Additionally, let’s consider the growth prior to the decline in 2021 and instead focus on the growth up to the end of 2020. At that time, the share price was around $18.50. This would mean that the 10-year absolute growth was 652% or a Compound Annual Growth Rate of 25%!

(Source: Yahoo – Price Per Share History)

Earnings

Looking closer at earnings history, we see that earnings have grown overall during the 10-year period, but they haven’t grown consistently. In this type of educational business, it seems likely to have some boom-and-bust periods, which cause volatility in the earnings performance.

The important thing to note is that the earnings have grown more than they have declined and that the growth has been fairly impressive.

Overall, average earnings have had a Compound Annual Growth Rate of 15.7% during this chart’s range.

Consistent earnings make it easier to accurately estimate the future growth and value of the company. So, in this regard, EDU is not an ideal candidate of a stock to accurately estimate future growth or current value.

(Source: BTMA Stock Analyzer – EPS History)

Since earnings and price per share don’t always give the whole picture, it’s good to look at other factors like the gross margins, return on equity, and return on invested capital.

Return on Equity

The return on equity is borderline and could use improvement. Five-year average ROE is average at around 16%. For return on equity (ROE), I look for a 5-year average of 16% or more. So, EDU just meets my requirements in this category. I’d like to keep an eye on the ROE and hope that it will consistently stay above 16% and ideally grow into the higher teens.

(Source: BTMA Stock Analyzer – ROE History)

Let’s compare the ROE of this company to its industry. The average ROE of 38 Education companies is -5.66%.

Therefore, New Oriental Education & Technology Group’s 5-year average of 15.64% and current ROE of 16.23% are well above average. It seems that this industry might be difficult to establish a high ROE, but relative to its competition, EDU is doing a sufficient job.

Return on Invested Capital

The return on invested capital is similar to ROE in that it had a dip in 2019 and could also use improvement. Five-year average ROIC is low at around 11%. For return on invested capital (ROIC), I also look for a 5-year average of 16% or more. So, EDU does not pass this test.

(Source: BTMA Stock Analyzer – Return on Invested Capital History)

Gross Margin Percent

The gross margin percent (GMP) has been slightly decreasing over the last five years. Five-year GMP is good at around 57%. I typically look for companies with gross margin percent consistently above 30%. So, EDU has proven that it has the ability to maintain acceptable margins over a long period. I’m not too concerned with this slight decrease in gross margins, but I’d like to keep an eye on it to make sure it doesn’t continue this declining trend.

(Source: BTMA Stock Analyzer – Gross Margin Percent History)

Looking at other fundamentals involving the balance sheet, we can see that the debt-to-equity is less than 1. This is a good indicator, telling us that the company owns more than it owes.

EDU’s Current Ratio of 2.01 is satisfactory, indicating that it has an adequate ability to use its assets to pay its short-term debt.

Ideally, we’d want to see a Current Ratio of more than 1, so EDU exceeds this amount.

According to the balance sheet, the company appears to be in good financial health. In the long term, the company seems stable in regards to its debt-to-equity. In the short term, the company’s financial situation is also adequate.

The Price-Earnings Ratio of 32.1 indicates that EDU might be selling at a high price when comparing EDU’s PE Ratio to a long-term market average PE Ratio of 15. The 10-year and 5-year average PE Ratio of EDU has typically been between 36.5 and 46.2, so this indicates that EDU could be currently trading at a low price when comparing to EDU’s average historical PE Ratio range.

EDU does not currently pay a regular dividend.

(Source: BTMA Stock Analyzer – Misc. Fundamentals)

This analysis wouldn’t be complete without considering the value of the company vs. share price.

Value Vs. Price

For valuation purposes, I will be using a diluted EPS of 0.23. I’ve used various past averages of growth rates and PE Ratios to calculate different scenarios of valuation ranges from low to average values. The valuations compare growth rates of EPS, Book Value, and Total Equity.

In the table below, you can see the different scenarios, and in the chart, you will see vertical valuation lines that correspond to the table valuation ranges. The dots on the lines represent the current stock price. If the dot is towards the bottom of the valuation range, this would indicate that the stock is undervalued. If the dot is near the top of the valuation line, this would show an overvalued stock.

(Source: BTMA Wealth Builders Club )

According to this valuation analysis, EDU is undervalued.

  • If EDU continues with a growth average similar to its past 10 years earnings growth, then the stock is overpriced at this time.
  • If EDU continues with a growth average similar to its past 5 years earnings growth, then the stock is undervalued at this time.
  • If EDU continues with a growth average similar to its past 10 years book value growth, then the stock is overpriced at this time.
  • If EDU continues with a growth average similar to its past 5 years book value growth, then the stock is undervalued at this time.
  • If EDU continues with a growth average similar to its past 5 years total equity growth, then the stock is undervalued at this time.
  • According to EDU’s typical PE ratio relation to the S&P 500’s PE Ratio, EDU is undervalued.
  • If EDU continues with a growth average as forecasted by analysts, then the stock is overpriced.

This analysis shows an average valuation of around $8.12 per share versus its current price of about $6.60, this would indicate that New Oriental Education and Technology is undervalued.

Forward-Looking Conclusion

According to the facts, New Oriental Education and Technology is financially healthy in a long-term sense in having enough equity as compared with debt, and in the short term because the current ratio indicates that it has enough cash to cover current liabilities.

Other fundamentals are solid, including EPS and Gross Margin Percent. The Return on Equity is borderline for my standards, but it is high for EDU’s industry. ROIC could use improvement as it didn’t meet my standards.

Lastly, this analysis shows that the stock is undervalued.

Another pro is that this stock has shown the ability to have great growth potential. From the chart below, we can see that accelerated growth took place after 2015 until the end of 2020. Then share price has been on the decline.

Even from 2007 to 2015, EDU has kept pace with or has out-performed the S&P 500. On top of that, EDU has had 5 years of growth way beyond the performance of the S&P 500 benchmark. When considering these factors, the sharp downturn of performance in the short period of the past year and a half seems like it might just be a temporary situation caused by COVID and regulations. I’m not too concerned with this downturn and believe that it’s very likely for EDU to return to its pre-COVID growth levels within the next few years.

Predicted Growth

Over the next five years, the analysts that follow this company are expecting it to grow earnings at an average annual rate of 23.78%. This year, analysts are forecasting earnings increase of -3.3% over last year. Analysts expect earnings growth next year of 44.8% over this year’s forecasted earnings. (Source: Forecast Earnings Growth)

If you invest today, with analysts’ forecasts, you might expect about 23% growth per year.

Here is an alternative scenario based on EDU’s past earnings growth. During the past 10 and 5-year periods, the average EPS growth rate was about 12.6% and 10.4%, respectively.

But when considering cash flow growth over the past 10 and 5 years, the growth has been 14.1% and 6.6%, respectively.

If considering actual past results of New Oriental Education, the story is a bit different. Here are the actual 10 and 5-year return results.

______________

10 Year Return Results if Invested in EDU:

Initial Investment Date: 7/12/2011

End Date: 7/12/2021

Cost per Share: $2.87

End Date Price: $6.51

Total Dividends Received: $0

Total Return: 126.55%

Compound Annualized Growth Rate: 9%

_______________

5 Year Return Results if Invested in EDU:

Initial Investment Date: 7/12/2016

End Date: 7/12/2021

Cost per Share: $4.09

End Date Price: $6.51

Total Dividends Received: $0

Total Return: 58.81%

Compound Annualized Growth Rate: 10%

_________________

From these scenarios, we have produced results from 9% to 10%. However, if we look at the growth rates prior to COVID up to 7/12/2020, the compound annualized growth rates were around 20% to 38%!

I feel that if you’re a long-term patient investor and believer in EDU, and its well-established one-stop shopping private educational services in China (including bookstores, learning centers, tutoring, test prep, and vocational training), you could expect EDU to provide you with around at least 10% annual return. Whereas, if you can buy when EDU’s price is favorable, you could find yourself holding a strong growth stock producing 20% or more in annual returns.

For me, the choice is certain. I would take an objective look at this company and realize that New Oriental Education and Technology Group is a chance to own a high-growth company with above-average long-term fundamentals (especially in its industry). For investors outside of China, this stock offers some global diversification and an opportunity to capitalize on China’s explosive growth potential.

New Oriental Education has a proven system of marketing, student enrollment, and successful services. Education among Chinese students is in high demand. I am a former professor, who worked in Asia for a decade and taught many Chinese university students. I know first-hand, the value of education for these types of students and the sacrifice that their families are willing to take to pay for educational services.

A main focus of New Oriental is to prepare Chinese students to study abroad. Obviously, most students’ plans of studying abroad were put on hold because of COVID. But let’s be honest. The COVID situation and its restrictions will improve. Demand for studying abroad will eventually return and we may even see an overflow of students, who have been anxiously waiting to go abroad. It seems evident that New Oriental’s services will be in high demand again.

Chinese regulations against private tutoring will also affect the company, but the families and educational companies will likely find ways to continue delivering these sought-after education services to the knowledge-hungry students.

As Warren Buffett has said, “I like to buy companies when they’re on the operating table.”

New Oriental Education is a good company that’s going through some temporary tough times. This has presented a bargain price for the stock and I believe that the benefits far outweigh the small risk.

To put things in perspective with numbers, EDU was producing annual returns of 20% to 39% over the past 10 and 5 years prior to COVID. So, you can see that this company has proven in the past that it has the potential for long-term large growth.

Considering all factors discussed in this article, I see little risk in buying this company (at a bargain price) and holding it for the great upside performance that this stock has proven that it can achieve.

Author: Grant Gigliotti, Seeking Alpha