New Oriental Education: Capital Return Improvement And Margin Expansion Are Potential Catalysts
Contributor since 2012 / 12153 Followers
Summary:
- New Oriental Education is assigned a Buy rating, considering the stock’s attractive valuations and the presence of potential re-rating catalysts.
- EDU’s capital return outlook is positive, with a significant increase in its share repurchase authorization and the potential for additional special or regular dividends.
- The company is expected to achieve significant operating margin expansion in Q1 FY 2025 and beyond, driven by strong revenue growth and the improved utilization rate for new learning centers.
Willie B. Thomas
New Oriental Education & Technology Group Inc. (NYSE:EDU) stock is still rated as a Buy. The stock’s valuations are appealing based on a comparison of its P/E metric with its expected earnings growth rate. There are potential re-rating catalysts for EDU in the form of an improvement in operating margin and an increase in capital returned to shareholders.
Earlier, I previewed EDU’s Q4 FY 2024 (YE May 31, 2024) financial performance in my July 12, 2024 write-up.
EDU’s Future Shareholder Capital Return Could Become Better
New Oriental Education surprised the market in a positive way with its latest shareholder capital return initiatives announced last month. My view is that there is the potential for an improvement in EDU’s shareholder capital return in the future.
On August 6, 2024, EDU revealed that “the aggregate value of shares that the company is authorized to repurchase under the share repurchase program is increased from $400 million to $700 million.” New Oriental Education subsequently disclosed on August 19 that it will be distributing “a special cash dividend” of “$0.6 per ADS” or “$100 million” in absolute terms in late September this year. In other words, the company had increased the amount of excess capital returned to shareholders in a significant manner.
I have a positive opinion of New Oriental Education’s shareholder capital return outlook.
EDU has $369.7 million remaining from its share buyback authorization as of August 6, 2024, and the company’s buyback plan expires on May 31, 2025 or at the end of FY 2025. This implies that New Oriental Education’s forward buyback yield is around 3.5%, assuming that it completes its share repurchase program.
At the company’s prior Q4 FY 2024 analyst call in end-July, EDU emphasized that it has “a lot of cash” or “$4.9 billion” in cash, deposits, and investments to be specific. New Oriental Education also stressed at its most recent quarterly results briefing that the company will “think about even more types” of “capital allocation to the investors.”
New Oriental Education’s latest management commentary indicates that the company is likely to return more capital to shareholders in the form of share repurchases and dividends.
With respect to share buybacks, EDU has already expanded the size of its share repurchase plan, as mentioned. There is the possibility of New Oriental Education further increasing the size of the company’s share buyback program or initiating a new share buyback plan, if it utilizes the remaining $369.7 million share repurchase authorization in full before May 31, 2025.
In terms of dividends, New Oriental Education has never paid regular dividends, although the company did distribute special dividends in an irregular fashion in the past. As a reference, EDU paid out special dividends to its shareholders in 2024, 2017, 2015, 2013, and 2012 as per its historical dividend payment track record.
At recent investor meetings organized by the sell side, New Oriental Education has indicated its intention to consider additional dividend distributions in the future. Mainland Chinese broker BOCI published a report (not publicly available) titled “Post-Results NDR (Non-Deal Roadshow) Takeaways” on August 14, 2024 highlighting that EDU is looking at potentially paying out “special dividends in both FY 2025 and FY 2026.” Separately, a September 11, 2024 Goldman Sachs (GS) report (not publicly available) titled “China Conference 2024” noted that “management has put the potential recurring dividend policy under consideration.”
In my view, it is highly probable that EDU will distribute additional special dividends or initiate regular dividends going forward, taking into account the company’s substantial cash pile and its recent management comments.
In summary, New Oriental Education’s future shareholder capital return could improve with more regular dividend distributions and additional share repurchases, which will most likely be well received by investors.
New Oriental Education Has The Potential To Improve Its Operating Profitability
Looking ahead, EDU is expected to achieve significant operating margin expansion in my opinion.
New Oriental Education’s positive top-line growth momentum should be sustained in the near future. EDU’s revenue rose by +32.1% YoY to $1,137 million in Q4 FY 2024 as per its results announcement. The company has guided for its top line for its core education services business (excluding the non-core live-streaming operations) to increase by between +31% YoY and +34% YoY for Q1 FY 2025, which is on par with its Q4 FY 2024 revenue expansion.
There are two factors supporting EDU’s good Q1 FY 2025 revenue guidance. One factor is that the company’s deferred revenue (balance sheet item reflecting cash received prior to the performance of services), a leading indicator of future top line, jumped by a significant +33.1% YoY in Q4 FY 2024. The other factor is that New Oriental Education is committed to growing its learning center network by +20%-25% for FY 2025 as per its Q4 FY 2024 earnings call commentary.
EDU noted at the company’s latest quarterly earnings briefing that it is anticipating a +2.0 percentage points YoY improvement in its operating profit margin for the core education services business in Q1 FY 2025. As a comparison, New Oriental Education’s operating margin contracted by -590 basis points YoY to 3.2% for Q4 FY 2024. As such, EDU’s shares are likely to perform well going forward, if the company can achieve its targeted operating profitability improvement for the first quarter of the new fiscal year.
At its Q4 FY 2024 analyst briefing, New Oriental Education mentioned that it “accelerated the learning center extension in this quarter and even in the last two quarters.” In other words, EDU’s Q4 FY 2024 operating margin was likely to have been impacted by a sharp increase in revenue contributed by new and unprofitable learning centers. According to Goldman Sachs’ September 14 report referred to in the preceding section, EDU disclosed that its learning centers will typically achieve breakeven in six months’ time. This means that New Oriental Education’s operating profitability will most probably get better going forward, as an increasing number of its new learning centers mature.
Another issue relating to the rapid growth of EDU’s learning center network is a decline in overall utilization rate as the company seeks additional students to fill up the new learning centers. Moving forward, New Oriental Education guided at its fourth quarter results briefing that “pressure on margins for the educational business will reduce in the next fiscal year (FY 2025) as we continue to improve the utilization of facilities.”
In a nutshell, an improvement in the company’s operating margin could help to drive a favorable re-rating of New Oriental Education’s share price and valuations.
Key Risks
There are certain risks to consider before initiating a position in EDU.
The first key risk is that New Oriental Education doesn’t distribute dividends for FY 2025 and beyond, and it also doesn’t complete its existing share buyback plan.
The second key risk is that the company fails to execute well on its learning center growth plans, which leads to a drop in the overall utilization rate of its learning center network.
Closing Thoughts
My Buy rating for EDU stays unchanged, as the stock is trading at an attractive valuation with potential re-rating catalysts.
In the previous July 12, 2024, article, I indicated that “New Oriental Education’s shares are undervalued based on the Price-to-Earnings Growth or PEG valuation metric.” This is still a valid argument. As per S&P Capital IQ data, EDU currently trades at 18.1 times consensus next twelve months’ normalized P/E, and the analysts’ consensus FY 2024-2027 normalized EPS growth projection is +38.2%. This translates into an undemanding PEG ratio of 0.47 times for New Oriental Education.
I have highlighted New Oriental Education’s key valuation re-rating catalysts like capital return improvement and margin expansion in this article.
Analyst’s Disclosure: I/we have no stock, option or similar derivative position in any of the companies mentioned, and no plans to initiate any such positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
Seeking Alpha’s Disclosure: Past performance is no guarantee of future results. No recommendation or advice is being given as to whether any investment is suitable for a particular investor. Any views or opinions expressed above may not reflect those of Seeking Alpha as a whole. Seeking Alpha is not a licensed securities dealer, broker or US investment adviser or investment bank. Our analysts are third party authors that include both professional investors and individual investors who may not be licensed or certified by any institute or regulatory body.
Asia Value & Moat Stocks is a research service for value investors seeking Asia-listed stocks with a huge gap between price and intrinsic value, leaning towards deep value balance sheet bargains (i.e. buying assets at a discount e.g. net cash stocks, net-nets, low P/B stocks, sum-of-the-parts discounts) and wide moat stocks (i.e. buying earnings power at a discount in great companies like “Magic Formula” stocks, high-quality businesses, hidden champions and wide moat compounders). Sign up here to get started today!