New Oriental Education & Tech Grp (ADR) Keeps Shining Bright

By Markets Fool.com

Image source: Getty Images.

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Right now, it seems as if New Oriental Education (NYSE: EDU) has done a good job of consulting its crystal ball. Coming out of the Great Recession, the Chinese company focused almost entirely on preparing Chinese high school students hoping to attend college in America to take English-language exams.

But sensing shifting winds in the business climate, encroachment from competitors, and an opportunity closer to home, founder and then-CEO (now Chairman) Michael Yu decided to pivot the company's focus to K-12 tutoring and after-school programs. Based on the company's string of encouraging quarterly reports -- including the one released Tuesday morning -- it was the right decision.

Just the numbers

For investors focused on the bottom line, there was a lot to like from the most recent report, which covered the company's first fiscal quarter.

Metric

Results

Growth (YOY)

Revenue

$534 million

16.5%

Operating income

$153 million

17.5%

Earnings per share

$0.90

6.7%

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New Oriental's fiscal first-quarter 2016 results. Data source: New Oriental investor relations. YOY = year over year.

In constant currency, revenue growth was even more impressive, up 24% according to Yu. This helps explain why the stock was trading up as much as 8% following its earnings release. Long-term investors -- focusing on deeper issues -- should be equally pleased with what's happening at the company.

After-school tutoring continues strong growth

Yu kicked off the company's announcement by saying: "We are very pleased with what was a very strong start to fiscal year 2017. ... By all accounts, this is a very solid start to the new fiscal year."

He isn't exaggerating.

Perhaps the most important metric for investors to note is total enrollments. In all of the company's K-12 after-school tutoring programs, enrollments jumped to 1.33 million, up an impressive 31.2%. At the same time, the company increased its number of locations throughout China by only 7%, to 771 learning centers and schools. That means that each existing school has seen its enrollment swell.

CFO Stephen Yang explained that some of this growth was due to New Oriental's approach to the start of the fiscal year: "In order to rapidly acquire grade 7 student customers before they start the first year of secondary school, we rolled out a large scale promotion this summer, by offering low price experiential courses for multiple subjects."

Balancing efficiency with reinvestment

Equally impressive was New Oriental's ability to balance its spending during the quarter. Total operating expenses grew slower than revenue, but were up 16.1% for the quarter. And the areas where the company was spending its money were the right ones: increasing teacher salaries and ramping up marketing for the start of the school year.

Ideally, that marketing spend will wane in the coming semesters as the back-to-school rush subsides. But training and keeping excellent teachers is vital. As Chinese families become familiar -- and comfortable -- with their children's after-school teachers, they will likely be loath to switch out.

At the same time, New Oriental continues to invest heavily in its online-to-offline (O2O) network. In short, this allows for a seamless transition between educational training and purchases made online, with real-world, paper-and-pencils instruction happening in classrooms. That type of network -- along with the aforementioned high switching costs and the company's impressive build-out of 771 locations in the Middle Kingdom -- will provide a sustainable moat for years to come.

This investment is the reason EPS grew much more slowly than revenue, but it's a trade-off that long-term investors should be more than willing to take.

Looking ahead

The midpoint of management's forecast for revenue growth next quarter is $330 million. That's 19% higher than the same time last year, and signifies 25% growth in constant currency. After today's jump, the stock is now trading for 35 times trailing earnings, but just 17 times free cash flow.

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Brian Stoffel has no position in any stocks mentioned. The Motley Fool recommends New Oriental Education. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.