Revenue composition more susceptible to online competitors

The following is the full report:

Revenue composition more susceptible to online competitors

The core business of New Oriental focuses on the standardized English training market, which contributes about 40% to 50% of the profit. We therefore believe that the new Oriental is more vulnerable to the challenges of online education institutions. Therefore, new Oriental plans to enter the primary and secondary education market in the form of small classes. The business is not susceptible to online competitors, but will be detrimental to the growth rate and profitability of the new Oriental. We cut the target share price of new Oriental by 27% to $27 and downgraded the stock rating to "hold".

Business transition leads to weak margins

New Oriental's revenue growth in fiscal 2015 is likely to be propped up. The company plans to open 60 to 70 new learning centers, as well as a redesigned "bubble children English" program. However, we expect the profitability of the new Oriental to remain flat and even fall. Fiscal 2015 and 2016 are expected to be 19.9% and 19.4% respectively, down from 2014 in the 20.4% fiscal year. This is because: 1 to strengthen investment in online projects (2015 of the financial year will reach 25 million to 30 million U.S. dollars, higher than the current 10 million U.S. dollars); 2 The revenue component will tilt towards higher growth, but lower-margin small-class primary and secondary school training. At the same time, there is little room to boost profitability by boosting operational efficiency after the rationalization of fiscal year 2014.

Unified strategy: Offline dominance, online replenishment

We anticipate that new Oriental will adopt a unified strategy to grasp the opportunities of online education market to make up for the threat of offline business. As a leader in content, we expect the new Oriental to remain the leader in the education industry and will use the line to make up the offline model.

Lower target share price, downgrade to "hold"

Taking into account the unfavourable outlook for the English preparation training market and the decline in profit margins, we will cut the net revenue forecast for the new Oriental 2014, 2015 and 2016 respectively by 3%, 2% and 2%, and cut 9%, 15% and 20% per share earnings of ads for non-US general accounting standards. Our new target share price of 27 U.S. dollars is unchanged at 1 times times the growth rate of the 2014-2016-year compound, which is expected to fall from 23% to 18%, and 18 times times the 2014-year forecast for non-US general accounting standards. As the price of new Oriental is close to its fair value, we have downgraded its stock rating to "hold". Uncertainties include competition from the online education industry and better than expected enrollment.