Non-GAAP operating margin declined 390bps y-o-y to 24.8%, of which summerpromotions dragged the margin down by 200bp and the remaining 190bps decline ismainly attributable to capex expansion, according to company estimates. We believe themargin will likely improve for the rest of FY18 due to increasing utilization rate. All in all,1Q non-GAAP net profit was 1% lower than consensus. The company guides that2QFY18 revenue will be in the range of USD447-461m, representing 31%-35% y-o-ygrowth, the mid-range of which is 6% greater than consensus.
Revenue beat but miss in margin. TAL’s revenue came in at USD456m in 2QFY18(ended August 2017), up 68% y-o-y, 4% higher than our expectation and consensusestimate. Quarterly student enrolments were up over 100% y-o-y to 2.2m, driven primarilyby summer promotions in small classes and online courses. Gross margin declined 5pptsy-o-y, of which 1) 2ppts was due to capacity expansion, 2) 1-1.5ppts due to onlinepromotions and summer promotions, and 3) 1.5-2.0ppts due to incremental loss from theacquired Shunshun Bita (overseas consulting business). Sales and marketing expensesincreased 35% q-o-q due to increasing headcount as well as more marketing andpromotion activities. As a result, non-GAAP operating margin declined 4.5ppts y-o-y to17.5% in 2Q. We expect the margin to decline 1.5-2.0ppts in 3Q primarily dragged by lossfrom Shunshun. No promotions will take place in the coming quarters. We estimateFY18e non-GAAP operating margin to decline 1.4ppts y-o-y, followed by a 1.9pptrecovery in FY19e as Shunshun should enter the mature stage. The company guides thatthe utilisation rate will likely improve from early 2018. Deferred revenue grew 57% y-o-y,of which deferred revenue from small classes grew by 60-70% y-o-y. 2Q non-GAAP netprofit came in at USD71, 4% lower than consensus. TAL’s mid-range revenue guidancefor 4QFY18 is USD414m, implying 59% y-o-y growth, largely in line with consensusestimate. Some seasonal factors have impacted the 3Q guidance as only 67.5% of thefirst semester’s revenue would be recorded in 3QFY18e (Sep-Nov 2017), versus 70.2%in 3QFY17.
Reiterate Buy rating, with a new TP of USD109. We raise our FY18-20e revenueforecasts by 3%/3%/9% on faster than expected capacity growth, but we cut our non-GAAP operating margin assumption by 3%/2%/1% to factor in the incremental cost ofcapacity expansion. All in all, we trim our FY18-19e non-GAAP net profit estimates by9%/3% but increase our FY20e net profit estimate by 5%. We raise our DCF-based targetprice to USD109 (was USD100), implying 32x FY19 ex-cash PE, against a 39% FY17-20e EPS CAGR and 33% revenue CAGR. Key downsides risks include failing to enhancethe utilisation rate.
Maintain Buy with a new TP of USD35 (from USD28.33). We lower our FY18/19eEPS estimates by 13%/3%, but increase FY20e EPS by 8% as we fine-tune ourrevenue and margin assumptions for FY18-20e. Our DCF-based TP is raised toUSD35, primarily due to the change in earnings estimates. Our new TP implies a 42xFY19e ex-cash PE against a 62% three-year EPS CAGR in 2017-20e. Downsiderisks include a slower-than-expected capacity expansion.
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