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ANALYSIS: OneSmart Expands Growth Initiatives With Broader Footprint

Donovan Jones 2019-05-31 09:00 AM

Short Take

OneSmart International Education Group Ltd. (NYSE: ONE) has reported financial results for its fiscal second quarter of 2019.

The firm provides a wide range of private supplementary education services to Chinese K-12 students.

ONE has had a challenging period over the past five quarters but intends to continue its expansion initiatives into Tier 2 and Tier 3 cities.

Company & Business

Shanghai-based OneSmart was founded in 2008 to address the additional education needs of K-12 children for families in the affluent and 'mass affluent' demographics.

Management is headed by Chairman and CEO Xi Zhang, who was previously associate director of strategic planning at Johnson & Johnson Medical International and marketing manager at Wrigley China.

OneSmart has created what it calls 'the largest premium K-12 after-school education service provider in China in terms of revenue in 2016 and 2017, according to Frost & Sullivan.'

ONE is really a collection of different services aimed at young children, primary school students, middle school students, high school students, and college exam preparation study needs.

In addition, the firm says it has a national market share of 2.4 percent and it operates a nationwide network of 225 'study centers' in 42 cities within China.

Customer Acquisition

Since ONE operates study centers in numerous cities, its customer acquisition efforts tend to be localized to each city.

Although the firm considers itself a 'nationwide' service provider, the country of China is so vast that it is forced to market to individual cities.

Management says that it has been able to command higher prices for its educational offerings due to its leading position in various markets in which it operates.

The firm also highlighted its full 'suite' of offerings which enables them to cross-sell other courses within their portfolio to existing students.

Market

According to a 2017 report by DBS Vickers Securities (PDF), it forecasted overall education spending market in China to grow by a CAGR 6.7 percent 'in the foreseeable future due to multiple drivers:'

  • End of one-child policy will increase student number growth

  • Rising income to support continued increase in household spending

  • Increased parent willingness to pay for education

The group expects the total market value for education and training to reach $474 billion by 2025, with the K-12 sector accounting for most of the demand.

Looking historically, the chart below shows the tremendous rise in education spending by households along with spending growth:

(Source: DBS Vickers Securities)

Competition

Major competitive vendors that provide quality private education services include:

  • New Oriental

  • RYB Education

  • TAL

  • ONLY

  • Virscend

  • Wisdom Education

  • China Yuhua Education

  • Maple Leaf Education

  • Xueda

Management says that its services are subject to intense competitive pressures as well as from a shifting regulatory environment as the Chinese government, both at the national and provincial levels has been increasing its oversight and regulatory footprint within the education sector.

Recent Performance

ONE’s topline revenue by quarter has been growing, albeit unevenly, since its IPO in early 2018, as the chart shows below:

(Source: Seeking Alpha)

Gross profit has been similarly uneven over the past five-quarter period:

(Source: Seeking Alpha)

Earnings per share (Diluted) returned to positive territory in the most recent reporting period:

(Source: Seeking Alpha)

In the past 12 months, ONE’s stock price has dropped 41.6 percent vs. RYB Education’s drop of 64.7 percent, as the chart below indicates:

(Source: Sentieo)

Commentary

OneSmart’s stock has had a difficult year as the firm has faced economic headwinds as well as regulatory setbacks.

In its most recent earnings call, management has explained that its additional expenses have been associated with opening 128 new learning centers in China, so the firm continues to expand its operations at a significant pace.

However, it faces extra regulatory compliance costs associated with new rules for ensuring higher quality and safe educational environments for students.

More recently, regulators have prohibited private educational groups from acquiring or partnering with public facilities without express permission, thus limiting the growth prospects from these potential tie-ins.

Management provided 2019 guidance of revenue growth between 40 percent - 45 percent over fiscal 2018.

While ONE expands its footprint into Tier 2 and Tier 3 cities, management will have the challenge of maintaining quality control and cost discipline as it broadens its footprint.

(The opinions expressed by contributing analysts do not reflect the position of CapitalWatch or its journalists. The analyst has no positions in any stocks mentioned, no plans to initiate any positions within the next 72 hours, and no business relationship with any company whose stock is mentioned in this article. Information provided is for educational purposes only, may be incomplete or out of date, and does not constitute financial, legal, or investment advice.)