Fading Results Tarnish Education’s Luster

By newsdoug on January 20, 2012

New Oriental (NYSE: EDU) and TAL Education (NYSE: XRS), two of China’s biggest names in the education services sector, have just posted new quarterly results that are less than inspirational, showing the formerly red-hot education sector may rapidly be losing its luster. Disappointment at the latest results is reflected in the companies’ stocks, with TAL shares dropping about 2 percent after its latest quarterly report showed its profit slipped nearly 40 percent even as revenues rose 70 percent. (company announcement) Shares of New Oriental have fared even worse, tumbling 11 percent after its reported an operating loss earlier this week even as its revenue grew by a healthy 38 percent. (results announcement) It seems that both companies are getting hit by the same phenomenon in a sector that has seen explosive growth over the last few years from Chinese looking to improve themselves and their children through outside classes that these companies offer. On the one hand, competition in the space is getting more intense, with a growing number of foreign companies such as Pearson (London: PSON) and Disney (NYSE: DIS) entering the space in the last few years to capitalize on demand. (previous post) At the same time, these companies are all facing the same problem, namely the lack of scalability for this industry. Whereas Internet and tech companies can significantly lower their costs as their number of customers grows due to the nature of their business, the same isn’t really true for education services since, at the end of the day, each student requires a relatively fixed amount of costs in the form of classroom space and salaries for teachers to instruct the classes. That potent combination means that even though revenues may continue to grow at a healthy pace for the next few years, especially as these companies tap demand in mid-sized and smaller cities, the cost of those revenues is likely to stay constant at best, and could even rise due to the stiff competition, meaning profits won’t grow and could even shrink more. If that’s the case, look for this sector to go through a bit of growing pain over the next 2 years, with sustained profit growth unlikely to return until competition eases with some needed consolidation.

Bottom line: The latest results from 2 top education companies reflect stiff competition and lack of scalability that will lead to eroding profits for the next 2 years.

Enjoy this blog? Please spread the word :)