New Oriental Makes the Honor Roll

It seems that the most dreaded part about being young is the time spent in school. I know I spent much time groaning about homework and exams. Yet things seem a bit different on the other side of the world. Students in China are enthusiastic about learning, and their eagerness is apparent in New Oriental's (NYSE: EDU  ) first-quarter earnings. 

China's private education leader aced analyst estimates, with revenue increasing 50.2% to $81.1 million and profits rising 63.1% to $33.9 million. Earnings per diluted American depositary share increased at a much slower pace of 19.2%, mostly because of a secondary stock offering in February that diluted the total number of outstanding shares by 38%.

Rapid growth in China's economy has providers scrambling to keep up with the increasing demand for educational services. To accommodate the demand, New Oriental opened two new schools and 17 learning centers and initiated a new mathematics program. The company is also seeking opportunities to expand into new areas such as vocational schooling and kindergarten classes by using some of the cash raised from the secondary offering.

To buck the rising competition, the company has aggressively tried to continue winning additional market share. Last quarter, selling, general, and administrative costs (SG&A) rose substantially as management stepped up marketing and promotional activities, which paid off with enrollment rates increasing 30.5% year over year. Costs continued to rapidly rise again this quarter, with cost of goods sold up 48% and SG&A costs up 42%, because of New Oriental increasing the number of courses taken and continuing brand promotion. Over time, these costs will diminish in comparison with revenue growth, and I don't view them as something to be concerned about.

Despite the rising costs, New Oriental still improved its operating margin through better efficiency as revenue growth outpaced the growth in expenses. The company continues to boast one of the best operating margins in the business, better than rivals based here in the U.S. such as Apollo Group (Nasdaq: APOL  ) , DeVry (NYSE: DV  ) , and Strayer (Nasdaq: STRA  ) .

There are more than 10 million students who take the Gaokao (Chinese SATs) every year, fighting for a mere 3 million spaces available in universities, so the rivalry among students is fierce. Students and their parents seem more than willing to shell out the additional costs to gain an edge, even at a young age. And the hard work pays off: The number of just the top 25% of people, according to IQ tests, in China is greater than the total population of North America.    

The Chinese place a significant value on education, and New Oriental's performance in its first year as a public company has shown that it is a dominant player in this business. With the stock jumping more than 12% on the news, I think a pullback may be necessary before getting in on this company. But so far, this company is at the head of the class.

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