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TAL Education Sees a Modest Slowdown Ahead

By Demitri Kalogeropoulos - Jan 23, 2020 at 8:37AM

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There's still plenty of room for growth in the Chinese private education market.

Investors have been pushing up the stock price of TAL Education Group (TAL -10.78%) on expectations of accelerating growth. The Chinese private education specialist beat Wall Street targets in late October, which set the bar high for this week's third-quarter report.

As expected, the company announced robust demand for both its in-person tutoring and online courses as it expanded its digital services and added new cities in China. That good news was slightly offset by surging marketing expenses and a reduced outlook for the rest of fiscal 2020.

Let's dive right in.

Students recieving tutoring instruction.

Image source: Getty Images.

Good growth

TAL Education's strengthening growth trends continued into the second half of the fiscal year. New student sign-ups accelerated for a second straight quarter, jumping 66% in Q3 compared to 50% growth over the prior six months. The company now counts 2.3 million students compared to 1.4 million a year ago.

The growth was supported by a wider base of learning centers, which now number 794 locations across 70 Chinese cities, up from 676 centers in 56 cities last year. TAL Education also benefited from a bulked-up offering of online tutoring services. These gains translated into a 47% increase in revenue, up to $862 million. That metric comfortably exceeded the outlook that management issued a few months ago, and executives sounded a confident tone. "This quarter's results reflect the progress in our efforts to build a healthy and sustainable business model," CFO Rong Luo said in a press release.

Rising expenses

Profitability was a mixed bag. Yes, the company returned to the black after losing money last quarter. Gross profit margin also inched higher thanks to healthy pricing trends. However, TAL Education is still pouring cash into its marketing and promotions. Those line items pushed selling expenses up by 88% to nearly $200 million.

As a result, operating income rose by just 10%, or 16% after adjusting for stock-based compensation. The earnings picture isn't much better if you zoom out a bit. Operating income is down 10% over the last nine months at a time when revenue has expanded by 36%. That gap helps explain why management is still suggesting that they aren't quite finished building a sustainable business model.

Looking ahead

The company's short-term outlook calls for more market-beating growth, although at a slower pace than in recent months. Sales in the seasonally strong fourth quarter are expected to land between $960 million and $980 million, translating into growth of around 34%. Investors reacted to that news by sending shares lower immediately following the report; Wall Street never likes to see moderation in a growth stock's expansion pace.

Yet TAL Education is still strengthening its sales pace as compared to the first half of fiscal 2020. Its wider network of classrooms and deeper online offerings are positioning it to capture more market share in both sales channels, too. Now it's up to the management team to demonstrate that it can pair this growth with a sustained march toward profitability.

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