TAL Education Stock: A Mixed Outlook (NYSE:TAL)

Elevator Pitch

I assign a Hold investment rating to TAL Education’s (NYSE:TAL) shares. In the company’s media releases, TAL Education describes itself as “a smart learning solutions provider in China” which provides “comprehensive learning services to students from all ages through diversified class formats.”

My view is that TAL deserves a Hold rating, as I view the outlook for the company as mixed. On one hand, TAL has successfully pivoted into new business areas within education such as content solutions and learning technology solutions, and there is substantial growth potential relating to its new live streaming e-Commerce business. On the other hand, TAL’s short-term profitability might be negatively affected by the need to make investments in new growth areas, and the company is still exposed to regulatory risks with its other education businesses.

Live Streaming e-Commerce Business

An October 14, 2022 research report (not publicly available) titled “Entry Into Live Commerce Provides Another Optionality” published by China Merchants Securities noted that TAL Education has recently started a new live streaming e-commerce business. In this report, it is highlighted that TAL is “leveraging its teaching content” by creating a “new channel in Douyin (the Chinese version of Tik Tok” known as “Xue Jia You Pi” which has achieved a daily GMV (Gross Merchandise Value) of around RMB10,000 between August and mid-October 2022.

As an indication of the growth potential of TAL Education’s new live streaming e-commerce business and how this could affect TAL’s future share price trajectory, it is worth studying what happened to one of TAL Education’s peer, Koolearn Technology Holding Limited (OTCPK:KLTHF) [1797:HK]. Year-to-date in 2022, the stock price of Koolearn’s Hong Kong-listed shares rose by +656% as per S&P Capital IQ’s price data.

An earlier July 14, 2022 Seeking Alpha News article cited research from Hedgeye mentioning that “Koolearn remains in hype mode with everyone talking about its new livestreaming growth opportunity with its platform” known as “Oriental Selection.” It is clear that Koolearn’s venture into the live streaming e-commerce space was the catalyst for its mind-blowing stock price performance in this year thus far.

As such, it is reasonable to suggest that there is meaningful upside for TAL Education’s shares, if TAL’s new live streaming e-commerce business referred to as “Xue Jia You Pi” becomes equally successful as “Oriental Selection” in time to come.

Notably, the China Merchants Securities report which I referred to earlier found that the first 50-day GMV for TAL Education’ new live streaming e-commerce business is below 10% of what Koolearn’s “Oriental Selection” achieved when it was first introduced to the market. Therefore, TAL Education’s “Xue Jia You Pi” hasn’t had the explosive start that “Oriental Selection” enjoyed, but there is also lots of room for improvement and an opportunity for “Xue Jia You Pi” to play catch-up going forward.

Successful Pivot

Chinese education companies as a group have been badly hit by regulatory headwinds such as “China’s ban on for-profit private tutoring in July 2021” as highlighted by media publication South China Morning Post. TAL Education is no exception, as its top line fell by -80% YoY from $1,444 million in Q2 FY 2023 (YE February 28) to $294 million for Q2 FY 2023 as indicated in its most recent quarterly earnings press release.

On November 13, 2021, Seeking Alpha News mentioned that TAL “plans to stop offering academic subjects to students from kindergarten through grade nine (K-9 business) in the mainland of China by the end of December 2021.” In fact, TAL Education has been loss-making at the operating income level for seven quarters running between Q3 FY 2021 and Q1 FY 2023 according to S&P Capital IQ’s financial data.

But TAL Education has been able to make a successful pivot away from its legacy K-9 business that has been negatively affected by changes in regulations for the education industry in China. Specifically, TAL registered a positive non-GAAP operating profit of $40.5 million in the most recent Q2 FY 2023. In other words, TAL has become a profitable company (at the operating income level) again despite losing a big chunk of its revenue from its legacy K-9 business.

At the company’s Q2 FY 2023 earnings briefing, TAL Education emphasized that “we continue to transform our business into a smart learning solutions provider”, and it credited its operating profitability in the recent quarter to new “business growth”, on top of other factors like “seasonal fluctuations” and “cost optimization measures.” As an illustration, TAL’s pivot towards new business areas have paid off, as the revenue contribution of content solutions and learning technology solutions (new businesses started since FY 2023) in aggregate went from 0% in FY 2022 to 25% for Q2 FY 2023.

Good Q2 FY 2023 Results Are Unsustainable

Unfortunately, TAL Education’s decent financial performance (it achieved positive operating profit for the first time almost two years) for the second quarter of fiscal 2023 isn’t likely to be sustainable.

The market’s consensus financial forecasts for TAL as per S&P Capital IQ data point to the company’s top line contracting by -15% QoQ in Q3 FY 2023. The company also noted at its Q2 FY 2023 investor call that “our best guess is that profitability level in the next quarter (Q3 FY 2023) will likely be lower than this quarter (Q2 FY 2023).”

TAL Education’s learning services business usually records higher revenue for Q2 and Q4 (in fiscal year terms) as a result of seasonality, so TAL’s Q3 FY 2023 top line won’t be as good as that of Q2 FY 2023.

An important issue is that TAL needs to continue investing in future growth as part of its pivot towards new businesses. This naturally translates into lower profitability for TAL Education in the short term. TAL Education acknowledged at its most recent quarterly results briefing that it will “continue to invest in new initiatives” for “the next few quarters to come.”

Regulatory Headwinds Aren’t Going Away

As I mentioned earlier in this article, new regulations led TAL Education to make an exit from its legacy K-9 education business. Looking ahead, TAL’s other education-related businesses aren’t necessarily immune to future regulatory headwinds.

A recent November 9, 2022 Seeking Alpha News article highlighted that China’s “Vice Premier Sun Chunlan” published an “opinion piece” noting that “a conscientious (education) industry cannot become a profit-seeking industry.”

As such, there is good reason to be concerned that it will be difficult for most education companies in China, including TAL Education, to charge reasonably high prices and make a meaningful profit on education-related services and products going forward.

Bottom Line

I think that the outlook for TAL Education is mixed, which justifies my Hold rating for TAL. TAL Education recorded positive operating income for Q2 FY 2023, but continued investments will weigh on the company’s profitability in the near term. In the medium to long term, regulatory risks remain a key concern for TAL.