The following is a sample equity research report, presented here for illustrative purposes only.
Theme: Education is the foundation of Confucianism. Every Chinese family has an “American Dream” to send their children overseas for a western education.
Thesis: China’s education sector is experiencing a boom due to 1. demographics (relaxation of one child policy), 2. increase in disposable income and emergence of middle class 3. under-penetration of private education, and parents willing to spend on private education (Confucianism).
Bright Scholar Education is the largest operator of international schools and bilingual schools in China with 62 schools. 87% of graduates from the international school are admitted into top 50 universities globally, which reflects the school’s teaching quality. Bright Scholar Education has a natural expansion pipeline from the ongoing township projects by Country Garden. Bright Scholar is also taking the active step of partnering with other developers to increase its pace of expansion. Next year, there will be 4 new schools under the partnership with Hebei Changsheng Group and Jiangsu Tianshan Group.
Bright Scholar Education targets the upper middle/upper class (international school fee is 80k RMB per year, bilingual/kindergarten is 30k RMB per year), the sweet spot to capture disposable income growth in China.
Strong revenue growth (from the above reasons) and strict cost control leads to increase in profits and margins.
Target Price
Bull Case: $25 -12x FY18 P/S Base Case: $20 – 10x FY18 P/S Bear Case: $16 - 8x FY 18 P/S
What is of value?
- Brand awareness: founded and lead by Country Garden, third largest developer in China mainly focused in Guangdong, Country Garden is on the name of its schools
- Partnership with Country Garden and other developers create sustained demand for schools by incorporating quality education as part of the development of residential community; allows for asset light model to speed up growth
- Increase in operating leverage as there is continuous room for fee increase as demand is price inelastic (cutting education expense is the last thing families will do) while staff cost increases at a lower rate.
· Tuition fee has 8-10% CAGR for the past 4 years in all operating segments.
· Staff cost as % of revenue decreased from 60.3% in 2014 to 46.5% in 2017.
· GAAP operating margin increased from -6.1% in 2014 to 16.2% in 2016
- Rapid revenue growth, CAGR 31.2% over past four years, while turning from FCF negative to FCF positive
o YoY revenue growth of 27.7%
o CFO more than 10X from RMB 46.6MM in 2014 to RMB 483MM in 2017
o CAPEX held between 60-140MM per year
- Strong Balance Sheet: net cash of RMB 1.9B, no debt
Risks:
- Decrease in teaching quality as growth in teaching staff may not be as quick as growing demand
- Changes in Chinese government’s attitude towards VIE structure
- Reliant on Country Garden and partnerships to sustain asset light model for growth
- Potential slowdown in rate of urbanization (in the long term after 2020/2030)
- Validity of financial statements, always a concern with Chinese companies
- Management and operational risk (RYB incident is just one of the ones reported)
Edge:
- Strong understanding of key drivers of industry growth
- Personal experience growing up in international schools, understand why international schools are attractive to Chinese parents
- Gugnir and Partners
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