- Beaten-down Chinese education stocks can recover by double-digits as the industry shifts to businesses like vocational training following this summer's regulatory crackdown, Morgan Stanley analysts said.
- They upgraded U.S.-listed New Oriental Education & Technology to "overweight" with expectations of 55% gains in the share price, according to an Aug. 29 report.
- The analysts expect further government support for vocational training, where they like Hong Kong-listed China East Education and predict gains of nearly 70% ahead.
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BEIJING — Beaten-down Chinese education stocks can recover by double-digits as the industry shifts to businesses like vocational training following this summer's regulatory crackdown, Morgan Stanley analysts said.
U.S.-listed after-school tutoring giants New Oriental Education & Technology and TAL Education have plunged by 90% this year. In July, Chinese authorities abruptly banned school-age tutoring businesses from operating on weekends and holidays, and ordered them to restructure as non-profits.
Despite the new rules, both companies have "ample cash" to expand into new businesses like non-academic tutoring, Morgan Stanley equity analysts Sheng Zhong and Elsie Sheng said in an Aug. 29 report.
They upgraded New Oriental to "overweight" and predict shares can soar by 55%, even after cutting the price target to $3.50. The company has already launched courses in art and speech, and is recruiting for dance, music and calligraphy classes, the report said.
That analysis is based on a financial model excluding the kindergarten to ninth grade after-school tutoring segment, which has accounted for about half of New Oriental's total revenue, the report said.
TAL Education derived a far greater 80% of its revenue from school-age tutoring, the analysts said. They upgraded the stock to "equalweight" and predict 7% gains ahead on a reduced price target of $5.40 a share.
The analysts noted it will take time for the company to grow new businesses, such as ventures into after-school child care and postgraduate exam prep.
TAL and New Oriental have yet to announce new dates for releasing their latest quarterly earnings reports, originally set for early August.
The government's new policy was harsher than many expected and forced many tutoring businesses to close entire departments with little notice, leaving many employees without jobs.
Vocational education to grow
The more lucrative future for Chinese education companies will be in vocational training, especially given government support for the sector that includes plans to establish a nationwide exam system for the segment, the Morgan Stanley analysts said.
They predict the vocational education market will grow by a compound annual growth rate of 7% in the decade from 2020 to 2030.
Chinese officials have spoken frequently in recent months about the need to help people find jobs. In addition to the disruption and uncertainty brought by the coronavirus pandemic, the country needs to address the impact of a rapidly aging population, and a large mismatch between business needs and employees' skills.
Vocational training is key for resolving structural issues in employment, Li Zhong, deputy minister of human resources and social security, said at a press briefing on Monday.
"It is necessary to give vocational training a leading role, focus on improving the quality of workers' skills and launch vocational training at a large scale and at multiple levels," Li said in Mandarin, according to a CNBC translation.
A plan distributed at the briefing showed China intends to subsidize 75 million vocational training slots in the next few years through 2025.
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The Morgan Stanley analysts' top pick in this segment is Hong Kong-listed China East Education, which they rate "overweight" and predict gains of nearly 70% to a price target of 14 Hong Kong dollars ($1.80). Shares have dropped more than 50% so far this year.
"The company will benefit from the vocational education promotion tailwind in China with its excellent reputation for training outcomes and subsequent employment opportunities," the report said. "We believe both revenues and margins will gradually recover following Covid in 2020, especially with the new majors rolling out, which are mainly 3-year classes to reduce business volatility."
Opportunity for investors
One of the most concerning lines in the after-school tutoring regulation was a ban on IPOs and foreign investment, including through a commonly used legal structure for stock listings in the U.S.: the variable interest entity.
"The aim is to strictly control excess capital flow to tutoring institutions," the Morgan Stanley report said.
"Based on the government's stated goals for each stage of education, we believe higher education and vocational education will provide relatively better opportunities for private capital," the report said, adding that "for vocational education and training, the government will encourage more private capital to provide services in this area."
— CNBC's Michael Bloom contributed to this report.
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