Deutsche Bank Markets Research Asia Industry Date China 4 January 2018 Consumer China Education Hotels / Leisure / Initiation of Coverage Gaming Tallan Zhou Karen Tang Research Analyst Research Analyst Bright future (+852 ) 2203 6464 (+852 ) 2203 6141 [email protected] [email protected] K12 after-school tutoring is a secular growth sector Top picks We analyze the supply/demand condition of China's K12 after-school tutoring New Oriental (EDU.N),USD101.57 Buy market and conclude the sector will likely see secular growth in the next five TAL Education (TAL.N),USD29.71 Buy years. We believe positive demographic growth, an increased number of Source: Deutsche Bank wealthy families, and greater education awareness are the demand drivers. However, China's supply of top universities is still insufficient and the Companies Featured admission rate remains low. This has led to surging needs for after-school tutoring services. We forecast the K12 tutoring market to see a 13-14% CAGR New Oriental (EDU.N),USD101.57 Buy in 2017-22E, assuming: 1) K12 students see a CAGR of 3%, 2) tutoring 2017A 2018E 2019E penetration rate climbs 2.5% p.a.; and 3) ASP rises (like-for-like basis) 5% p.a. P/E (x) 26.3 42.0 33.6 EV/EBITDA (x) 17.0 33.6 25.3 More demand for education in the long term Price/book (x) 6.7 7.8 6.4 China’s Gaokao (college entrance exam)-takers as a percentage of the newborn population increased to 65% in 2016 from only 25% in 2002, while TAL Education (TAL.N),USD29.71 Buy the birth rate remained unchanged at 0.11-0.12%. However, we now see 2017A 2018E 2019E newborns increasing from 2016, thanks to the government’s two-child policy. P/E (x) 36.8 77.5 52.6 (1.3m more newborns in 2016). Besides the positive demographic drive, more EV/EBITDA (x) 28.1 66.2 39.7 Price/book (x) 10.4 18.4 13.3 middle-class families are increasing spending on K12 tutoring for children. Per Source: Deutsche Bank capita consumption on education has tripled in Beijing, Shanghai and Jiangsu in the past decade amid increased education awareness, with more families investing in education, in order for their children to get into top universities. … but the reality is: China’s supply of top universities is still insufficient Admission rates into top universities (Project 985 and 211 universities) remain low at less than 3% on average. Although students from tier 1 cities such as Beijing/Shanghai/Tianjin have a higher admission rate, the rate is declining. Beijing’s admission rate to the Project 211 and 985 universities declined to 8% in 2016 from 10.6% in 2013. The intensified competition seen in Gaokao has resulted in strong competition from primary school entry exams to high school entry exams, with significant records showing students from “key schools” have a much higher possibility of being admitted into top universities. Consequently, this unbalanced supply/demand creates a huge demand for after-school tutoring, as public school education alone is perceived as insufficient for average K12 students. Valuation and risks We initiate Buy on EDU (New Oriental) (target price USD116) and TAL (target price USD35). EDU and TAL are leaders in the K12 tutoring market but they only account for less than a combined 4% market share. We expect them to grow share robustly, and believe they will penetrate into lower tier cities to increase their total market share. Our valuation is based on DCF, because K12- tutoring is a strong cash flow business with visible and stable growth. We also cross-check our DCF-based valuation by PEG. Risks include: 1) change of policy; 2) disease outbreak; and 3) aggressive network expansion. ________________________________________________________________________________________________________________ Deutsche Bank AG/Hong Kong Distributed on: 04/01/2018 07:54:27 GMT Deutsche Bank does and seeks to do business with companies covered in its research reports. Thus, investors should be aware that the firm may have a conflict of interest that could affect the objectivity of this report. Investors should consider this report as only a single factor in making their investment decision. DISCLOSURES AND ANALYST CERTIFICATIONS ARE LOCATED IN APPENDIX 1. MCI (P) 083/04/2017. 7T2se3r0Ot6kwoPa 4 January 2018 Hotels / Leisure / Gaming China Education Investment thesis K12 tutoring is a secular growth sector Our key thesis We believe the boom in China’s K12 tutoring market will continue in the next five years due to: 1) increased birth rates, thanks to the new “two-child policy”; 2) competition remaining intense, as admission rates into top universities (Project 985 and 211 universities) are still low; and 3) the number of wealthy families continues to grow, leading to increased consumption on education expense per family. Initiating TAL and EDU with Buy We initiate with a Buy on TAL and EDU. TAL and EDU are leaders in the K12 tutoring market but only account for less than a combined 4% market share. We expect them to grow share robustly, penetrating into lower tier cities to increase their total market share. Figure 1: Valuation comp sheet for HK/US listed education names Current Market cap Next Yr DB Ticker English name Chinese name price (USD m) Current Yr Next Yr EV/EBITDA Recomm. EDU US Equity EDU 新東方科技教育集團 92.19 14,508 40.7x 30.1x 19.4x BUY TAL US Equity TAL 好未來教育集團 29.29 14,725 76.4x 47.2x 34.1x BUY HK listed education 1569 HK Equity MINSHENG EDUCATI 民生教育 1.53 827 15.9x 13.8x 8.8x NR 6169 HK Equity CHINA YUHUA EDUC 中國宇華教育集團有限公司 3.46 1,502 20.9x 17.7x 14.8x NR 2001 HK Equity CHINA NEW HIGHER 新高教集團 4.07 769 21.6x 16.0x 12.1x NR 6068 HK Equity WISDOM EDUCATION 睿見教育國際控股有限公司 4.48 1,176 24.0x 18.3x 13.3x NR 1565 HK Equity VIRSCEND EDUCATI 成實外教育 4.99 1,972 39.9x 27.4x 21.0x NR 1317 HK Equity MAPLELEAF EDU 楓葉教育 9.10 1,587 20.5x 17.1x 13.9x NR US ADR education REDU US Equity RISE EDUCAT-ADR RISE Education Cayman Ltd 12.55 688 47.7x 21.2x 15.4x NR FEDU US Equity FOUR SEASONS EDU 四季教育(開曼)公司 10.10 469 42.5x 20.4x 15.2x NR BEDU US Equity BRIGHT SCHOL-ADR Bright Scholar Education Hol 18.52 2,168 45.8x 30.4x 18.9x NR Source: Deutsche Bank; Bloomberg Finance LP; pricing as of 12/29/2017 Our forecast for the next five years We forecast the K12 tutoring market will enjoy a CAGR of 13-14% in 2017- 2022E. We expect enrollment and price to be the driver, with total market size growth driven by: 1) increased number of K12 students (at a CAGR of 3%), 2) rising tutoring penetration rates, which we believe will climb 2.5% p.a. (more K12 students to join K12 after-school tutoring classes), and 3) ASP increases (like for like basis) of 5% p.a. Gaokao penetration and positive demographic driver In the past 10 years, we have seen a stable birth rate in China. However, we have also seen an increasing number of Gaokao students. Gaokao’s penetration rate increased to 65% in 2016 from only 25% in 2002. In addition, the two-child policy started to take effect in 2016, one year after the policy was approved by the government. Page 2 Deutsche Bank AG/Hong Kong 4 January 2018 Hotels / Leisure / Gaming China Education China saw 1.3m more newborns in 2016 and we expect another 2-3m more newborns in 2017E. In the next five years, those who were born in 2016 would become the key consumers of pre-school or young children’s education. Intense competition to get a spot in top universities remains China’s general admission rate (59% in 2000 and 74.5% in 2017) for university/college has increased significantly in the past two decades. Unfortunately, only 3% of Gaokao students are admitted into top universities (universities from Project 985 and Project 211). Tier one universities’ admission rate is higher, at an average of 15%. Our channel checks further support our view that more parents intend to enroll their children in after-school tutoring from a young age (primary school students account for 59% of total), to prepare them for the three examinations before Gaokao: entrance examinations for primary school, middle school and high school. In most parts of China, middle schools are generally referred to as “key schools” or ordinary school. Students from these key schools usually have much higher potential to be admitted into for top/tier one universities. As a result, while the total number of primary school students has remained stable in the past decade, the number of students from top tier cities has continued to grow over the same period (more families are aiming to relocate to tier one cities), such as Beijing and Shanghai, etc. Increased number of wealthy families to drive “education consumption” China’s middle class has been rising quickly, as reflected in urban areas’ growing annual disposable income. The middle class believes receiving public school education alone is not enough for their children, and after-school tutoring will further improve their children’s examination ranking and admission rate. We believe middle-class families are willing to pay more for after-school tutoring than others. According to iResearch, c.60% of middle- class students actively attend tutoring classes and more than 62% of them attend two or more classes.