After a painful retrenchment over the last two years, China's private education sector is showing early signs of a brighter future in the latest upbeat results of TAL Education (NYSE: XRS). The company not only posted growth that was solidly higher than its previous guidance, but also forecast an acceleration of that growth in the current quarter as it begins to reap the rewards of an overhaul that has produced a leaner, more focused company.
The positive results prompted two major research houses to raise their price targets for the company, hinting that a new period of growth could be coming for long-neglected China education stocks.
Both TAL and rival New Oriental Education (NYSE: EDU) were once the darlings of western investors, who were betting on strong growth based on surging demand for education services from newly affluent Chinese. But in their quest for growth, both companies built up excess capacity in major cities like Beijing and Shanghai, driving down their margins as they competed with foreign rivals like Disney (NYSE: DIS) and Pearson (London: PSON).
As part of their broader retrenchment, companies like TAL and New Oriental have been closing underperforming schools and crafting new strategies to reignite growth. In TAL's case, the company is making a big push into smaller cities where competition is less intense. It is also focusing more on smaller classes and individual tutoring, areas with greater potential even though revenue is typically smaller than that for large classes.
Following the overhaul and new focus, TAL reported that revenue growth for its fiscal quarter through May accelerated to 24.5 per cent at $61.4 million (HK$476 million), beating the top end of its previous guidance by about $2 million (HK$15.5 million). That growth was easily better than gains of 14 per cent and 20 per cent in the previous two quarters. Equally important, the company forecast that revenue growth would accelerate further in the current quarter to 30-33 per cent.
TAL shares rose a relatively modest two percent after the report came out to $10.96, nearing a one-year high. Goldman Sachs (NYSE: GS) and Morgan Stanley (NYSE: MS) both raised their price targets for the company after the strong results, and maintained their equivalent of "buy" ratings. Goldman raised its 12-month price target  6.7 per cent to $16, while Morgan Stanley raised its target by  5 per cent to $14.30.
As a longtime financial reporter, I don't always put a lot of faith into analyst stock price targets, which are often quite bullish and designed to generate investor excitement. But in this case, both TAL and New Oriental do look like they could be attractive investments for similar reasons. Both have undergone major restructurings to put more emphasis on the quality of their operations rather than just trying to open as many schools as possible.
In addition, both companies should have relatively strong accounting practices in place, following a series of financial scandals dating back more than two years that resulted in a prolonged downturn for US-listed China stocks. New Oriental became a target of an investigation by the US securities regulator during that downturn, but was ultimately exonerated of any wrongdoing.
Both TAL and New Oriental shares are up about 30 per cent over the last six months, as interest has slowly returned to the sector following the de-listing of many smaller Chinese firms during the crisis. But shares of both are still about 30 per cent below their pre-crisis highs.
It's probably still too early to say if the turnaround for these companies will be sustainable, since the sector could face some major headwinds due to China's economic slowdown that has prompted many consumers to cut back spending. But more solid growth for the rest of this year would certainly show that these companies are finally back on solid footing and could enjoy strong prospects over the next two years.
Bottom line: TAL Education's latest results indicate the company may be poised for a new period of strong growth after a major operational overhaul.
To read more commentaries from Doug Young, visit youngchinabiz.com