China YuHua Earnings: Reducing Fair Value Estimate on Disappointing Revenue and Margin Trend

We have lowered our fair value estimate for YuHua 06169 to HKD 2.06 from HKD 2.42 based on the disappointing first-half (ending February 2023) results. Revenue declined by 1.2% year on year due to lower student enrolment in its high schools. The sharp contraction in gross margin to 46.9% from 56.6% and 67.2% in the first half of fiscal 2022 and 2021, respectively, is more concerning, as the company continues to invest heavily in its campuses and teachers. As a result, the revenue and margin trends are significantly underperforming higher education peers we cover. We lower our revenue forecast to CNY 2.4 billion from CNY 2.5 billion and our net income forecast to CNY 1.1 billion from CNY 1.4 billion in fiscal 2023. We also lowered our revenue and margin forecasts through fiscal 2027, resulting in a net income CAGR of negative 4.3% from fiscal 2022 to 2027, down from our prior negative 0.1% forecast. The shares closed 47% below our fair value estimate on May 2, but we suggest investors stay on the sideline until positive catalysts emerge.

Gross margin contraction was mainly due to higher depreciation, employee benefit, and student training and scholarship costs. Depreciation costs jumped more than 30%, and capital expenditure quadrupled year on year in the first half. YuHua also significantly increased its teacher count over the past 12 months. The number of teachers reached 7,205 as of February 2023, up 49% from one year ago. Management mentioned the schools are old and need maintenance and upgrades. Besides, as student enrolment grows, the schools must make necessary investments to meet regulatory requirements such as teacher/student ratio. We think YuHua probably underinvested in the past and must make up for that ahead of regulatory assessment. To factor in rising costs, we forecast a 48.3% gross margin in fiscal 2023, down from 59.6% in 2022. We expect gross margin to decline to 44.5% by 2027 as we think tuition fee hikes will lag cost inflation.