Concerns about K-9 schools and spillover effects of education and training policies led to a decline in stock prices

Due to market concerns about Yuhua K-9 School, its stock price fell from a peak of HK$8.2 at the end of May to the current HK$3.5 (down 58%), and the price-earnings ratio for FY22 was lowered from 15.2 times to 6.4 times. The new version of the “Public Promotion Law Enforcement Regulations” prohibits dividends to K-9 compulsory education schools, so Yuhua K-9 schools may not be merged into the group. We estimate that this will affect about 8% of the adjusted net profit for fiscal year 22. Management has previously mentioned this. But on the other hand, Yuhua's other schools (kindergartens and high schools) will not be affected by the policy and will register as for-profit and continue to operate. Yuhua also plans to transform its three K-9 schools, located in Xingyang, Luohe, and Jiaozuo, with a total capacity of about 36,000 people into vocational colleges.

The prospects for higher education business are steady and unchanged

We expect Yuhua's higher education business to maintain steady growth, with a compound growth rate of 10% in the 21-23 fiscal year: 1) the expansion of the new Lankao campus in the Zhengzhou school supports the increase in the number of endogenous students; 2) tuition fee increases; 3) it is expected that the three newly built vocational colleges in Henan will commence operation in the 2022/23 school year, but license applications are still ongoing. If these schools successfully transform next year, we expect to enroll around 6,000 students in 2022/23, with tuition fees of around 13,000 yuan and total revenue of 78 million yuan (3% of group revenue); 4) The balance sheet performance was steady, with net cash exceeding 3.7 billion yuan, including net cash of 1.1 billion yuan (convertible bonds not included in liabilities) in net cash up to the middle of fiscal year 21, and tuition fees of 2.6 billion yuan for the 2021/22 school year. The outlook is steady, but the underestimation is serious. Yuhua's current valuation is close to K-12 stocks, and the latter has been significantly affected by the policy. Given that the policy tone of the higher education industry is still supportive, we think Yuhua's continued decline in stock prices is irrational. We reiterated the purchase rating of Yuhua, but lowered the target price based on the segment plus total valuation from HK$8.6 to HK$6.7: giving the higher education business a price-earnings ratio of 16 times over the next 12 months (based on industry valuation cuts, down from 21 times, corresponding to the average historical price-earnings ratio plus 1 standard deviation), maintaining the 8-fold forward-looking price-earnings ratio of the high school and kindergarten business (K-9 business valuation is not given). Our target price corresponds to 14x/12 times the forward-looking price-earnings ratio for fiscal year 22/23.