Zhonghui Group (universities and vocational education institutions, 382 HK — HK$2.74 — Long Term — Target Price = HK$4.5) - 2HFY22 profit margin will improve; reaffirms Long Position

The 1HFY22 performance was in line with the profit warning. Revenue/adjusted profit increased 48.4%/32.0% year-on-year to RMB 823 million /264 million yuan, with a dividend rate of 30%. However, sales and marketing expenses increased 1.7 percentage points to 2.8% of revenue, and management expenses rose 4.2 percentage points to 18%. As a result, net interest rates fell 4.0 percentage points to 32.1%. Excluding the three-month contribution of Guangdong Huashang Technical School, net endogenous profit increased by about 29.5% over the same period last year.

For 2HFY22, we expect a steady increase in operating profit of about 17.6% year over year, and the core operating margin to improve to 40.1% (35% for 1HFY22), mainly due to reduced management and marketing expenses for 2HFY22. Management maintained guidance on revenue of RMB 1.65 billion and net profit of RMB 600 million for FY22. We expect (1) the steady growth of schools in Sichuan and (2) the contribution of Huashang Technical School to increase profit margins in the next few years, while the number of students and per student income of Huashang Business School will provide steady organic growth. We lowered our operating margin forecast to reflect the increase in management and sales expenses in FY22 (FY22E's operating margin: 37.6% VSFy21a's 41.0%) and the forward valuation of FY24E to arrive at our 12-month target price of HK$4.5.

Investment arguments - We are optimistic about the stock's medium- to long-term growth visibility, thanks to (1) steady endogenous growth, (2) continued increase in profitability, and (3) the potential of its vocational education business. Despite its low valuation and significant growth, the market's main concern remains policy risk. As a result, we lowered the valuation multiplier from 10x FY22 P/E to 8x, with a target price of HK$4.5, meaning 64% upside. Reiterate long positions.