2017 performance in line with expectations

The performance of Chengshi Foreign Education in 2017 is in line with our expectations, but the company's revenue (up 15% to 953 million yuan over the same period last year) is 8% lower than the market consensus, and the company's adjusted net profit is in line with market expectations.

Trend of development

The enrollment of the new campus in 2017 is weaker than expected. Revenue rose 15 per cent year-on-year to 953 million yuan, mainly due to a 12 per cent year-on-year increase in enrollment to 38498 students and an increase in tuition fees. The company's gross profit margin rose slightly to 47.7% (47.3% in 2016), although the group's overall student-teacher ratio fell to 14.7 by the end of 2017 (15.7 in 2016).

The decline is mainly due to the higher growth rate of the K12 education sector (tuition income increased by 18% year-on-year, while tuition income in the university sector increased by 9% year-on-year). The company's adjusted net profit rose 28% year-on-year to 331 million yuan after deducting exchange gains and losses.

The new campus continues to enroll students to drive growth in 2018, but the impact is mainly reflected in the second half of the year. We expect the company to increase its enrollment by 7000 by the end of 2018, mainly considering the opening of six new schools in the second half of 2017 and the announcement of new schools in Dazhou that will begin in the second half of 2018. At the same time, given the continuing policy uncertainty, we expect tuition growth to stagnate, so the increase in enrollment may be the main driver of the company's performance growth. The company's gross profit margin may also be under some pressure (we expect the company's gross margin to be 47% in 2018).

Policy uncertainty remains. The new civil promotion law needs supporting local implementation rules to land. At present, 14 provinces have announced the supporting implementation rules, while Sichuan Province has not yet announced. Private schools registered as for-profit schools under the New people's Promotion Act may face higher tax rates, and we suggest waiting for more details.

Profit forecast

Taking into account the weak growth in tuition fees and the lower-than-expected growth in enrollment in 2017, we lowered the company's 2018 revenue forecast by 9% to 1.2 billion yuan and the company's 2018 net profit forecast by 16% to 384 million yuan. At the same time, we introduced the company's 2019 revenue forecast of 1.4 billion yuan (corresponding to 23% year-on-year growth) and adjusted net profit forecast of 513 million yuan (corresponding to 34% year-on-year growth).

Valuation and suggestion

At present, the company's share price corresponds to 31 times 2018 earnings and 23 times 2019 earnings.

We maintain the company's "neutral" rating and target price of HK $4.7, based on a price-to-earnings ratio of 30 times 2018, which is 4% lower than the current share price.

Risk.

Policy uncertainty; the performance of the new campus is below expectations.