Key points of investment:

China Oriental Education announced its 2024 semi-annual report. Revenue was RMB 1.98 billion, up 1.6% year on year, and adjusted net profit was RMB 0.28 billion, up 57.9% year on year. The company's profit exceeded our expectations, mainly due to the company's promotion of cost and expense control to achieve rapid profit growth.

Costs and expenses are effectively controlled, and a profit release model is initiated. In the first half of '24, China Oriental Education's gross profit was 1.05 billion yuan, up 5.4% year on year. Gross margin was 53%, up 1.9 percentage points year over year. We believe that the company actively promoted various cost control measures in the first half of the year. On the one hand, the cost of materials related to teaching is strictly reviewed; on the other hand, the employee performance evaluation and elimination system is vigorously promoted. The cost of raw materials fell 12% year on year to 0.169 billion yuan in the first half of the year. On the premise of ensuring a relatively stable number of teachers, the company reduced the number of employees by about 1,092, a year-on-year decrease of 9.4%. Meanwhile, employee compensation expenses increased by only 4.3% year-on-year, to 0.378 billion yuan.

While refined management improved the company's operational efficiency, the company adopted a more robust marketing strategy. Sales expenses were 0.464 billion yuan, a decrease of 9.5% over the previous year. The sales expense ratio was 23.4%, down 2.9 percentage points year over year. We expect the company to firmly promote fine management and control of various costs and expenses, and the annual gross margin is expected to increase 2.5 percentage points to 50.4% year-on-year. The marketing expense ratio decreased 2.2 percentage points year over year to 23.9%. As a result, the adjusted profit margin will expand 2.3 percentage points to 9.4% year over year.

Spring recruitment students prefer cost-effective classes, and the enrollment strategy is adjusted in a timely manner to respond. The number of new trainees in the first half of '24 was 0.078 million, down 7.7% year over year. Among them, the number of new one-year trainers in the long-term course increased by 52.5% year-on-year, making it the only training program that increased.

Affected by the year-on-year decline in the number of 2-year and 3-year trainees, the number of long-term trainees dropped 6.4% year over year to 0.033 million. The number of short-term course trainees within 1 year also decreased by 8.7% year-on-year to 0.045 million. The proportion of new trainees in the medium and long-term education system was 41.7%, an increase of 0.6 percentage points over the previous year. We believe that the spring recruitment students are mainly employees, and the training services provided by the company focus on meeting the skill improvement needs of employees. These people want to develop a more comprehensive set of skills in a shorter period of time, so they prefer one-year courses. The company adjusted its marketing strategy in due course and launched courses to cater to such students, and achieved a high increase in enrollment. At the same time, the company suspended enrollment in short- and long-term majors that had no scale effect and were relatively inexpensive. As a result, although the number of trainees declined year-on-year, the contract debt (advance payment of tuition fees) for the first half of the year increased 10.5% to 1.46 billion yuan compared to the end of last year. Through the above measures, the company's average profit increased by 60.6% year-on-year in the first half of the year, reaching 1,922 yuan.

The regional center was put into operation to help the company develop further education business. The company has planned 8-10 regional centers in Chengdu, Jinan and other places. The capacity of a single school will reach 0.015 million people, and the software and hardware facilities meet the standards of advanced technical schools and even technician colleges. Since the vocational education reform was promoted, the promotion path for secondary vocational school students has been expanded from a single path of passing the college entrance examination to multiple paths of college entrance examinations, separate college admissions, and vocational education college entrance examinations, and the appeal of secondary vocational schools has gradually increased. We expect that through the completion and commissioning of the regional center, the company will develop further education business to meet the further education needs of skilled trainers. Therefore, the company's enrollment target will also be expanded, thus achieving an increase in the number of trainees.

Maintain an increase in holdings rating. The company focuses on refined operations and controls various costs and expenses. We expect further reductions in costs and expenses throughout the year. At the same time, the completion of a regional center project is expected to expand the company's enrollment targets and benefit the growth of the company's trainees in the medium to long term. In view of the improvement in operating efficiency in the first half of the year, we raised our adjusted net profit forecast for 24/25/26 to RMB 0.387/0.426/0.463 billion yuan (the original forecast was 0.319/0.369/0.411 billion yuan). We raised our target price to HK$3.01 (the original target price was HK$2.82) and maintained our incremental rating.

Core hypothetical risk: Oriental Education's enrollment falls short of expectations; academic license applications fall short of expectations.