The decline in the admission of Dalian high school caused a one-time impact of the income growthrate to be less than prediction, but the annual guidance is still expected to be reached: FY2019H1company recorded revenue of 744 million RMB with growth of 17.8% year-on-year; revenue was9.3% lower than our expectation of 820 million RMB, which was mainly due to a 3.3% year-on-yeardecline in high school income revenue resulting of a 9.3% year-on-year decline in the number ofhigh school students. As of FY2019H1, there are 15 high schools in total, of which Dalian has thehighest proportion of students. The first year of high school freshmen enrolled in September 2018was mainly born in 2003. In 2003, factors of the Year of the Sheep and SARS caused sharp decline ofthe neonatal population in Dalian, which affected the company's high school enrollment. However,we observed that the impact of the newborn population in Dalian is one-off, and the influence onother regions is limited, which will not affect the company's future enrollment trend. The number ofstudents in the company's primary school segment increased rapidly by 55.8% year-on-year, and thenumber of middle school students also increased by 19.6%. As of FY2019H1, Secondary School inLuzhou, Sichuan has not been consolidated, and it is expected that the annual income will still reach20% of the expectation.
　　The increase in salary and equity incentives led to downward trend of gross profit margin, with theprofit rate in line with expectations: FY2019H1 recorded gross profit of 327 million RMB with ayear-on-year increase of 10.9%; gross profit margin was 43.9% with 270bps year-on-year decrease.
　　During the period, the company's management expense ratio also increased slightly by 210bps to13.8%, which was mainly affected by the increase in equity incentive expenses up to expectations.
　　Impact of the education sector has stabilized, core regulatory provision remains unchanged, the policyhas contributed to the long-term industrial development: Since August 2018, the impact of policy forHong Kong stocks listed education company has fully priced in. At present, the negative policies thatexceed the consensus of the market are expected to be less probable. The core regulatoryprovisions are: 1） Non-profitable companies can’t conduct mergers and acquisitions; 2） VIE structureis non-protocol control; 3） Related transactions need to comply with three public principles, andthree core terms remain unchanged. Stabilizing the policy will drive the development of the industryinto a new phase.
　　Maintain “Buy” rating, but high school business may affect the company's annual performance, thuscut target price to HK$5.5: Based on the impact of the student structure downward shifting, we cutour earnings forecast. The company's revenue for the 2019-2021 fiscal year is expected to be 16.4,19.0 and 2.24 billion RMB （the same below）， with year-on-year increase of 21.9%, 16.4% and 17.5%respectively; the adjusted net profit is 7.2, 8.4 and 9.8 billion RMB, with year-on-year increase of20.2%, 16.4% and 16.1% respectively. Maintaining company's “Buy” rating and cutting target priceto HK$5.5 will lead to 20, 17, and 15 times PE in 2019-2021.
　　Risk tips: changes in China's education policy; expansion of company acquisition and self-buildingbelow expectations; student and parent satisfaction with teaching quality declines; VIE architecturepolicy risk.