Hope Education announced 1H22 revenue of Rmb1.53bn (+29% YoY), adj. net profit of Rmb453m (-17% YoY). Revenue came in line, but adj. np missed expectation. Declining earnings was due to rising COGS (+39% YoY), owing to high-quality strategy. In 1H21, the company also had a high base due to the recovery of impairment loss of Rmb180m. After adjustment, np increased by 24% YoY in 1H22.
　　Great synergy between domestic and overseas schools. Enrolments rose by 18% to 232k in SY21/22, of which, undergraduate enrolments and junior college enrolments increased by 21% and 23%. Growing enrolments was backed by 3m quota expansion for junior colleges in three consecutive years and study abroad program innovated after acquisition of INTI University, forming a competitive differentiation with peers and driving new enrolments to increase by 15% YoY to 82k. And about 20k of those signed up for study abroad program. As INTI can recruit 60k international students after obtaining KDN license, the company began to deploy Southeast Asia in SY21/22. New enrolments of INTI and Thailand Shinawatra University surged by 43% and 24%. We believe synergy between domestic and overseas schools will further empower enrolments and we forecast new enrolments to reach 110k and total enrolments to reach 293k in SY23/24, representing three-year Cagr of 16.5% and 14.7%.
　　High-quality strategy implies higher costs. “Opinions on Promoting the High-quality Development of Modern Vocational Education”, issued in October 2021, promoted provincial quality evaluation standards, while Hope Education announced its high-quality strategy. Hence, in 1H22, the company renovated buildings, hired teachers and rose teachers’ salary. Hope Education booked reconstruction cost of Rmb1.15bn (+67% YoY) and teachers’ salary cost of Rmb388m (+48% YoY). The company also targeted to achieve an 18:1 student-to-teacher ratio before 2025 vs. 19.8:1 in FY21. Sales expenses and G&A expenses grew by 61% and 32%, owing to expansion of recruiting team and consolidation of 6 merged schools. Therefore, rising costs and expenses curbed gross margin to 50.7% (-3.5ppts YoY) in 1H22. Coupled by high base due to the recovery of impairment loss of Rmb180m in 1H21, adj. np margin dropped by 16.5ppts to 29.7%. As high-quality strategy continues, high costs may lead to gross margin of 45.2%, 46.7% and 46.3% in FY22E, FY23E and FY24E.
　　Reiterate BUY. We believe effect post-merger management will drive np margin. However, costs and expenses are expected to maintain, owing to high-quality strategy and expanding recruiting team. Thus, we lower our adj np forecast to Rmb702m, 815m and 922m for FY22E, FY23E and FY24E, representing adj. EPS of Rmb0.09, 0.10 and 0.12. We lower TP to HK$1.38 and maintain Buy.
　　Risks: Expense control fails due to unfavorable post-merger management; Pandemic leads to a decline in overseas study demand, affecting enrolments of study abroad program.