Elevator Pitch
I have a Hold rating for Gaotu Techedu Inc. (NYSE:GOTU) shares.
Earlier, I wrote about Gaotu Techedu’s new live-streaming e-commerce business and the company’s financial prospects in my February 9, 2024 article. This latest update evaluates GOTU’s recent quarterly financial performance and its outlook.
GOTU’s Q1 2024 operating loss and second quarter top-line guidance fell short of expectations. I deem Gaotu Techedu’s current valuations to be fair based on peer and historical comparisons. GOTU’s shares could also potentially find support from the management’s confidence in its full-year performance and the company’s share repurchase program. Therefore, I have made the choice to maintain a Hold rating for Gaotu Techedu.
First Quarter Operating Loss Was Wider Than Expected
GOTU disclosed the company’s financial results for the first quarter of this year on May 21, 2024 before trading hours.
Top line for Gaotu Techedu rose by +33.9% YoY from RMB707.3 million for Q1 2023 to RMB946.9 million in the latest quarter. In its Q1 2024 results press release, GOTU attributed the good top-line performance to “strong market demand” for its “learning services.”
The company’s actual Q1 2024 revenue was consistent with what the market had anticipated. As a reference, the analysts’ consensus top-line estimate was RMB943.7 million (source: S&P Capital IQ) or just -0.3% lower than GOTU’s Q1 2024 sales.
But GOTU’s Q1 2024 operating loss of -RMB77.7 million was worse than the sell side’s consensus forecast of -RMB62.8 million as per S&P Capital IQ data. Also, Gaotu Techedu had registered a positive operating profit of +RMB95.1 million a year ago in Q1 2023.
Gaotu Techedu’s recent first quarter operating loss turned out to be wider than expected because of an unfavorable sales mix and higher operating costs.
Gross margin for GOTU contracted by -610 basis points YoY from 77.4% in the first quarter of 2023 to 71.3% for Q1 2024. Gaotu Techedu indicated at its Q1 2024 earnings briefing that “the proportion of revenue generated from our one-on-one classes, smart textbooks and offline classes is gradually increasing.” These growing products and services are relatively less profitable than the company’s core online large-class tutoring services.
Also, Gaotu Techedu’s operating profitability for the latest quarter was negatively impacted by higher operating expenses. GOTU’s selling costs and R&D (Research & Development) costs increased significantly by +82.8% YoY and +56.3% YoY to RMB506.4 million and RMB151.6 million, respectively in Q1 2024. I noted in my early-February write-up for Gaotu Techedu that “higher-than-expected costs and investments” were a “key risk factor” and the company’s recent quarterly profitability was indeed hurt by a substantial growth in expenses.
In the next section, I touch on GOTU’s short-term revenue outlook.
Second Quarter Top-Line Growth Guidance Was Disappointing
Gaotu Techedu offered its guidance for Q2 2024 revenue expansion in tandem with its first quarter results release. GOTU’s forward-looking top-line guidance was a disappointment.
In specific terms, GOTU is anticipating a +30.4% increase in its top line to RMB918 million in the second quarter of 2024 as per the mid-point of its guidance. As a comparison, Gaotu Techedu’s actual YoY Q1 2024 revenue growth was a relatively stronger +33.9%. Notably, a sell-side analyst from Citigroup (C) referred to GOTU’s Q2 2024 revenue guidance as “conservative” at the company’s Q1 2024 earnings call.
GOTU mentioned at its recent quarterly results briefing that the “education services we provided for college students and adults” are expected to expand at a slower pace than “non-academic tutoring services and other traditional learning services” and the company as a whole in Q2. This explains why Gaotu Techedu’s second quarter guidance points to revenue growth deceleration. Specifically, Gaotu Techedu’s learning services for “college students and adults” represented about a fifth of its Q1 2024 top line.
Gaotu Techedu also noted in the company’s Q1 2024 results release that its “strong performance in the first quarter has strengthened our confidence to continue strategic investment in educational products and learning services.” GOTU’s comment on investments suggests that its Q2 2024 operating loss might still be significant due to elevated costs, even though the company didn’t provide margin or earnings guidance.
I draw attention to GOTU’s post-results stock price performance in the subsequent section.
But Negatives Are Priced In
GOTU’s shares fell by -13.1% and -7.9% on May 21, 2024 and May 22, 2024, respectively after the company reported a wider-than-expected operating loss and a modest revenue guidance.
Gaotu Techedu’s valuations have returned to reasonable levels following the recent post-results share price correction. GOTU is now trading at 2.59 times (source: S&P Capital IQ) consensus next twelve months’ price-to-revenue. This is roughly on par with its peer New Oriental Education & Technology Group’s (EDU) consensus next twelve months’ price-to-sales valuation multiple of 2.55 times. Also, Gaotu Techedu’s current price-to-sales metric is close to its 2024 year-to-date mean price-to-revenue ratio of 2.69 times.
It will be reasonable to say that the negatives relating to the worse-than-expected Q1 operating loss and its disappointing Q2 top-line guidance have been factored into GOTU’s stock price and valuations. Gaotu Techedu’s current price-to-revenue multiple is at a level comparable to its historical trading average and its listed Chinese education peer EDU.
More importantly, GOTU’s full-year outlook and share buyback plan could help to limit further downside for the company’s shares.
Notwithstanding the below-expectations second quarter revenue guidance, Gaotu Techedu stressed at its Q1 earnings call that the company expects its “revenues to accelerate” in “the second half of the year” according to its “assessment of the current situation.” In other words, GOTU remains confident in its 2H 2024 top-line growth prospects.
Separately, GOTU still has around $67.6 million remaining from its current share buyback authorization that expires in late-November 2025. This is equivalent to about 4% of Gaotu Techedu’s current market capitalization. As such, Gaotu Techedu has the ability to support its share price with buybacks, if the company’s stock price continues to weaken.
Concluding Thoughts
My Hold rating for GOTU remains unchanged. On one hand, Gaotu Techedu’s results and guidance were disappointing. On the other hand, GOTU’s shares are now reasonably valued after a significant correction in its stock price post-Q1 results.