Elevator Pitch
I have a Buy rating for Gaotu Techedu Inc. (NYSE:GOTU) stock. With my earlier update for GOTU published on May 18, 2023, I previewed Gaotu Techedu’s Q1 2023 earnings.
After considering the positive change in sell-side analyst sentiment for Gaotu Techedu and the company’s decent short term financial prospects, I have chosen to upgrade my rating for GOTU from a Hold to a Buy. In my view, Gaotu Techedu’s shares have legs to run, as analysts become increasingly bullish on the stock and the company’s financial performance gets better over time.
Sell-Side Analyst Sentiment For GOTU
The analysts’ sentiment towards Gaotu Techedu has improved significantly in the past couple of months, and this suggests that there is room for GOTU’s shares to rise in the future.
Six months ago, the consensus sell-side rating for GOTU was a Sell with an average analyst score of 2.67. Gaotu Techedu’s mean analyst rating had gone up to 4.00 now, which implies a consensus Buy for the stock. Analyst ratings of 1 and 5 refer to Strong Sell and Strong Buy ratings, respectively. In the past six months, the mean consensus target price for Gaotu Techedu was raised by +78% from $2.48 to $4.42.
Also, two new sell-side analysts initiated coverage of GOTU’s shares in April 2023 and June 2023, respectively, which brought the total number of analysts covering Gaotu Techedu’s stock from three previously to five now. It is reasonable to assume that investor interest in GOTU’s shares has grown in recent times.
Furthermore, the sell-side is increasingly bullish about Gaotu Techedu’s financial performance for the near term. According to consensus financial data taken from S&P Capital IQ, GOTU’s consensus fiscal 2023 top line forecast (in RMB terms) is currently +24% higher than it was at the beginning of this year. Similarly, the analysts’ consensus FY 2023 EBIT estimate (in local currency terms) for Gaotu Techedu has been increased by +189% from RMB53 million as of January 1, 2023 to RMB153 million as of July 27, 2023.
In summary, analyst sentiment for GOTU has turned positive, and this should help to draw investors’ attention to the stock’s favorable financial outlook as detailed in the next section.
Gaotu Techedu’s Business Outlook
GOTU’s financial performance for the current year is expected to be reasonably strong.
As indicated in its most recent quarterly results press release, Gaotu Techedu has guided for a +22.4% YoY increase in its revenue from RMB538 million for the second quarter of 2022 to RMB658 million in Q2 2023 based on the mid-point of its management guidance. The sell-side analysts think that GOTU’s actual second quarter top line performance could potentially be better than the company’s financial guidance. The current market’s consensus forecasts (source: S&P Capital IQ) point to Gaotu Techedu’s top line expanding by +23.9% YoY to RMB667 million in the second quarter of the current year.
At its most recent first quarter results call, GOTU stressed that it has “confidence in the scale of annual revenue growth in 2023.” Specifically, the sell-side analysts (as per consensus data sourced from S&P Capital IQ) expect Gaotu Techedu to turn around from a -61.9% top line contraction (in domestic currency terms) last year to register a +20.5% revenue growth this year.
In my prior May 18 write-up, I emphasized that “the growth in Gaotu Techedu’s non-academic tutoring services points to a more favorable top line outlook.” I stick with my view that non-academic tutoring will be the key revenue growth driver for GOTU in the foreseeable future. Gaotu Techedu disclosed at its Q1 2023 earnings call that gross billings for the company’s non-academic tutoring business grew by a “triple-digit” percentage on a YoY basis in the first quarter thanks to “booming market demand.”
Gaotu Techedu is also poised to witness a meaningful improvement in the company’s profitability for the current year. As per S&P Capital IQ consensus data, GOTU’s gross profit margin is projected to expand by +200 basis points from 73.6% in FY 2022 to 75.6% for FY 2023. The market consensus also sees Gaotu Techedu’s normalized net income margin improving by +3.7 percentage points from 5.4% to 9.1% over the same time period.
Apart from positive operating leverage and other cost control measures, a change in GOTU’s client acquisition approach was the key factor driving the company’s profit margin expansion. In the past, Gaotu Techedu was largely reliant on buying advertisements on the major social media platform to promote its services. In recent times, GOTU has created its own content such as videos which are hosted on its livestreaming channel as a means of attracting potential customers. This new marketing strategy will allow Gaotu Techedu to generate significant cost savings relating to advertising.
In a nutshell, Gaotu Techedu is expected to return to positive revenue growth and achieve higher profit margins in the current fiscal year.
Concluding Thoughts
GOTU’s current valuations are undemanding. The market values Gaotu Techedu at consensus forward FY 2025 Enterprise Value-to-Revenue, EV/EBITDA, and normalized P/E multiples of 0.92 times, 7.8 times, and 13.4 times (source: S&P Capital IQ), respectively. I believe that the improvement in analyst sentiment and the company’s favorable financial outlook will serve as catalysts to re-rate GOTU’s shares, and this justifies my Buy rating for Gaotu Techedu.
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