Gaotu Techedus (NYSE: GOTU) shares are rated Hold. I have mixed opinions about GOTU. I like Gaotu Techedu’s QoQ revenue growth and its new stock buyback plan, but I’m concerned about its progress Business pivot and compliance risks. Therefore, I have decided to put a hold rating on GOTU stock.
In its media releases, Gaotu Techedu describes itself as a provider of “educational services for students and adults, non-academic tutoring services as well as educational content and digitized learning products”.
Similar to many of its Chinese educational peers, GOTU has had to stray from its core business due to regulatory headwinds in China. In its earlier press release dated February 16, 2022, Gaotu Techedu announced that it will “stop offering tutoring services related to academic subjects for high school students” to comply with the country’s new laws.
GOTU’s most recent financial performance for the third quarter of 2022 was mixed based on a review of the company’s headlines.
On the bright side, Gaotu Techedu delivered positive revenue growth and gross profit margin improvement quarter-on-quarter.
Revenue of GOTU increased +13% sequentially from RMB538 million in the second quarter of 2022 to RMB606 million in the third quarter of this year. In contrast, Gaotu Techedu had suffered from a -26% QoQ revenue decline in the second quarter of 2022. Also, the company’s gross profit margin increased by +190 basis points QoQ from 70.3% in Q2 2022 to 72.2% in Q3 2022. This indicates that Gaotu Techedu’s business focus is progressing well and is benefiting from positive to some extent operational leverage.
On the negative side of things, GOTU turned from positive gains in the previous quarter to losses in the most recent quarter, and the company’s operating cash flow also declined in Q3 2022 on a QoQ basis.
Gaotu Techedu was slightly profitable in the second quarter of this year with positive non-GAAP net income of +1 million RMB. But GOTU recorded a non-GAAP net loss of -45 million RMB for the third quarter. Operating cash flow also declined from $94 million in the second quarter of this year to $35 million in the third quarter of 2022.
GOTU acknowledged in its Q3 2022 earnings call that “we strategically increased our investments in sales and marketing to improve our market penetration rate” and this resulted in losses and a decrease in cash flow for the company. Specifically, Gaotu Techedu’s sales and marketing spend to revenue ratio increased from 50% in the second quarter of 2022 to 56% in the third quarter of 2022.
In the next section I explain how the different business areas of GOTU have developed.
Differences in the performance of the various divisions of GOTU
GOTU’s non-academic tutoring business performed well in the third quarter of 2022 as the revenue from this business increased by +69% QoQ to RMB364 million in the most recent quarter. Discussing third-quarter results, Gaotu Techedu noted that “our non-academic tutoring services is one of the new business areas we are focusing on,” and stressed that its non-academic tutoring business is “gradually gaining recognition from students and parents “. This certainly explains the good development in the non-university tutoring business.
On the other hand, in Q3 2022, GOTU’s Educational Services and Digitized Learning Products business segments revenue shrank by -15% and -44%, respectively, on a QoQ basis. This implies that Gaotu Techedu’s business alignment is still ongoing and not all of the company’s new deals are performing as well as the company had hoped.
Focus on share buybacks and compliance risks
Aside from Gaotu Techedu’s financial performance, there are two other company developments worth mentioning.
On November 22, 2022, GOTU announced a new $30 million stock repurchase program that will run for the next three years. The level of potential share buybacks is telling, given that the size of the buyback plan represents nearly 11% of its current market cap. Considering the -63% drop in GOTU’s share price over the past year and the current unassuming consensus for the price-to-sales multiple of 0.81 for the next twelve months (source: S&P Capital IQ), Gaotu Techedu’s new share buyback plans send a positive signal for the stock’s undervaluation.
However, Gaotu Techedu faces compliance risks that cannot be ignored. GOTU issued an 8-K filing on November 21, 2022. In the 8-K filing, the company announced that the NYSE informed GOTU that it was below compliance standards “due to the trading price of its” ADSs (American Depositary Shares). GOTU shares last traded at $1.06 on November 23, 2022; If the average share price stays below $1 for the next half-year, Gaotu Techedu’s ADSs could be suspended for trading under NYSE regulations.
Gaotu Techedu is a hold. GOTU isn’t a buy as it has compliance risks and the company just made losses in the third quarter. The stock isn’t a sell as the company just announced a major buyback program and posted positive QoQ sales growth in the most recent quarter.