Gaotu Techedu: What To Watch With Upcoming Q1 Results

Elevator Pitch

My Hold investment rating for Gaotu Techedu's (NYSE:GOTU) shares stays unchanged.

I highlighted the key positive and negative factors contributing to the "rollercoaster ride for Gaotu Techedu's shares" between late November last year and early February this year in my previous February 10, 2023, write-up.

The focus of my current article is the preview of GOTU's upcoming results release for the first quarter of 2023. In my view, there is a low probability of Gaotu Techedu delivering a Q1 2023 earnings beat, as the company is still in the midst of its strategic transformation which requires GOTU to continue investing in new growth opportunities. It is premature to rate Gaotu Techedu as a Buy now, when GOTU is still allocating capital to top line diversification initiatives that are a drag on its bottom line. As it stands now, I maintain my Hold rating for Gaotu Techedu.

Analysts Expect Improved Revenue Performance And Lower Earnings For GOTU In Q1

GOTU is expected to announce the company's Q1 2023 financial results next Tuesday on May 23, 2023, before U.S. trading hours. According to the sell-side's consensus financial figures for Gaotu Techedu taken from S&P Capital IQ, analysts see the company registering a better top line performance which comes at the expense of weaker profitability in the first quarter of 2023.

Specifically, the market forecasts that Gaotu Techedu's revenue will increase by +11% QoQ from RMB629.6 million in the fourth quarter of last year to RMB700.2 million for the first quarter of the current year. This also implies that the YoY top line decline for GOTU could potentially narrow from -51% for Q4 2022 to -3% in Q1 2023.

Separately, the sell-side analysts predict that GOTU's normalized net profit might decrease from RM92.5 million for Q1 2022 and RMB87.4 million for Q4 2022 to RMB61.4 million in Q1 2023. As per the current consensus financial estimates, Gaotu Techedu's normalized net margin is expected to contract by 4 percentage points YoY from 12.8% in Q1 2022 to 8.8% for Q1 2023.

My Bet Is On Gaotu Techedu's Actual Q1 Results Meeting The Sell-Side's Expectations

I am of the view that Gaotu Techedu's Q1 2023 earnings disclosure next week won't be a re-rating catalyst for the stock, as I think the market's consensus financial projections for GOTU are reasonable.

I previously mentioned in my earlier February 10 article for GOTU that "efforts relating to revenue diversification might pay off for the company this year, with expectations that Gaotu Techedu can deliver positive top line expansion" for full-year 2023.

Notably, GOTU disclosed at its Q4 2022 earnings call that "paid course enrollments for our non-academic courses in the fourth quarter achieved triple-digit quarter-over-quarter growth", and this is an indication of decent progress that it has made in diversifying into new products and services. In fact, Gaotu Techedu has managed to grow the revenue contribution from non-academic tutoring services to approximately 60% of the learning services revenue segment, which in turn accounts for 90% of GOTU's top line for the company as a whole. The digital products segment made up the remaining 10% of Gaotu Techedu's total revenue.

With K9 academic tutoring services being banned in China since 2021, Gaotu Techedu has worked hard to find new revenue streams. GOTU's efforts have been rewarded, as the growth of the non-academic tutoring services business means that it is very likely that the company will achieve much narrower YoY top line contraction (-3%) in Q1 2023 as per analysts' consensus estimates.

However, Gaotu Techedu's diversification plans are still a work-in-progress. At the company's fourth quarter results briefing, GOTU stressed that there is a need to "explore and experiment with new business initiatives to expand the range of our (products and services) offerings."

A corporate development worth noting is Gaotu Techedu's introduction of a new e-commerce live streaming business that is branded as "Gaotu Jiapin" at the end of the prior year. Investors in general tend to have a positive view of education companies diversifying into the e-commerce live streaming industry. As an example, Chinese education company Koolearn Technology Holding Limited (OTCPK:KLTHF) [1797:HK] saw its share price rise by 12 times in a single month in mid-2022 after launching its new e-commerce live streaming brand "Oriental Selection" as reported by Seeking Alpha News. In addition, "Gaotu Jiapin" can help to increase the company's visibility in the eyes of consumers, which could aid cross-selling efforts for its other services and products.

Also, there is tremendous potential for GOTU to grow its top line contribution from its digital products business segment. In its FY 2022 20-F filing, Gaotu Techedu revealed that its key digital product offerings include a "multi-function translation pen" and other "smart devices." China's smart learning device market is projected to expand by a CAGR of +17.1% from RMB65.9 billion in 2021 to RMB145.0 billion for 2026 as per Frost & Sullivan research cited in the IPO prospectus of Readboy Education [2385:HK]. As a comparison, GOTU's sales generated from digital products are estimated to be around RMB250 million (a fraction of the size of the industry as per market research) based on the company's disclosure that its digital products business segment accounts for 10% of its top line.

In a nutshell, the growth in Gaotu Techedu's non-academic tutoring services points to a more favorable top line outlook for the company, but GOTU's near-term profitability could weaken on further investments in new growth initiatives.

Closing Thoughts

My preview of GOTU's Q1 2023 earnings suggests that the analysts are justified in expecting weaker profitability and lower earnings for the company in the short term. I decided that a Hold rating for Gaotu Techedu is appropriate, as the company has yet to complete its revenue diversification plans.

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