TAL Education Facing Margin Pressure; Brean Steps To The Sidelines

Brean Capital has downgraded TAL Education Group (ADR) (NYSE: XRS) to Hold from Buy on greater-than-expected margin pressures.

TAL Education reported fourth-quarter non-GAAP operating margin of 14.4 percent, down from 16.4 percent a year ago. Gross margin also declined to 49.3 percent from 52 percent last year.

"The company's continued investments from O2O and more rapid geographic/network expansion should pressure margins in FY2017, though we believe these investments should support the company's market positioning in K12 and strong revenue growth over the longer-term," analyst Anne Shih wrote.

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In addition, the analyst believes that the First Leap Education acquisition and proportionally greater contributions from one-on-one and online classes should weigh on XRS' margins longer term.

However, Shih remains fundamentally positive on the company's strategy of increasing market share in K–12 over the next few years and expectations of sustained mid- to longer-term revenue growth of about 30 percent year-over-year.

Meanwhile, TAL Education's fourth-quarter non-GAAP EPS of $0.23 topped Street by penny and revenue grew 42.1 percent to $175.0 million, beating consensus estimates of $168.0 million.

The Beijing, China-based company also provided strong first-quarter revenue guidance of $181.1 million to $183.2 million, exceeding consensus' estimate of $174.3 million.

"However, given the stock's rapid recent ascent but upcoming further margin pressures we choose to step to the sidelines, waiting for a better entry point and/or improved visibility on timing for margin recovery," Shih added.

ADRs of TAL Education closed Friday's regular session down 0.83 percent on the day at $54.73.