This Company Is Thriving In China, Even As the Economy Slows
China’s economy is a growing concern for investors. As The New York Times notes,
“China’s economy is slowing, and the slowdown is probably worse than Beijing says.
Official numbers … show an economy that is posting new, but manageable, lows. For the last three months of 2018, growth came in at 6.4 percent compared with a year earlier. That’s the slowest pace since a decade ago, when China was grappling with the global financial crisis.
For the full year, according to official data, the Chinese economy grew 6.6 percent. That’s the weakest pace of growth since 1990, when China’s economic miracle stumbled in the aftermath of the crackdown on protesters in Tiananmen Square the year before.”
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But not all companies are feeling the pain.
New Oriental Education & Technology Group Inc.(NYSE: EDU) is a provider of private educational services in the People’s Republic of China (the PRC). The company provides educational services under its New Oriental brand.
EDU offers a range of educational programs, services and products, consisting of English and other foreign language training, test preparation courses for admissions and assessment tests in the United States, the People’s Republic of China and Commonwealth countries, primary and secondary school education, development and distribution of educational content, software and other technology, and online education.
In the most recent quarter, PR Newswire reported,
“EDU added 185 schools and learning centers over the past year, including 24 learning centers and one new training school this quarter, bringing its total to 1,125 at the end of November. The company also saw total student enrollments climb 23.6% year over year to roughly 2,320,800.
For the quarter, total net revenues increased by 27.8% year-over-year to US$597.1 million. The company reported a loss but investors greeted the news bullishly.”
Chenggang Zhou, New Oriental’s Chief Executive Officer, commented on the results, noting:
“As we execute our well-proven ‘Optimize the Market’ strategy’, we continued to progress our capacity expansion plan in this quarter. We added a net of 24 learning centers in existing cities, and opened a new training school in the city of Jinhua.
Altogether, this increased the total square meters of classroom area by approximately 30% year-over-year and 5% quarter-over-quarter by the end of this quarter.
[…] Starting from the fiscal year 2019, we initiated a pilot program to standardize teaching content and methodology in the U-Can middle and high school tutoring business, which has started to bear fruit as we achieved a remarkable increase of customer retention.
As we develop best practices gradually, we will begin to roll out the pilot program in our online and offline K-12 tutoring business to further improve teaching quality. We believe this will in turn boost our competitive advantages as we offer the best learning experience to our students.
Moreover, we continued to make strategic investments in our dual-teacher model classes and new initiatives for K-12 tutoring on our pure online education platform, Koolearn.com, which is expected to see increasing demand in cities of lower tiers and in remote areas.”
This news confirms the potential bottom that is visible in the long term chart shown below.
A Trade for Short Term Bulls
As with the ownership of any stock, buying EDU could require a significant amount of capital and exposes the investor to standard risks of owning a stock.
To reduce the risks of a trade, an investor could purchase a call option. This allows them to benefit from upside moves in the stock while limiting risk to the amount paid for the options. However, buying a call option can also require a significant amount of capital and includes the risk of a 100% loss.
Whenever an option is bought, the maximum risk is always equal to 100% of the amount of spent to purchase the option. Since options cost significantly less than a stock, the risk in dollar terms will usually be relatively small to own an option.
To further limit the risks of the trade, an investor could use a bull call spread. This strategy consists of buying one call option and selling another at a higher strike price to help pay for the cost of buying the first call. The spread strategy always reduces the risk of an options trade.
This strategy is designed to profit from a gain in the underlying stock’s price but has the benefit of avoiding the large up-front capital outlay and downside risk of outright stock ownership. The potential risks and rewards of this strategy are summarized in the chart below.
Source: The Options Industry Council
Both the potential profit and loss for the bull call spread are limited. The maximum loss is equal to the net premium paid when the trade is opened. The maximum profit is limited to the difference between the strike prices, less the debit paid to put on the position.
This strategy could be especially appealing with high priced stocks where the share price and options premiums are often a significant commitment of capital for smaller investors.
A Specific Trade for EDU
For EDU, the April 18 options allow a trader to gain exposure to the stock.
An April 18 $75 call option can be bought for about $3.95 and the April 18 $80 call could be sold for about $2.47. This trade would cost $1.48 to open, or $148 since each contract covers 100 shares of stock.
The amount paid to enter the trade is the largest possible loss on the trade. This is generally true whenever a trader is creating a debit to enter an options trade. “Creating a debit” means there is a cost to enter the trade. You could create a debit by simply buying puts or calls to open a directional trade.
In this trade, the maximum loss would be equal to the amount spent to open the trade, or $148.
The maximum gain on the trade is equal to the difference in exercise prices less the amount of the premium paid to open the trade.
For this trade in EDU the maximum gain is $3.52 ($80 – $75 = $5.00; $5.00 – $1.48 = $3.52). This represents $352 per contract since each contract covers 100 shares.
Most brokers will require minimum trading capital equal to the risk on the trade, or $148 to open this trade.
That is a potential gain of about 137% based on the amount risked in the trade. The trade could be closed early if the maximum gain is realized before the options expire.
In this trade, options provide income and defined risk. These are the type of strategies that are explained and used in TradingTips.com’s Extreme Profits Calendar service. This service uses seasonals as one indicator in its trade selection process. To learn more about how options can be used to meet your goals, click here for details on Extreme Profits Calendar.