Demand for learning services remains strong, and market leaders are building advantages in their respective areas. With the worst of the regulatory clampdown now over, in our view, operations are stabilizing. We are Overweight high-quality education stocks.

Earnings better than expected: Most of the costs from closing K9 academic tutoring centers were reflected in the latest reported quarter, resulting in nonGAAP net losses of US$802mn for EDU (F1H22) and US$853mn for TAL (F9M22).

EDU's net cash position (excluding deferred revenue) of US$3.56bn at the end of November was better than we expected, as were TAL's shutdown costs. Youdao's non-GAAP loss from continuing operations narrowed to Rmb208mn in 4Q21.

Transition on track: Demand for learning services and products remains strong, and we expect TAL, EDU and DAO to achieve US$749mn, US$403mn, and Rmb980mn in non-K12 academic tutoring revenues in F23. Indeed, we estimate DAO will see 3% revenue growth in 2022 despite the closure of its K12 academic tutoring business last year. Further, given growing demand for non-academic tutoring, market leaders are establishing advantages in their respective areas; DAO leads in learning devices and emerging new courses, TAL leads in science and cultural arts tutoring, and EDU leads in reading courses and other areas.

Regulatory implementation will continue, affecting the pace of recovery but not its direction: We expect more regulatory details to be rolled out in 2022, including 1) a potential further reduction in high school academic tutoring, and 2) requirements for non-academic tutoring services, mainly covering issues such as the content and location/area of learning centers and staff qualifications. We also expect further adjustments to non-academic course content, formats and pricing, but we do not think non-academic businesses are at risk of being shut down. Most non-academic students are from lower grades and were formerly enrolled in academic courses, so this enables a large size at the beginning, but we plan to monitor retention rates to confirm future growth trends.

Revisiting quality names – EDU, TAL, DAO: Sentiment towards the space remains low, but we believe the worst is over and quality names are undervalued. We are OW EDU for its attractive valuation, the F23 recovery of the overseas and domestic test prep business, and its potential in non-academic tutoring, TAL for its leadership in non-academic tutoring, and DAO for its potential to become a leader in the learning device business and edtech products.