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• We expect tutoring demand to shift to TAL and EDU due to the shutdown of small institutions. We believe regulations are helping TAL and EDU by increasing the entrance barrier for K12 tutoring business;
• We see EDU’s expansion strategy begin to have payoff as it continues to fill up learning centers. On the other hand, as TAL slows down its capacity expansion last year, we expect its non-GAAP operating margin will recover better than consensus expects this quarter;
• Raise TAL and EDU’s TP from US$32 and US$82 to US$40 and US$100, respectively. Reiterate our BUY rating on TAL and EDU.

Regulation is helping TAL and EDU
As our publication on December 28, 2018, “Regulation nearing its end… BUY TAL and EDU” points out, regulations have paved the ground for big after school tutoring (AST) and both TAL and EDU will benefit from the regulations. Recent AST policy development in Sichuan province further confirmed our view. Sichuan government will start to control the number of teaching licenses, which make it more difficult for new AST institutions to enter this market.
 
We expect TAL and EDU to post strong numbers
Our F4Q19 and F3Q19 top line, operating profit, and net income estimates are 1.6%, 6.7% and 4.5%; and 2.5%, 6.0% and 5.0%, respectively, versus the consensus for TAL and EDU. We expect TAL and EDU to issue F4Q19 and F3Q19 top line guidance 1.9% and 1.6% higher than consensus.
 
Slow expansion improves TAL’s margin
As TAL slowed its learning center expansion in C2018, we expect its utilization to continue to increase, which leads to a margin recover. We estimate TAL will has a F4Q19 non-GAAP operating margin 0.8ppt higher than consensus due to this utilization improvement.
 
Regulation impacted EDU less than our expectation
We expect margin dragged down due to regulation is ~1%, less than ~1.5% we previously estimated. Therefore, we expect EDU will have a better non-GAAP operating margin performance in this quarter. We estimate EDU will have a F3Q19 non-GAAP operating margin 0.4ppt higher than consensus.

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