LEAP Into These 2 Undervalued Chinese Education Stocks

Includes: EDU, XUE
by: Simon Monger

New Oriental Education and Technology Group Inc. (NYSE: EDU) and Xueda Education Group (NYSE: XUE) are two education providers worth investigating after Chinese companies fell out of favor in recent months. Concerns about accounting irregularities in several Chinese-based public companies have made investors a little more cautious when investing in one of the fastest growing emerging markets.

But, as education providers, the companies benefit from strong secular domestic demand driven by the urbanization of one of the world’s largest economies and populations. Meanwhile, the People’s Bank of China (PBOC) noted in its 2010 China Regional Financial Operation Report that the country’s economic growth remains strong as it rolls out policies to develop strategic emerging industries.

New Oriental: The Industry Leader Appears Undervalued

New Oriental Education and Technology Group Inc. (EDU), a provider of private educational services in China with more than 1.8 million students enrolled, represents one of the largest plays on China’s fast-growing educational sector. As the largest provider of private educational services, the company represents one of the most stable and safe plays in the sector.

During the full year 2010, the company reported revenues that increased 32% to $352.8 million, while its net income jumped to $2.01 per diluted share. These results and the recent undervaluation of the company’s stock led RW Baird to upgrade the stock to Outperform from Neutral. Citing valuation and sustainable margin expansion, the analyst issued a $140.00 per share price target on the stock.

Investors looking to take a position in New Oriental may want to consider purchasing the 110 Jan ’12 LEAPS (long-term equity anticipation securities) for $13.00 per contract plus commissions. If the stock rises to $140.00 per share, investors would then profit $14.00 per contract, or 10%, plus have a strongly leveraged position for any further upside in the shares.

Xueda Education: An Auxiliary Play on Chinese Education

Xueda Education Group (XUE), a provider of personalized tutoring services for students in primary and secondary school in China, represents a great auxiliary play on the education sector. With mass urbanization creating increasingly competitive universities, families spend a significant portion of their income on education and education-related services like tutoring.

Ultimately, this secular growth in demand led to its revenues nearly doubling in 2010, compared to 2009, while the firm swung to a net profit. The company was also recently upgraded by Outperform from Neutral at RW Baird, citing valuation as a catalyst for the move. The analyst issued a $12.00 per share price target on the stock, which represents a significant 50% premium to the current market price.

Investors looking to capitalize on this demand may want to consider the company’s 10 Jan ’12 LEAPS (long-term equity anticipation securities) that trade for $1.20 per contract. For the rights to 100 shares, investors can pay just $120.00 (plus commissions) and generate a net profit of $80.00, or 66%, on the position with greater leverage in the event of a further move higher.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.