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Pearson - Shares fall 10% as US market remains tough

Equity research team | 17 October 2016 | A A A
Pearson - Shares fall 10% as US market remains tough

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Pearson plc Ordinary 25p

Sell: 589.20 | Buy: 589.80 | Change 12.80 (2.22%)
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Shares fall 10% as US market remains tough

A tight control on costs means that both short and long term profit guidance is unchanged in Pearson's nine-month interim management statement. However, market conditions, especially in North America, remain challenging for the group. The shares fell 11% on the news.

Our View

Paper is being replaced by digital content the world over, and Pearson believes that will be the case in education too. With this in mind, the group is restructuring to focus on providing online and interactive educational content. The switch will reduce profitability in the short-term, but could boost long term prospects. Provided the group sees some improvement in its key markets, Pearson expects a substantial recovery in profitability from 2017 onwards.

The problem with the group's plan is that, while the opportunity there, moving online means competing with the mass of free educational content available on the web. While Pearson hasn't explicitly referenced this concern, convincing a customer to continue paying for something they can get for free elsewhere is always going to be difficult.

As Pearson re-focuses, operating costs are being taken out of the business (headcount is set to fall by 10%) and non-core assets like The Financial Times and The Economist have been sold. These disposals have shored up the balance sheet, and give Pearson the cash to hold the dividend steady during the restructure. However, to avoid a cut in the longer-term, investors will need to be confident that Pearson's strong existing customer relationships will help it rise above the competition.

The shares offer a prospective yield of over 6.5%. This means that if things go well, and Pearson can rise to the challenge, investors can look forward to a high level of income. The potential for longer term capital gains driven by an improved business performance is there too.

However, a turnaround is far from guaranteed. With the dividend only just covered by forecast earnings this year, investors should not be counting any chickens yet.

Third Quarter update in detail:

Underlying sales declined by 7%, driven lower by Pearson's biggest market, the US. North American sales as a whole declined by 9% as retailers chose to stock less Higher Education courseware, although the group say that this trend has improved from September.

Underlying sales in the group's Core markets, including the UK, European and Australian businesses, declined by 4%. The drop is primarily due to expected declines in vocational course registrations in UK schools.

In Pearson's Growth markets, underlying sales declined by 3%. As previously disclosed, Pearson withdrew from an agreement to run three Saudi Colleges of Excellence, and made cuts in the direct delivery businesses. Lower enrolment levels in English language learning hit sales in Brazil, but the rest of Latin America grew strongly in the quarter.

Penguin Random House benefited from international movie-tie-in sales for The Girl on the Train by Paula Hawkins, Me Before You by Jojo Moyes, and The BFG and other classics by Roald Dahl.

As the group builds working capital, Pearson's net debt typically peaks in this quarter. Net debt at the end of September was £1,365m, down from £2,082m this time last year.

Pearson continue to expect adjusted operating profit and adjusted earnings per share before restructuring costs of between £580m and £620m and between 50p and 55p respectively. If current exchange rates prevail, a 4.5p EPS benefit can be expected.

Unless otherwise stated, all estimated figures, including prospective dividend yields, are taken from a consensus of analyst forecasts compiled by Thomson Reuters. These estimates should not be taken as a reliable indicator of future performance.

All yield figures are variable and not guaranteed. The information in this article is not intended to be advice or a recommendation to buy, sell or hold any investment mentioned, nor is it a research recommendation. No view is given as to the present or future value or price of any investment, and investors should form their own view in relation to any proposed investment.

This article is not advice or a recommendation to buy, sell or hold any investment. No view is given on the present or future value or price of any investment, and investors should form their own view on any proposed investment. This article has not been prepared in accordance with legal requirements designed to promote the independence of investment research and is considered a marketing communication. Non-independent research is not subject to FCA rules prohibiting dealing ahead of research, however HL has put controls in place (including dealing restrictions, physical and information barriers) to manage potential conflicts of interest presented by such dealing. Please see our full non-independent research for more information.