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Pearson - North American weakness means dividend set to be cut

George Salmon | 18 January 2017 | A A A
Pearson - North American weakness means dividend set to be cut

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Pearson plc Ordinary 25p

Sell: 537.40 | Buy: 538.00 | Change -8.40 (-1.54%)
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Pearson shares fell 24% after the group's January trading update shows a 'further unprecedented decline' in North American higher education revenues, with the downward trend expected to continue into 2017. With this in mind, the group no longer expects to reach its prior operating profit goal for 2018. The dividend is set to be rebased from 2017.

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 transforming itself to focus on online and interactive educational content.

To raise the cash required, the group is selling its main media assets. The Economist and Financial Times newspapers have already gone, and Penguin Random House is soon to follow. CEO John Fallon was confident that the proceeds from these sales would mean the group could cover the costs of the restructure and maintain the dividend before the group came out the other side a leaner and more profitable organisation.

This sounded like an excellent outcome for shareholders, but the sales removed the group's main safety net should it hit a wobble. In this context then, Pearson's admission that the dividend will be on the block following weak trading in North America is particularly galling.

Rather than the group failing to get to grips with online specifically, this drop is more reflective of demand for educational resources declining generally. Now all the group's eggs are well and truly in the educational basket, this isn't good news. Profit growth is now far from assured so the group's debt pile is looking more burdensome.

A longer term problem with the group's plan is that, while there is surely demand for online education resources, moving online means competing with the mass of free content available on the web. It seems that convincing a customer to continue paying for something they can get for free elsewhere is already proving difficult, and the group is slashing prices. If these lower prices entice budding scholars back, then it could be all change again, but for now things look bleak.

January trading statement in detail:

The group expects full year revenue to drop approximately 8% in underlying terms, primarily due to weakness in North American higher education courseware, where revenue fell 30% in the final quarter. The US market is shrinking and has a lower participation rate, while around 12% of the drop can be attributed to inventory correction in the channel reflecting the cumulative impact of these factors in prior years.

The group's other divisions have performed in line with expectations. Online program management, virtual schools and professional certification continue to grow.

The group expects to report profit in line with prior guidance this year as costs and staff bonuses are reduced. So while 2016 adjusted operating profit and earnings per share will come in at approximately £630m and 57p respectively, the group expects to miss its goal of increased operating profits to at least £800m by 2018.

The final dividend of 34p brings the 2016 overall to 52p. Looking forward, as a result of the difficulties the group is seeing in its North American market, the dividend will be rebased from 2017 onwards. Preliminary guidance for 2017 is for an operating profit of £570m to £630m, and adjusted earnings per share of 48.5p to 55.5p.

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.

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 disclosure for more information.