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Pearson - Improving trends in the US

George Salmon | 4 August 2017 | A A A
Pearson - Improving trends in the US

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Pearson plc Ordinary 25p

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First half revenues rose 1% to £2bn in underlying terms, primarily due to higher gross sales and lower returns in North American higher education courseware. Adjusted operating profit improved significantly, from £15m to £107m cost savings and dollar strength more than offset some cost inflation.

The shares rose 2.9% on the news.

Our View

Digital content is replacing paper the world over, and Pearson believes that will be the case in education too. The group is transforming itself from staid publishing house to trailblazer in the emerging world of digital education content.

To raise the cash required, the group has sold most of its 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 Pearson could cover the costs of the restructure and maintain the dividend while still emerging a leaner and more profitable organisation.

This sounded like an excellent outcome for shareholders, but the sales removed the main safety net should there be a wobble. You can probably see where this is going.

Rather than a failure to get to grips with online specifically, that wobble came in the form of weak demand in North America. Unfortunately for investors, the decline was of 'unprecedented' size, and Pearson had to revaluate its stance on holding the dividend steady. While the group is still targeting a sustainable and progressive dividend, this is going to be from a significantly lower base. At the interim stage we saw a 72% cut, and the prospective yield is now just above 3%.

While we can see the rationale behind digital education resources, moving online means competing with the mass of free content available on the web, and could potentially be an uphill struggle. It's an emerging industry so all could yet change again, but for now profit growth is far from assured.

On the positive side, education is not the most volatile end market out there, and further significant cost cuts are planned. If delivered, these should help bring the group closer to the robustly profitable, cash generative business investors were promised.

First half results

Trends in gross sales and returns in H1, and so far in H2, are similar to that reported for the first three months. Gross sales are slightly ahead, while returns, although down significantly on last year, are running a little higher than expected.

After recent declines, sales trends improved in the important North American market (63% of group revenue). Underlying revenues were flat, despite US college enrolments dropping 1.5% and a moderate decline in school assessment. Pearson reported good growth in the schools market, driven by market share gains, and in professional certification as VUE global test volumes rose 4%.

Pearson's other divisions, Core, which serves more established markets such as the UK and Australia, and Growth, which includes emerging economies such as China and Brazil, saw underlying revenue grow 1%.

The board has declared an interim dividend of 5p per share, and is planning a £300m share buyback following the sale of a 22% stake in Penguin Random House, expected to complete in September.

The 2020 restructuring plan, which targets annual cost savings of £300m over the next three years, is underway. Pearson expects to achieve the first £70m of savings next year.

As usual, Pearson expects overall sales to be weighted towards the second half of the year. Guidance for the full year is unchanged, with adjusted operating profit of between £546m and £606m, as underlying market pressures continue to impact gross sales.

Unless otherwise stated estimates, including prospective yields, are a consensus of analyst forecasts provided by Thomson Reuters. These estimates are not a reliable indicator of future performance. Yields are variable and not guaranteed. Investments rise and fall in value so investors could make a loss.

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.