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Pearson - Profit expectations upgraded, despite sales slip

Nicholas Hyett | 17 October 2017 | A A A
Pearson - Profit expectations upgraded, despite sales slip

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Pearson plc Ordinary 25p

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Despite the continuing decline in underlying sales, performance is in line with management's expectations. Together with favourable tax movements, that's helped Pearson narrow its expected profit range to the upper end of previous guidance.

The shares rose 7.1% following the announcement.

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 are long gone, and a chunk of Penguin Random House has recently followed them out the door. 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 slightly above 3.1%.

The third quarter trading update is finally starting to show signs that the strategy is bearing fruit. US sales, while still slipping, are seeing significant growth in the digital sphere. Competition from free online alternatives is having less of an impact than the group had expected, and much less than sceptics had feared.

Digital education resources are still an emerging industry, so all could yet change again, but Pearson does finally look like it's making progress. We'd hesitate to say that Pearson's shift to digital has been vindicated, but it certainly looks less risky now than it did 6 months ago.

Q3 Trading Update

Pearson now expects to deliver full year profits of between £576m and £606m (previously £546m to £606m).

The move comes despite a 2% fall in underlying group sales, reflecting a 4% decline in underlying US sales as North American assessment and courseware revenues continued to decline. This was partially offset by a 3% increase in revenues from the group's Growth division, which benefitted from stronger South Africa textbook sales and higher demand for English language courses in developing markets.

The group expects structural pressures in the US market to continue in the medium term. However, sales of digital courseware are progressing well, with digital sales revenues up 11%. The group has now signed 477 contracts for institution-wide Direct Digital Access.

The group has seen improvements in its balance sheet position. Net debt at the end of the quarter stood at £1,312m (2016: £1,365m) following a lower dividend payment and good operating cash flow. The sale of a 22% stake in Penguin Random House closed on the 5th October and the group expects to begin the return of £300m in surplus capital via a share buyback soon.

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.