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Pearson - off the naughty step?

George Salmon | 27 July 2018 | A A A
Pearson - off the naughty step?

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Pearson plc Ordinary 25p

Sell: 874.20 | Buy: 874.60 | Change 1.60 (0.18%)
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Pearson's reported operating profit is an eye-catching £233m, well ahead of last year's figure. But a significant portion of that came from gains on the sale of assets.

After making adjustments, including for restructuring costs and exchange rates, that headline number falls to £107m, which still represents a 46% improvement on the equivalent figure last year.

The shares rose 3% on the news.

Pearson has declared an interim dividend of 5.5p, up from 5p last year.

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Our View

Digital 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.

The Economist and Financial Times are long gone, and a chunk of Penguin Random House 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 was the result of weak demand for traditional courseware 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. The dividend was sliced by two thirds from 52p to 17p at the full year stage with a prospective yield 2.3% next year.

Recent updates have brought more positive news. The US is still a tough market, but we're getting significant growth in the digital sphere. Competition from free online alternatives is said to be having less of an impact than the group had expected, and much less than sceptics had feared.

Nonetheless, we'd hesitate to say the shift to digital has been vindicated just yet. Not only does the group still need to prove it can establish itself in this new sector, it'll need to prove it can do so in a robustly profitable way.

The rewards could be great, but a few things need to go Pearson's way for those rewards to be realised.

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First half trading details

The dominant North American business saw underlying revenues rise 3%. Adjusted operating profit rose 49% to £64m.

While enrolments continued to drift down, which impacted gross sales of higher education courseware, lower returns meant on the group saw a net increase. New contracts helped Assessments generate modest growth, with revenues in the Services division, which runs online programmes in partnership with universities, also rising.

The Core business (which includes the UK and Australia) saw underlying revenues rise 2% as declines in courseware and assessment were more than offset by a rise in Services revenue. Profits remained flat at £10m.

Growth, Pearson's emerging market division, revenue fell 4% as declining sales in South Africa were only partially offset by improvements in China and Mexico. However, profits rose from £8m to £11m.

The remainder of group profit came from the group's remaining 22% stake in Penguin Random House.

Net debt has fallen from £1.6bn to £775m, as disposal proceeds and operating cash flows were only partially offset by the share buyback and divided payments.

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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.

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.