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Pearson - cost savings better, but revenue trends worse

George Salmon | 16 January 2019 | A A A
Pearson - cost savings better, but revenue trends worse

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Pearson plc Ordinary 25p

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Pearson has confirmed it's set to deliver adjusted operating profit of £540-£545m, around the central point of previous guidance.

However, that's driven by higher cost savings, rather than an improved operating performance. Underlying group revenue is down 1%.

The shares fell 4% on the news.

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Our view

Digital is replacing paper the world over, and Pearson believes that will be the case in education too.

With this in mind, the group is transforming itself from staid publishing house to trailblazer in the emerging world of digital education content.

The benefits are obvious. An online subscription model would bring attractive recurring revenues, no longer needing to produce a physical product reduces costs, and the requirement for customers to have a unique username and password restricts the second-hand market.

As part of the restructure, Pearson's publishing assets like The Economist and Financial Times have been sold, and a chunk of Penguin Random House recently followed them out the door.

While sharpening the group's focus on education, the sales also removed the safety net should market conditions turn. Unfortunately, that's exactly what happened. Unprecedented declines in the American higher education market forced the dividend to be slashed.

So where does that leave investors now? Well, net debt is expected to be under a third of cash profits this year, so the rebased payment looks sustainable. But with a prospective yield of just 2.2%, Pearson will need to prove it can meaningfully grow, not just maintain, the dividend.

Recent updates have brought some positive news. The US remains a tough market, but we're getting 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.

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 it to emerge a leaner and more profitable organisation.

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Full year trading update

North American revenue declined 1% over the year, as rising digital sales were offset by courseware declines of 5% .That drop is at the high end of the 'flat to mid-single digit' percentage decline the group had expected.

In the Core business, which includes the UK, Australia and Italy, revenues were flat. Growth was 2% up to the end of Q3, so this represents a weak fourth quarter, something Pearson had alluded to by flagging weak trends in UK Student Assessment and Qualifications.

Growth markets delivered a stronger than expected performance. Underlying sales rose 1% over 2018, despite the negative momentum earlier in the year.

Pearson's cost efficiency programme is ahead of plan, with incremental cost savings predicted to be £130m and restructuring costs £100m. The group now expects to deliver in excess of £330m of total annual savings by the end of 2019, up from the original £300m target.

Pearson says it finished the year with a net debt position of around £200m, down from £432m last year.

2019 adjusted operating profit is expected to be between £590m to £640m, although another sales decline in US higher education courseware is expected.

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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. 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.