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Pearson - US courseware a struggle, but some light elsewhere

Nicholas Hyett, Equity Analyst | 16 January 2020 | A A A
Pearson - US courseware a struggle, but some light elsewhere

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Pearson plc Ordinary 25p

Sell: 589.20 | Buy: 589.80 | Change 12.80 (2.22%)
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Full year sales look set to remain unchanged year-on-year, as progress in core and growth markets offset weakness in US courseware. Operating profits are expected to scrape in at the bottom end of guidance at around £590m. These trends are expected to continue in 2020.

Pearson will begin a £350m share buyback shortly, using the proceeds of the Penguin Random House sale.

The shares fell 9.4% in early trading.

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Our view

The imminent exit of Penguin Random House, CEO John Fallon and now CFO Coram Williams, marks the start of a new chapter in Pearson's simplification story.

While Pearson is now firmly focused on the education market, the transition towards e-learning and digital materials has been more difficult. The group's been packing away the textbooks for some time, but physical courseware remains a significant contributor to revenues and profits. Unfortunately demand for physical books has declined even quicker than expected, and that's left Pearson exposed to some unfavourable sales trends.

The pivot to Digital is gathering pace but it's not yet enough to offset the declines in physical courseware, particularly in the key North American region. Convincing customers to fork out for digital products is a challenge, and digital revenues are likely to be lower margin too. The battle for students is competitive, and Pearson's losing ground to traditional rivals as well as new free-to-use online content.

It's no surprise then that the overhaul is also focusing on costs. So far cost savings remain on track, but they can only go so far. Once that towel's been wrung dry Pearson will need digital revenues to start gushing.

A potential bright spot is that, in the past, economic downturns have tended to lead to spikes in demand for courseware. The recently unemployed look to upskill themselves and university student numbers boom. With global economic conditions looking fragile Pearson will be hoping we see a similar trend this time round - although an increasing focus on vocational over academic qualifications might temper that trend.

For now, the shares change hands for 11.6 times expected earnings, notably below the longer term average. There's a prospective yield of 3.3% too, but given the challenges ahead and change of CEO it's always possible that cash is redirected elsewhere.

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Third quarter trading update (26 September 2019)

Core markets saw revenue rise 5%, while Growth rose 4%. Areas of particular strength included the North American school business Connections (+6%), global Online Program Management (+10%), Professional Certification test centres (+10%) and Pearson Test of English (+17%).

However sales of US Higher Education Courseware fell 12%, as print revenues continued to decline. Pearson group also struggled with delivery issues following the adoption of a new Enterprise Resource Planning system. The digital: print split now stands at 63%:37%, with digital revenues growing modestly.

Pearson's simplification programme has delivered cost savings of £130m, with total annualised savings of £335m by the end of 2019. The group has agreed the sale of its remaining 25% stake in Penguin Random House for £530m.

Next year (2020), adjusted operating profits are expected to be between £500m and £580m, including the 25% stake in Penguin Random House. The 76% of total revenue that does not include US Higher Education Courseware is expected to sustain low single digit growth overall, while US Higher Education sales continue to struggle.

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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.