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Pearson - school and test centre closures to hit profits

Nicholas Hyett, Equity Analyst | 23 March 2020 | A A A
Pearson - school and test centre closures to hit profits

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Pearson plc Ordinary 25p

Sell: 589.20 | Buy: 589.80 | Change 12.80 (2.22%)
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Pearson has been hit by the closure of schools and its test centres in several key markets. This is expected to be offset to some degree by increased interest in the group's digital and online products - although to what extent remains unclear.

The group is looking to make further cost savings the impact of disruption on profits and has "paused" its share buyback.

The shares fell 8.3% in early trading.

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Our view

The coronavirus outbreak creates something of a mixed picture for Pearson.

The imminent closure of schools and testing centres is bad news for profits this year and the effect on cash flow has led the group to suspend its share buyback programme and look to cut costs.

Fortunately Pearson has relatively modest level of debt - although with profits under pressure leverage looks set to increase significantly - and access to a reasonable amount of cash. Management will hope that helps it ride out the storm, while pent up demand for exams spills into its testing centres once the crisis has passed supporting a recovery in the second half.

Nonetheless there's no getting away from the fact that the short term will be painful and the longer lockdowns last the more damaging they become.

However, longer term school and university closures could boost demand for the online and digital learning products Pearson have spent years shifting towards. It's not been an easy transition, and a widespread increase in uptake has the potential to transform the group's prospects. At present the group's offering many of its services free of charge to virus hit students, but whether schools are prepared to fork out when the crisis is over is a different question.

Given the uncertainty in the market it's far too early to make predictions about the groups prospects for the full year. Sustained lockdowns could see the impact leach into another academic year, which will impact on the group's highly seasonal sales, and the longer the lockdown lasts the closer the group will come to covenants. However, there is at least the potential for a strong recovery and so far there's been no mention of amending dividend plans - with analysts forecasting a prospective yield of 4.1%. As always though no dividend is guaranteed, a fact that's proving painfully true in the current market.

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Coronavirus update

The majority of the group's Pearson VUE test centres are closed until at least the middle of April. This is expected to affect operating profit by £25m-£35m, with a similar impact for each additional month of closures (partially offset by cost savings). The group did, however, note that pent up demand is likely to improve performance once test centres reopen.

Delays or cancellations of testing in the US already announced are likely to negatively impact operating profit by £15m, with potential for further cancellations to come.

There has been a strong increase in applications for the group's Global Online Learning products. This includes expansion of existing programmes and interest from areas which had not previously considered virtual schooling.

As well as operating efficiencies the group has said that it is exploring whether it qualifies for governmental relief in its key markets. At the end of February Pearson had around £1bn in liquidity through a combination of cash on hand and existing credit facilities. A net debt to cash profits (EBITDA) of 1.3 times at the end of 2019 gives it "significant headroom" against covenants.

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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.