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Pearson - some progress in digital, but profit plummets

Nicholas Hyett, Equity Analyst | 24 July 2020 | A A A
Pearson - some progress in digital, but profit plummets

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Pearson plc Ordinary 25p

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Underlying sales fell by 17% in the first half to £1.5bn, as modest growth in online learning failed to offset declines from the closure of schools, universities and test centres.

Pearson reported an underlying operating loss in the half of £23m, compared to a £144m profit last year. If conditions don't change dramatically, with schools opening as usual, then Pearson is on course to meet market expectations for the full year.

The group announced an interim dividend of 6.0p, the same as last year.

The shares fell 2.8% in early trading on the news.

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Our view

In some ways this quarter is a perfect illustration of all Pearson's recent problems.

The group's slow shift to digital education materials has been vindicated to some extent - as schools shut and demand for digital alternatives soars. Demand for physical textbooks has continued to decline for years, even setting lockdown aside. However, while Virtual Schools and VUE Online Proctoring are bright spots, the fact revenues have still fallen 17% shows just how much of the group's revenues are still anchored in pen and paper teaching.

To make matters worse, even where Pearson has been able to grow sales, profits have failed to follow suit. As things stand the cost of on-boarding new contracts and investing in new courses is far outweighing the extra sales in Global Online Learning. That might prove money well spent if customers hang around after lockdowns finish. But there's no guarantee those currently dipping their toes in online education for the first time will dive straight in when more traditional alternatives become available.

The net result is a huge free cash outflow, offset by a final bout of asset sales. While that's meant Pearson's been able to sustain its dividend in the first half, it also means the group continues to slowly devour itself as it pours cash into an uncertain digital future.

Fortunately Pearson has relatively modest level of debt - although with profits under pressure leverage looks set to increase significantly - and access to a substantial 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.

The current crisis could end up being make or break for Pearson. If the group can get customers to shift online and stick with it then all the pain of the last few years will have been worth it, if not the group risks becoming a lesson in how not to handle the looming digital revolution.

Pearson key facts

  • Forward Price/Earnings Ratio: 14.5
  • 10 year average forward Price/Earnings ratio: 14.2
  • Prospective yield: 3.5%

We've introduced this section in response to recent survey feedback.

Please remember yields are variable and not a reliable indicator of future income. Keep in mind key figures shouldn't be looked at on their own - it's important to understand the big picture.

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Half Year Results

North American Courseware underlying sales fell 14% to £375m, with operating profits down 11% to £36m. This was generally a continuation of trends seen last year, with some modest impact from the closure of campus book shops in the US and to a greater extent in Canada. The division saw some shift towards online and digital products during the half.

Sales in Global Assessment fell 27% to £397m, with operating profits down 61% to £71m. The division struggled with the cancellation of testing in the US and closure of Pearson VUE centres. However, VUE Online Proctoring saw a significant increase in demand, with tests up from 66,000 to 580,000.

Underlying International revenue sales fell 23% to £404m, with operating profit down 60% to £46m. This reflects the closure of schools and test centres across UK, APAC, Continental Europe, Latin America, China and India, and Middle East and Africa as well as declines in the Pearson Test of English.

Global Online Learning was the one division to show growth, with sales up 5% to £316m, although profits declined 41% to £24m. The decline in profits reflects increased investment in new programmes and the cost of enrolling new students (with a 61% increase in students applying for virtual schools).

The group has identified a further £50m of cost efficiencies, expected to be realised in 2021.

Pearson reported negative free cash flow in the half of £251m. Disposals of the group's K12 courseware in the US and the remaining stake in Penguin Random House meant overall net debt fell slightly to £982m. The group has approximately £1.6bn of cash available from cash on hand and its credit facilities.

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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 original HL content, published by HL.

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