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Pearson - digital sales soften pandemic blow

Nicholas Hyett, Equity Analyst | 14 October 2020 | A A A
Pearson - digital sales soften pandemic blow

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Pearson plc Ordinary 25p

Sell: 589.20 | Buy: 589.80 | Change 12.80 (2.22%)
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Pearson's total sales fell 14% in the first 9 months of the year. That's an improvement on where the group was at the half year stage (when sales were down 28%) and reflects a significant increase in demand for Global Online Learning and improving trends in Global Assessment.

Full year results are expected to be broadly in line with market expectations.

The shares rose 3.8% in early trading.

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Our view

The current crisis has shone a spotlight on Pearson. Digital learning has never been more in demand, yet the extra attention has also highlighted how much work the group has left to do.

Digital courseware sales are potentially highly cash generative and higher margin than physical sales, while digital subscribers are potentially stickier. That would represent a significant improvement to earnings quality and if Pearson can deliver the transition it would be a highly attractive proposition.

With schools and test centres shut, the need for digital alternatives has soared. Virtual Schools and VUE Online Proctoring are benefitting from that demand. Unfortunately, the fact that revenues have slumped 14% shows just how much of the group's revenues are still anchored to pen and paper teaching. Demand for physical textbooks has been on the decline for years and that's made Pearson's pivot to digital protracted and painful.

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 stay in the pool when more traditional alternatives become available.

The net result at the half year was 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.

A change at the helm at such a tough time would usually be a source of concern. However an experienced digital focussed leader is likely just what's needed right now. Still the new team will have their work cut out.

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 boost results in the second half.

While a new wave of lockdowns could be seen as bad news for Pearson the real test will come once the immediate crisis has passed. If the group can convince customers to stick with their digital shift 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 digital revolution.

Pearson key facts

  • Price/Earnings ratio: 15.1
  • 10 year average Price/earnings ratio: 14.2
  • Prospective yield: 3.5%

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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Third Quarter Trading Update

Global Online Learning sales accelerated dramatically in the third quarter, rising 32% year-on-year (6% in in Q1 and 3% in Q2). That reflects a 41% increase in enrolment in virtual schools for the 2020/21 academic year and strong sales of Online Program Management into the undergraduate and international markets.

Sales in Global Assessment fell 3% in the third quarter (-45% in Q2 and -3% in Q1). Pearson VUE testing centre volumes rose 8% in the third quarter, as the group increased its online proctoring volumes from 102,000 in 2019 to 1,352,000 in 2020. Physical test centres opened but faced reduced capacity due to social distancing requirements. School and Clinical testing continued to experience a modest negative impact from the pandemic.

North American Courseware sales fell 15% in the third quarter (-18% in Q2 and -10% in Q1). That reflects rapid decline in package and print product, partially offset by growth in digital and sales to not-for profit institutions to support inclusive access.

The International business saw sales fall 26% in Q3 (-31% in Q2 and -10% in Q1). That reflects disruption to Australian and Indian immigration processes, which drives significant demand for the Pearson Test of English (PTE) product. The division has also seen sales of School and Higher Education Courseware disrupted.

Pearson retain financial headroom of £1.6n through committed facilities and cash balances.

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This article is original Hargreaves Lansdown content, published by Hargreaves Lansdown. 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.