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Pearson - first quarter sales rise, strong increase online

Sophie Lund-Yates, Equity Analyst | 26 April 2021 | A A A
Pearson - first quarter sales rise, strong increase online

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Pearson plc Ordinary 25p

Sell: 589.20 | Buy: 589.80 | Change 12.80 (2.22%)
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Underlying revenue rose 5% in the first quarter, reflecting a 25% increase in Global Online Learning. There was also a 1% increase in North American Courseware, as the division benefited from increased funding and a sales shift to digital in Canada, which offset declines in the US.

Global Assessment fell 2% as US revenue was down "significantly", partly because of the reuse of materials from cancelled exams. The International division also fell 2%, as Covid impacted the courseware and franchise businesses in Latin America. There's been a slight improvement in Pearson Test of English volume and courseware recovery in China.

The group's paid £100m relating to a European Commission ruling about alleged state aid. Pearson expects to recover these funds "in due course".

Pearson continues to expect full year performance to be in-line with the outlook given in early March.

The shares rose 1.2% following the announcement.

View the latest Pearson share price and how to deal

Our view

First quarter results prove the pandemic has accelerated demand for digital learning and testing. Pearson's doing its utmost to make the most of the shift.

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 if Pearson can deliver the transition.

Virtual Schools and VUE Online Proctoring were particular beneficiaries of lockdown rules. While positive revenues suggest things are headed in the right direction, the work's not over yet. A 5% uplift in overall sales when online sales were up five times that amount highlights how much of the group's revenues are still anchored to physical teaching and testing. Demand for physical textbooks has been on the decline for years and that's made Pearson's pivot to digital protracted and painful.

Even where Pearson has been able to grow sales, profits haven't historically flowed smoothly. Huge investment in Global Online Learning means margins are only being propped up by the increased revenue. Those currently dipping their toes in online education for the first time could swim away when more traditional alternatives become available. That would hurt profits.

Overall the group's poured an enormous amount of cash into securing a new digital focussed future. And the sale of Penguin Random House saw the departure of a prized asset. Although it does mean net debt's drastically improved, providing a stronger foundation from which to propel growth.

That brings us to the new strategy. Focussing on direct-to-consumer business and slimming the group's physical footprint makes sense. We welcome the review of the international courseware business. All-in, it feels like digital transformation efforts have a new lease of life.

But that's not to say Pearson's report card is a straight-A situation. These ideas have merit, but that's very different to getting the job done on budget and in time. These plans mean yet more money is being poured into plugging the hole in revenues, and it's far too soon to know if the efforts will stem the flow long-term. Shaking up the corporate structure brings significant execution risk.

Essentially there are a lot of "what ifs". If Pearson can convince customers to stick with their digital shift as lockdowns ease, 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. Although the market doesn't seem to share our concerns, with a price to earnings ratio some way higher than the ten-year average.

Pearson key facts

  • Price/Earnings ratio: 22.5
  • 10 year average Price/Earnings ratio: 14.5
  • Prospective dividend yield (next 12 months): 2.5%

All ratios are sourced from Refinitiv. 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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Full year results (figures exclude the effect of exchange rates and portfolio changes) 8 March 2021

Sales fell 11% to £3.4bn for the full year, ignoring the impact of exchange rates and acquisitions and disposals. That reflects increased demand for Pearson's virtual tools during the pandemic, which was offset by declines elsewhere. Underlying operating profit fell 40% to £313m.

The group announced a new strategy, which will see it focus on direct-to-consumer business. The International Courseware division is under strategic review.

Pearson expects 2021 adjusted operating profit to be in line with current market expectations. A final dividend of 13.5p was announced, which matches the payment in 2019.

North American Courseware saw sales fall 13% to £894m, because of reduced secondary courseware sales in the pandemic. Cost savings failed to offset these declines and operating profit fell 20% to£190m.

Test centre closures meant overall testing volumes fell 22% in Global Assessment. This was despite strong increases in Online Proctoring and some recovery for Pearson VUE in the final quarter. Sales fell 14% to £892m, and operating profits were down 30% to £245m.

International was the weakest performer, with sales falling 19% to £914m. Operating profit fell 39% to £182m. Disruption to Australian immigration and test centre closures, and weaker courseware purchasing were named as major factors in the poor performance.

Global Online Learning was boosted by increased Virtual Schools enrolment and growth in its higher education Online Programme Management (OPM) business. As a result, this was the only division to grow, with sales rising 18% to £697m and operating profit up 23% to £99m.

Free cash flow rose to £229m from £213m, reflecting lower restructuring costs. Net debt, including leases, more than halved to £463m, and is now equivalent to 0.8 times cash profits. The reduction was thanks to the sale Penguin Random House (PRH), receipt of deferred proceeds from the US K12 sale, and repayment of the loan to PRH.

Pearson has no plans to restart the share buyback programme, which was paused in March 2020.

Strategy update

The new strategy will see the introduction of five new business divisions. These are:

Virtual Learning (Virtual Schools and OPM). Pearson believes there will be continued growth in virtual school learning in the US, post Covid. Virtual school revenue was £413m last year, up 29%.

Higher Education, which will include US Higher Education Courseware, Canadian Higher Education Courseware, International Higher Education Courseware. The group plans to "recapture the secondary market" in textbooks, and is launching a college study app in the autumn.

English Language Learning, made up of Pearson Test of English, Institutional Courseware and English Online Solutions. The group achieved "modest" revenue in this area in 2020, but believes it can build scale quickly with existing assets and capture a higher portion of the market.

Workforce Skills: BTEC, Pearson College and Apprenticeships

Assessment & Qualifications - this will house the Pearson VUE, US School Assessment, Clinical Assessment, UK GCSE and A level and International academic qualifications businesses. This area grew tenfold last year, boosted by remote and online proctoring.

All five divisions will sit within Pearson's new Direct to Consumer group.

Pearson will be reviewing the International Courseware business, and plans to significantly reduce its overall physical footprint. The reorganisation of the business structure will cost £40m - £70m in the current financial year. The resizing of the corporate office estate will result in costs of around £130m, and cash costs of about £10m. This should translate into recurring savings of £10m from 2022, and £20m a year thereafter.

Find out more about Pearson shares including how to invest

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 Refinitiv. 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.