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Pearson - on track to meet expectations

Sophie Lund-Yates, Equity Analyst | 30 July 2021 | A A A
Pearson - on track to meet expectations

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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 17% to £1.6bn in the first half, with growth in online services and a recovery in in-person testing following last year's closures and exam cancellations. Underlying operating profit of £127m was recorded, compared to the £23m loss this time last year.

For the second half Pearson still expects flat virtual learning revenue as virtual school enrolments also stay flat, and for higher education sales to decline as expected. Full year underlying operating profit is thought to match market predictions.

The shares rose 1% following the announcement.

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Our view

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. We're particularly encouraged to see online revenues driving a larger portion of the whole. These rose 25% when the group total was up 17% - which means the gap is closing. A step in the right direction, but 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. 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: 22.6
  • 10 year average Price/Earnings ratio: 14.7
  • Prospective dividend yield (next 12 months): 2.4%

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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Half year results (figures are underlying)

Global Online Learning revenue was up 25% to £355m, as there was strong growth in Virtual Schools following high enrolment levels. Higher sales offset increased investment meaning operating profit rose 129% to £48m. Global Assessment benefited from easier comparisons after last year's test centre closures, so revenue rose 34% to £480m. Pearson Vue centres did particularly well, and operating profit rose 131% to £147m.

US Higher Education Courseware continues to decline, although this was offset by stronger Canadian sales in the half. Overall, North American Courseware sales rose 2% to £346m, and operating profits were up 33% to £43m. Pearson has launched a subscription-model new college learning app, Pearson+.

The reopening of schools, bookstores and test centres helped International revenues, which rose 8% to £416m, and operating profits were up almost 50% at £72m. Performance is still being held back in some markets were social restriction measures are still in place.

Underlying operating margins are now 8.0%, compared to -1.5% this time last year. Despite the improved profitability, there was still a free cash outflow of £151m, including restructuring costs and taxes. This is an improvement on last year's £251m outflow.

Net debt stood at £646m, down from £982m at the same time in 2020.

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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 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.